Income Tax Savings via Tax Alpha

In the world of investing, the quest for "alpha" is the primary goal for investment managers. Delivering investment alpha means obtaining investment returns that are better than their benchmarks. So, alpha measures the difference between a portfolio's actual return and what was expected based on its market risk. It is the ability to obtain returns higher than deserved by engaging in value-adding market timing or security selection. The problem with investment alpha is that while it is real, it has never been proven to be achieved as the result of skill.

However, unlike investment alpha, tax alpha is not elusive or hard to identify. Instead it can be quantified in dollars and cents and ends up as money in the bank. Tax alpha is the garnering of tax savings  beyond the tax liability you would have otherwise paid.

Let me give you a quick example of tax alpha realized for a client, Mr. Banks (not his real name), earlier this year.  Mr. Banks retired and as part of his retirement package, he received a lump sum distribution from a non-qualified retirement plan.  Transitioning into retirement always requires a major change in the amount and method of making tax payments/withholding. As part of our proactive tax-planning services, we calculate our clients anticipated tax liabilities and compare this to their tax withholding to see if any changes (such as making quarterly tax payments) are needed.  In order to calculate this for Mr. Banks, we asked him for his last pay stub showing the non-qualified deferred compensation payout. Upon reviewing this pay stub, I noticed that $3,000 worth of Social Security and Medicare taxes were withheld, BUT SHOULD NOT HAVE BEEN.  If we had not identified this, the IRS (and not the client) would have kept the $3,000.

This is just one example of how proactive tax planning generates tax alpha. 

Tax alpha is generally not generated by CPA's or tax preparers for individuals because these professionals spend most of their time preparing returns after the tax year is complete and not proactively managing their clients' tax liability/withholding.