What You Should Know About Tax Advantaged Investments

Last Updated (Tuesday, 07 October 2008)

People often misinterpret the meaning of tax advantaged investments.  Some are concerned that tax advantaged investments indicate a strategy that is devious or unlawful.  What you need to understand is that the only money you will ever have to spend, lose or invest is what the government allows you to keep.  Many taxpayers do not realize that they do have a choice as to whether they will pay a small or large amount of income tax.  Why pay the IRS investable funds you are allowed to keep?

Tax advantaged investments are not “loopholes” in the Tax Law that the IRS is out to close up.  They are not morally wrong, as some would have you believe.  A common fallacy is to confuse tax evasion with tax avoidance.  Tax evasion is illegal and punishable.  Tax avoidance, however, is legal and is encouraged by the lawmakers.  The United States Congress promotes the shifting of funds from the taxable sectors of the economy to areas of public need or good by passing laws which create tax deferred; tax sheltered and even tax free investments.

Many, uninformed of the nature of the tax advantaged investments, would have you believe that you are “robbing” the economy of tax dollars by not giving your taxes to the government to spend in their great wisdom.  Such advocates are ignorant of the fact that tax advantaged investments are put into housing, energy, food, strategic metals, research and development, medical needs and transportation.  These tax advantaged investments are actually a boon to the economy.

Rather than being filtered through bureaucratic mazes to the economy, these otherwise diverted tax dollars are being applied directly to where there is a need - creating new jobs, expanding specific industries and adding to the growth of the country.  The famous jurist, Judge Learned Hand, remarked that, "There is nothing sinister in so arranging one's affairs as to keep taxes as low as possible."

In another famous quote, Judge Hand wrote: "Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes" Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934).

It is important to note that understanding tax advantaged investments should be a prerequisite to becoming involved in them.  Many tax advantaged investments carry only minimal risk to the investor.  Allocating funds into municipal bonds, life insurance, IRAs, etc. can provide excellent tax incentives.

On the other hand, some tax advantaged investments, such as oil and gas limited partnerships or real estate limited partnerships, can be and often are risky (note: this is not a comprehensive list of risky tax advantaged investments).  Although there is the possibility of substantial returns with such endeavors, many have and many will continue to chance the loss of their investment.  Yet when compared with the alternative, a 100% chance of loss when paying tax, such investments can look quite attractive to some investors.  After all, which investment will offer the greater possibility of providing you income in your golden years or at any other time?

Individuals also need to remember that Congress has passed tax incentives because such investments are risky.  Tax advantages are provided to encourage investing in high-risk areas that further the social good of the country.

Being involved with a tax advantage investment requires a proper frame of mind.  Peace of mind is what you have to lose if you are uncomfortable with such an investment.  Tax advantaged investments can be complex -- particularly with the ever-changing tax laws.  Working with a knowledgeable and licensed investment advisor will help you avoid many of the pitfalls and help you keep more of your hard-earned dollars from taking a one-way trip to the IRS.

Brock and Associates, LLC is a fee-based financial planning firm that specializes in retirement, estate, and tax planning.  For more information regarding tax planning strategies, please contact our office.