Any sophisticated tax strategy needs at least one thing to be successful: an implementation plan. While you may have a clear vision in mind for how things will unfold, if the taxpayer isn’t on the same page as you, the strategy will fall flat. Part of how you can contribute your expertise is by emphasizing the importance of assigning specific people to each step—even if that means hiring outside help—and creating a timeline for meeting deadlines.
This is especially true when you are looking to implement a complex strategy that requires you to file special paperwork or create new accounts and entities. One example is the tax strategy known as income shifting. This involves transferring assets from taxpayers in a higher tax bracket to those in a lower tax bracket in order to reduce the overall tax burden. A common example is shifting unearned investment income from a parent to a child through a trust or as a gift. Another method known as tax inversion involves shifting income from a high-tax to a low-tax jurisdiction.
If you are proposing income shifting as part of your client’s tax strategy, a detailed implementation plan is essential. Review the seven phases below to guide you in creating your own plan:
1. Strategy
The first step is always to conduct a thorough evaluation of the taxpayer’s financial situation and develop a strategy. One mistake tax planners often make is defaulting to “pet strategies” that tend to be money-savers without considering whether that specific approach actually makes sense for that particular client. Start by defining your objective. What is income shifting meant to accomplish for this client? What is the estimated boost to their tax savings? Are there any possible side effects of using this strategy—for instance, could the income shift prevent you from implementing another profitable tax strategy? Make sure income shifting is achieving the right objectives for the taxpayer in question before proposing it.
2. Contracts
The next step is to establish contracts, particularly if you have multiple entities doing business with each other. Keep in mind the “arm’s length” doctrine: transactions between related parties should be conducted similarly to transactions between unrelated parties. In the same way that a taxpayer couldn’t walk into a local business where they don’t know anyone and ask for a loan, they should not transfer assets between two businesses they own without proper documentation. If your client is hiring a family member, they need to keep timesheets. Be sure to set up official contracts and actual records to create a legitimate paper trail for this process.
Similarly, the taxpayer could not go to an unrelated business and sell them a service for much less than they paid for it. The agreement you put together should reflect fair market value, and if assets are being sold, they will need to create invoices as they would for any other customer.
3. Record Keeping
In line with the above, record keeping is essential to the implementation process. Guide the taxpayer in identifying the necessary documentation for timesheets, invoicing, prorating, allocating expenses, and conducting valuations and using comparables. For example, if the taxpayer plans to hire their child to work at their restaurant, how did they determine a fair market value wage for bussing tables? Any financial decisions should have corresponding records.
Other possible records include a note amortization schedule—if regular payments will need to be made between entities—and rental agreements if real properties are involved. For instance, if the taxpayer owns a commercial property personally and their business occupies it, they need an officially signed lease that states how much the business entity will pay on a regular basis. You will typically want to advise that the taxpayer hire an attorney to create that lease agreement and any other contracts between companies. A good rule of thumb is to have an attorney draft any contracts involving third parties that are not related.
4. Bank Accounts
Again, remember that all business transactions should mirror what would happen between completely unrelated parties. So if your client is hiring a family member or creating a new entity in the course of income shifting, they will need to establish a separate bank account.
5. Accounting Responsibility
Once we have established record keeping and the process that needs to happen going forward, we need to make sure that we are clarifying responsibilities. Assign specific people—whether that is the taxpayer themselves, a member of their business team, or an outside vendor—to own each task. Make a checklist of every ongoing payment or official documentation needed to maintain a legitimate paper trail, so you are certain that someone has agreed to be responsible for each one.
6. Transferring Ownership
If a specific asset is involved, now is the time to transfer ownership. If you are moving a property from the main entity to the individual owner, you might have to treat it as a distribution, depending on the entity type, and you may need to establish the fair market value at that time. You might also recommend creating a quitclaim deed, which releases the owner’s interest in the property without stating the nature of their interest or rights to the property.
Similarly, if income shifting involves hiring a family member or another ongoing arrangement, make sure all the documentation is in place and set the official start date.
7. Monitor and Review
Finally, we enter into the monitor and review stage where the main task is to check in on everyone who has been assigned an ongoing responsibility to make sure everything is getting done. This is also the perfect time to tweak things. This way, you are not noticing needed changes and making adjustments during tax season when you are also trying to meet compliance deadlines. Work with your Certified Tax Planner to come up with a cadence for regularly reviewing the tax strategy implementation plan and revising it as needed.
Summary
Though income shifting is a sophisticated tax strategy, it does not have to be complicated. By taking the time to understand the taxpayer’s objectives, identify the steps needed, and clearly assign a person and deadline to each task, you can use this strategy to accomplish major tax savings for your client. High-income individuals and business owners in particular stand to benefit from income shifting, and once they see the impact your strategic expertise can make, they can become loyal clients who yield consistent and profitable business for you in the future.
For additional training on how to implement income shifting and similar sophisticated tax strategies, sign up to become a Certified Tax Planner today.
