During the 1970s, when it was still possible for American citizens to be in a marginal income tax bracket that devoured 70% of their highest earnings, the CEO of a major corporation was playing golf with friends. His drive off the first tee hooked sharply out of bounds. Instead of continuing play with a new ball, this wealthy and successful individual spent 10 minutes poking through the underbrush at the edge of the course searching for the missing ball. His golf partner asked why a person whose time was so valuable would waste it looking for a $2 golf ball. “It might be a $2 ball to you,” the CEO replied as he plucked the ball from a hedge, “but it’s a $6.67 ball to me.”

As a business person, the CEO understood the effect of taxes on the outcome of his decisions. In the case of his golf ball, he knew that to have $2 to buy a golf ball after taxes, he would have to earn $6.67 before taxes. Since he was in the 70% tax bracket, only 30% of his last earnings would be available for consumption. Here is how we can determine his pretax cost of a $2 golf ball:

This story underscores how taxes have an impact on our decisions, even fairly mundane decisions. Taxes influence ordinary business decisions, investment decisions, and even the value of the common golf ball.

As an investment professional, how familiar are you with the language and concepts of taxation? In helping clients to meet their financial goals with respect to college tuition, retirement, or just building net worth, do you discuss or explain the tax consequences impact of investment decisions and/or actions?

First, a caution. This module is in no way a complete discussion of the U.S. system of income taxation, nor does it offer exhaustive discussion of any one subject. Federal income tax law is intensely complex, occupying thousands of pages of statutes, regulations, and court rulings. It is not a logical system like mathematics; it is more like the English language-a changing system that contains a limited number of grammatical rules but an even larger body of idiomatic expressions, strange spellings, and puzzling exceptions to the rules.

Nothing in the typical training or experience of the investment professional or in this module can be construed as a basis to render professional tax advice; the client should seek such advice from certified tax professionals. Nevertheless, the impact of taxation in the realms of business and investments is so fundamental that the investment professional would be remiss in not discussing taxes with clients or in acting as if taxation did not matter. Thus, this module concentrates on the typical tax questions facing the investment professional and the impact of those taxes on investment decisions.

Author: Jennifer Coombs

Jennifer Coombs is an associate professor at the College for Financial Planning. Prior to joining the College, Jennifer spent a decade working in the financial services industry in New York City, with a special focus on equity research and analysis. She holds a Bachelor of Science degree in Finance and Political Science from Clarkson University. You can contact Jennifer at jennifer.coombs@cffp.edu.

Complexity Level: Intermediate