Looming tax bill adding to your winter blues?
This is the time of year when clients engage with us to discuss options for paying their April tax bills. Often, clients opt to use cash from their investment accounts or deplete cash reserves. But what if there was another way to pay the tax bill without disrupting an investment strategy?
Borrowing to pay taxes may be a cost-effective way to meet tax obligations while keeping cash and investments intact for continued long-term growth. The advantages of borrowing are greater when there is a large, event-driven tax bill, such as a sizable nonrecurring capital gain from the sale of a business or the appreciation of such, as real estate or stock -- the sale of which could be subject to additional taxation. Some clients opt to set up an installment loan with the IRS or explore qualification for a personal loan with lower interest charges and fees.
One option to consider is a securities-based line of credit. This type of credit offers a cost-effective, straightforward way to pay a large tax bill while also providing additional flexibility, such as access to liquidity year-round. This solution may not be available or applicable to everyone, as it is not without risk. Pledging securities may result in a margin call that could require additional capital contributions be made or result in the sale of securities. However, for qualified applicants, a securities-based line of credit can provide alternative solutions, such as:
• Offering a flexible option for managing large expected or unexpected expenses;
• Involving simple implementation with no setup cost;
• Creating no disruption to an investment portfolio/strategy or long-term asset allocation;
• Eliminating the risk of selling out of the market at the wrong time;
• Limiting potential large capital gains tax liability;
• Providing time for more thoughtful tax planning, strategic asset planning;
• Allowing investments to continue to compound based on higher portfolio value;
• Extending the ability to borrow at low rate of interest;
• Maintaining interest-only payments to keep monthly obligation low; and
• Drawing sources of principal repayment from events such as an annual bonus or planned tax harvesting.
Beyond tax season, establishing a securities-based line of credit can meet a variety of needs, including taking advantage of investment opportunities, e.g., private equity, business investments or funding a philanthropic or estate planning strategy. With interest rates at historic lows, a line of credit can also provide liquidity when buying a new home before selling a residence, for new home construction or Renovation Bridge financing, or for financing the cost of continued care facilities for a loved one.
If a securities-based line of credit is not an option, consider funding an upcoming tax bill with cash -- an easy and straightforward solution. However, diminishing cash reserves can impact interest earnings and limit future flexibility. Liquidating an asset can also provide funds for meeting tax obligations, though access to proceeds from the sale may not be immediate and may trigger unfavorable tax consequences such as capital gains tax.
Upcoming tax obligations do not have to disrupt investment strategies or deplete cash reserves. While borrowing or using a line of credit to fund a tax bill may not be suitable for every individual, it does offer a myriad benefits for others. The best way to discern what options are available is to schedule a discussion with a financial adviser to help to determine the best approach.
• Erica Duncan is regional private banking manager for PNC Wealth Management.