014 | Strategic Tax Planning, Cashflow Management, and Effective Wealth-Building: Listener Q&A

Episode 014 – Strategic Tax Planning, Cashflow Management, and Effective Wealth-Building: Listener Q&A

Welcome to the Vital Strategies Podcast, your go-to resource for paying less tax, building more wealth, so you can live a great life. Today on the podcast, we’re going to be answering listeners’ questions around tax planning, how to manage cash flow, and digging into wealth building and financial freedom.

If you want us to answer your questions on future episodes, feel free to go to vitalstrategies.com/questions and submit your questions there. Make sure you listen to the end as we walk through how to get the tax bill to zero, why that may be a bad idea and how to build wealth outside of your business.

I’m your host, Patrick. Lonergan. Let’s get started answering some questions.

We’re going to start off with tax. Sophia says, I’m thirty-five, and my online boutique success has pushed my personal income to $500,000.

Sophia, congratulations. That’s great.

As a single mother, I’m looking for smart investment advice to secure my daughter’s future. What strategies do you recommend for solo entrepreneurs?

Now I think this is a great question and I think we should start with one of the best things you can do is find a way to get your daughter involved in your business, have her helping you with bookkeeping, fulfilling orders, working on your social media account, and getting her on the payroll. Now that does a few things for her.

You can effectively move dollars from your top tax bracket into the 0% bracket for her, and she can invest in things like a Roth IRA. Now, Roth IRA grows tax free forever, which we think is a fantastic tool if we have one place to put money. We would pick the Roth IRA because of the tax nature, you just never pay tax on the gains.

Another strategy would be to fund her 529 plan that could set her up to not have any debt coming out of college. And then if she doesn’t use all those dollars, she can almost overfund it because they can convert to Roth IRA when she’s done, if they don’t get used. Then finally I would say fund a brokerage account.

That would be a great strategy to also help set her up for long-term financial success. I think there’s also nuance to this question that maybe is outside of the, we’ll call it blocking and tackling of the investment and tax strategy, and I think if we’re trying to set your daughter up for success, there’s a level of financial wisdom you could impart on her.

You can help her understand spending less than you make matters. Letting those dollars compound over time versus spending them on a new fancy car or something like that, that depreciates, and then getting her involved in your business and really truly understanding what it takes to generate profit in a business is a really valuable skill.

That’s probably more valuable than anything you could do from an investment account for her. So I think the more you can get her plugged in, have her understand balance sheet, profit and loss statements, the relationships that you’ve built in your business, those are very valuable pieces, but you can also set her up for success doing some of those investment pieces as well.

Again, funding the Roth IRA a A five-twenty-nine plan, and the brokerage account, she can fund all of those herself if you’re running those wages through the business for her. So. We think those are great strategies to set her up long term.

Alright, our next question is from Alex. After selling my software company and now building our consulting practice, my taxable income hit $2 million this year.

Congratulations, Alex.

My CPA seems to be in over their head. Could you share tax-saving strategies for tech consultants like me?

Yes, we have a number of strategies that I think could apply. We’re always going to start with our level one strategies. The opportunities there are really good administration and bookkeeping.

We think some that make sense are doing things like making sure you’re maximizing home office deduction, Augusta rule. If you’re getting your kids on payroll, that’s fantastic. And then another one that is often missed with consulting, and I think it depends on the type of work you’re doing, but there could be an opportunity for the QBI deduction.

Again, there are limitations with specified service trade, and businesses and consulting can fall into that category. So. Financial advisors, attorneys, consultants, they miss out on that opportunity. But we’ve seen opportunities where consultants have sort of different parts of their business. For example, we had a consultant that did marketing services.

Those were not SSTB. And people could pay for those outside of the consulting services. And so we had them really break it up into two separate entities. We think that makes a lot of sense and can help you maximize the qualified business income deduction by doing that. And it could save you hundreds of thousands of dollars in taxes depending on how much revenue goes over there.

Then we start moving into level two and level three tax strategies, and we think maximizing retirement plans, the episode we did with Bruce Gendein on cash balance plans could be a great opportunity to get a lot of dollars into retirement plan that moves the dollars from the tax bill today to the retirement plan.

And we need to have a strategy for how to minimize that on the backend. We’ve got some, I think, interesting conversations coming up in the podcast that will help us with that, but I would say that would probably be the next thing we would look at. And then depending on how much free cash flow you have, we could start looking at possibly level three strategies that we could also take advantage of there.

So. Again, great question. If your CPA is over their, your, their head with your tax strategy, that’s not uncommon. Oftentimes, CPAs, we need to understand that their business model is really filing the compliance, just getting the tax return into the IRS. In a way that is compliant. Their business model’s not designed to be tax strategist.

So I think the goal would be to find somebody that can help you with tax strategy. You know, again, we’re taking on new clients. You can check us out at vitalstrategies.com/client just to see if it’d be a fit for us to work together. But I think having a real strategy, figuring out how to get proactive instead of reactive, would be a key piece.

Tom. Tom’s, an orthopedic surgeon, and he says, I hate paying taxes. How do I get my taxable income to zero? Tom, we love this question. I feel you. I don’t like paying taxes. I think I’d be a little better with paying taxes if I felt like the government used it well, but I feel like a dollar goes into the system and the bureaucracy eats at most of it, and then a nickel trickles out to the wrong people.

So I’m sympathetic there, but I’m going argue I don’t think it makes a lot of sense to get your taxable income to zero. But I think this is a good thought exercise, so we’re going look at some different opportunities to do that. The reason why I don’t think it makes a lot of sense is because the marginal brackets, if we reduce it down, we skipped out on paying tax at the 10%, the 12%, the 22%, the 24%, and it may make sense to actually pay tax in those brackets because reducing it to zero, we may not have the opportunity to reduce it down the road.

So we stopped paying it 10%, but we’re now paying it at 37% later. So, I don’t always love getting it to zero. If I had a preference, I would get it below the thirty-two percent bracket into the twenty-four. That’s where I would probably take it down to. But with that being said, let’s look at a couple ways to get it to zero.

So Tom, I’m going make some assumptions about your life and I’m going put a few different scenarios in play to get the tax bill to zero. And I’d also like to just start off and say, we’re almost always going to pay tax on the dollar that we’re spending on our lifestyle. So. If you’re spending $30,000 a month on lifestyle, that’s $360,000 a year, it’s really hard to get the taxable income below $360,00 just because we’re consuming most of that and those dollars can’t be diverted to tax planning.

With that being said, I think the first opportunity that we could utilize to get the tax bill to zero or close to it would be start investing in real estate. Tom, I’m going have you be married and I’m going have your spouse be a real estate professional. Okay. That allows us to accelerate a bunch of depreciation using strategy called cost segregation study, and then as a real estate professional, you can offset those what are typically passive losses.

They now become active losses and can offset your income as an orthopedic surgeon, I. If we owned enough real estate and were able to accelerate enough loss, that would be one strategy that we could potentially get the taxable income to zero. There might be some payroll tax, depending on the structure and how you get your wage that we may not be able to get it to zero, but we could get the income tax to zero.

The next move would be move to Puerto. Rico. Again, I do not love the strategy of moving you and your family to places just to pay less tax. Now we’ve seen clients do it. We’ve had clients move from New Jersey. It made sense for them to move to Florida and be closer to family, and that move made a lot of sense for tax purposes.

We’ve also seen clients move from California to Texas. They were effectively over 50% income tax rate and were able to move down to 37% rate. Effectively that gap in the taxes paid for the mortgage payment on their house. So that move made a lot of sense. So a move to Puerto Rico, Puerto Rico has no income tax, but you have to be physically present in Puerto Rico for at least a hundred eighty-three days during the taxable year.

Now, you can’t have a tax home outside of Puerto Rico during the tax year, and you can’t have a closer connection to the United States or other foreign country than Puerto Rico. You need to meet those three requirements to be able to line up in the 0% tax bracket. So that could be, again, a long-term strategy that works.

The real estate strategy could also be a long-term strategy if you kept acquiring real estate, that could keep offsetting your income. But there are some one-off strategies that we could look at. The first one would be, we’re trying to get an episode on this. It’s been rescheduled a few times, but I think we’re going get it done.

The film tax credit. Film tax credit can wipe out almost all of your income. We think tax credits are the best. They’re better than, than deductions. If I have a hundred thousand dollars tax credit and a hundred thousand dollars tax bill, it wipes it out, so that’s fantastic. The problem with that is it’s not really an ongoing strategy that allows us to minimize the tax bill.

So, film tax credit can be good. It can also fit into the wealth building category if that film does really well, and they’re generally. Name brand films with name brand actors that you’re familiar with. But yes, those are some ideas on how to get the tax bill to zero. Tom, I appreciate the sentiment of doing that, but I don’t know if that makes great financial sense long term.

And then we might be hard pressed to get the payroll tax to zero if our income isn’t structured properly. But those are just a few ideas on how to do that.

Our next question is from Jasmine. She’s a film producer and she says, my independent film projects have finally paid off, and I was able to take home about $800,000 last year.

However, I’m struggling with what I consider a huge tax bill that my CPA is telling me to pay. What specific advice can you give creatives around their taxes?

This is interesting, and we’ve got clients that are filmmakers, and I think the challenge for creatives is their swings in income can be dramatic.

If a film does really well, income can be really high. If there’s some misses out there that don’t take hold, like the revenue can be off dramatically. So when we think about this, there’s a few different things that we want to do. We want to make sure that, again, we’re doing all the level one tax planning, making sure all those good administration and bookkeeping pieces are in place.

And the QBI deduction is a fantastic opportunity. The thing that needs to be paid close attention to is just the wage that you’re taking out of the business. because the QBI deduction, the qualified business income deduction is the lesser of two numbers. It’s the lesser of 50% of your wages or 20% of net income.

When you’re one of the only employees, or if you’ve got a small number of employees, you can start changing your wage and every dollar in wage brings the net income number down. So in that scenario, you can really dial into that deduction to make sure that you’re maximizing it. But it’s one of those things, if you’re income is varying from year to year, you have to make some changes in that wage and it takes some attention.

So that’s something you have to get done before December 31st, or there’s going to be a problem. Then once we do that, I think when we start looking at level two and level three tax planning, there’s some things we want to avoid. We really want to avoid strategies that have consistent multi-year commitments because they can be really hard to fund if our income is variable.

Now the only caveat to that is if we’re able to put away enough dollars to fund those for let’s say three to five years, I don’t necessarily mind using those strategies, but we’re going to want to build in some flexibility to our level two and three tax planning to make sure that if our income gets cut in half next year, that we’ve got a strategy to be able to either fund that plan or stop funding it to make sure that we’re not creating more problems than we were avoiding with that strategy. So, I think the answer to your question is, again, creating some flexibility inside of your planning and then really having somebody take a look at it that can design something that works well for both your personal and professional goals.

That concludes our answers for our questions on tax planning. Next, we’re going to look at some questions around cashflow.

Our first question is from Alex. I’ve been investing business profits into other business opportunities. I have a good eye and can spot opportunities and good operators.

Good for you, Alex.

I found out the hard way this year that those investments weren’t tax deductible. And that’s true when we invest in a business that has a capital contribution and there’s no real tax deduction generally associated with that. So, what it does is we’re putting dollars into an illiquid investment and we can’t get them back.

So continuing Alex’s question. Because our business grew 20% year over year. Our tax bill also grew, and I didn’t plan for that. Now, I don’t have any cash to pay the IRS. What do I do?

All right, Alex, I’m sorry to hear this. I don’t love that we’re behind on paying the IRS, so I don’t know your entire situation, but there are some strategies you can execute in 2024, that will give you a deduction in 23. I don’t know what you have set up for a retirement plan, but you could execute on a SEP IRA if you have one. The SEP could be funded all the way up until the filing deadline for your entity. You could have all the way up to September to fund that strategy.

If we need more deduction than that and we have the cash to do it. A cash balance plan can also be funded up until the filing deadline. So SEP IRA cash balance plan, those two could be strategies that we could go ahead and fund. Even profit sharing could fit into that mix. So those are things we could take a deduction for 23 that we could fund in 24.

Let’s say the revenues aren’t showing up in 24 to be able to fund that strategy, I would say the next thing to do would be you can work out a payment plan With the IRS, our strategy is always to be proactive versus reactive with the IRS and the tax bill, this even goes for, this is a little bit of a aside.

If people just haven’t filed returns, it makes sense to get those returns filed and then just be in touch with the IRS and start putting together a strategy to pay those back taxes. because ignoring it doesn’t make it go away. And when I think about the federal government and owing them money, I don’t like that idea.

They have a lot of control over me. They can seize assets, they can put liens on property, they can take bank accounts. None of those things are anything that I like. So if the tax bill is less than $50,000, you can set up a payment plan. And there’s a couple different ways to set those plans up. We’ve helped clients do that in the past, but that would be the strategy there.

So Alex, good luck with that and I hope it works out.

Next is our question from Michael. Again, we’re talking about cashflow and he says, I’m a real estate investor in the Santa Fe area. I don’t pay a lot of taxes because of the depreciation from the investment properties. The problem that I am regularly running into is my lack of liquidity, because I’m always finding new deals.

I’ve had to tell my wife not to buy groceries earlier in the year because we were that tight on cash. How do I find new sources of liquidity to be able to buy groceries?

Michael, I can absolutely appreciate this question and one of the reasons I picked this was I’ve been in the exact same boat. We own a lot of real estate.

When we were first getting started, there was always an opportunity and there was always something we could put our money into, and I think we can absolutely look at some strategies to create some liquidity. The first would be setting up some lines of credit. Not sure how much equity you have in property, but lines of credit can be a fantastic liquidity tool that you have cash sort of flow in and out of.

I think they’re equivalent to a high-interest savings. We’ve used lines of credit on property to be able to go into other deals, refinance those, and then when the dollars come back we, we pay off the line of credit. So I think lines of credit are great. We’ve also seen some of our real estate friends, partners that don’t manage liquidity well.

And there’s some thinking that, oh, when I make more money, I won’t have a liquidity problem. No. We’ve seen investors that will sell out of a project, have a $20 million payday, and within a few months or a few years, they are in a liquidity crunch because they’ve got all of those dollars allocated to new deals.

So, I think there’s a mindset shift that needs to take place where we start thinking about our liquidity. We’re really paying attention to minimums and maximums from just the cash on hand perspective. Especially as our debt grows, we have to have liquidity in place because we can run ourselves into a situation where we’re filing bankruptcy just because we don’t have the cash to sort of service the debt.

And that’s a, that’s a terrible spot to be. Again, I’ve sort of been there and I’m speaking from experience on this side of things, so I think having some minimum and maximum thresholds, anything below the minimum is danger zone, and you do everything in your power to avoid that. And what that does is it just allows you to be more particular on deals or negotiate from a position of power.

Like if I don’t get this deal, I’m not willing to buy it because it’s not that good. And then on the upper ends of the liquidity threshold, like if we’re above that number that we decide is sort of the upper end of the limit, we can get those dollars to work for either in new real estate opportunities or we could start building some portfolio wealth or just make other investments in general.

So. The answer to your question is there’s a mindset shift that needs to take place because it almost doesn’t matter how much money we have, there’s always going to be more opportunities than we can put our time and money into. So make that shift and then second, utilize lines of credit as an opportunity.

Those could be lines of credit against real estate, could be lines of credit against investment accounts. We think looking at all of those options are really good.

All right. Next question. Uh, this person didn’t submit their name, but I have a digital marketing agency that’s grown 30% a year for the last few years. I’m starting to make real money and managing both my company and personal finances is overwhelming. What advice do you have for young entrepreneurs to manage their wealth effectively?

This is a great question and I think it leads to, especially considering how your business is growing, you don’t need strategies.

What you need is people in your life to help you. And I would say the first thing to start with would be finding executive assistant, finding a bookkeeper that can take some of those administrative things off of your list if you can get to the point where you’re just signing some checks and sending those out.

I don’t like giving up sign authority to anybody. That’s just a recipe for disaster, for fraud. I’ve seen it too many times in too many businesses, too many nonprofits, too many government organizations. When people have check writing ability, it causes problems. So, sign your own checks. But I think getting a bookkeeper in place can help.

A Financial advisor that can help with tax strategy, that can coordinate with CPA, that will help take a bunch of the heavy lifting off of your place and can give you some peace of mind that things are going well. So again, I would say some key pillars are get your liquidity in order, have a minimum and maximum threshold.

We’re going talk a little bit more about some of those minimums. We think a minimum is six months of income is a good number, maximum a year’s worth of income of liquidity. Especially as a business owner, that figure gives us margin, both personally and professionally in the business to have some safety there.

Then the next piece would be start building some portfolio assets. Find a financial advisor that can help with that. Get the tax bill as low as you possibly can. That just takes dollars from the IRS and moves it into wealth building. And if you can find somebody that can help manage all those pieces, that’s great.

Also, having some legal to help make sure asset protection is in order is also really good. Again, all things we help our clients with, but you can build your own team there.

Finally on cash flow. This question’s from Jordan.

As the owner of a growing boutique agency, managing cash flow has become my biggest stressor, especially with uneven client payment schedules. What strategies can you recommend for smoothing out cash flow in a service-based business?

Jordan, this is a great question, and I think the same piece around liquidity matters that we just talked about. Having sort of cash in the bank, not trying to reinvest that in the business, just protecting that liquidity is important.

But I think there’s a few things you can do, especially in a service-based business that can make a huge difference. First, don’t invoice people. In your agreements have it set up where you are going to charge the monthly rent or the monthly payment, and you’re going to withdraw it every month. You can set this up straight through QuickBooks.

You can set it up through ACH credit card. My preference is ACH. Just have the money come out. Just reduces the credit card fees. If you like credit card fees, just build that into your pricing model. Don’t charge more for the credit card and just. Suck it out every single month. The problem is, if you’re collecting 70, 80, a hundred thousand dollars a month and it’s all coming from credit card, you’re going be paying $2000, $3,000 a month in credit card fees.

It becomes real dollars. So I would say set up those automatic payments so the money just comes out and you’re not providing the service until the money hits the account. And then the other thing to think about, and I’m not sure, just looking at the nature of this question, the uneven client payment schedules, if there’s a lot of churn in your business, client retention is a challenge. I think that could be a key area of focus. If you’re constantly having to go find new clients, the longer you can maintain those client relationships. You could look at having annual agreements that people have to stay engaged for a year, that could help. And then just maybe more important than the agree side of things is how do you just show up and deliver tremendous value to your clients?

If you can do that month in and month out, they’ll keep paying you. So hopefully that helps.

Okay, we’re going to move on to some questions around wealth building our next topic.

Casey says, real estate investment has always intrigued me as a potential wealth building strategy. My income fluctuates. How do I get started in real estate investing? And what pitfalls should we avoid?

So, Casey, great question. I love real estate. I think it’s a fantastic wealth building tool. If we think back to the last episode, we talked about how the appreciation, the leverage we get with the loan, the appreciation of the asset. If it’s a million dollar asset and it goes up 5%, there’s $50,000.

If we put $200,000 down, that’s 25% return on our investment. At year one, we layer in the amortization of the loan. Somebody else is paying that property down. It becomes, again, another wealth building tool that comes into the mix. And then when we factor in depreciation, that offsets some income tax for us. It’s fantastic. So, I love real estate. Love all the benefits it provides.

But if you have fluctuating income, there’s some things you should really consider before you put money into real estate. Real estate is illiquid. If I need those dollars back out, it’s hard to do. So, I think the first step is just make sure you have a liquidity plan mapped out for the next 12 months.

Now we help each of our clients with a cashflow calendar that spells out exactly what the next 12 months of projected income and expenses look like. It’s got everything from living expenses to the home remodel to the tax strategy, all built into that cashflow calendar. And I think this is even more important if you have variable income, you’ve got to get those projections built out.

Then once you have the minimum and maximum amount of cash on hand sort of outlined, and your cashflow calendar shows that you’re going to be okay for cash on hand. We like to see you start saving money in a liquid portfolio brokerage account, and this is outside of the liquidity dollars, but we like to see you have up to one year’s worth of income in that portfolio.

Again, it’s just another margin of safety over and above the liquidity. If things go sideways, you can sort of tap into those dollars. Once you have that year’s worth of liquid assets on hand, then we think investment into real estate makes a lot of sense. Again, real estate is illiquid. We love it as an asset class, but when we buy some real estate, the debt also increases.

So we think that affects the liquidity we should have on hand. We should probably have a little bit more now that we have this debt, and the leverage is fantastic, but it can cut both ways. We’ve seen how when prices are appreciating, it can be fantastic. But we’ve also seen if prices are depreciating, we’re seeing that in some parts of the country right now.

We saw it in the late two thousands, and it was awfully painful when the asset values come down and those loans come due, like commercial financing, for example, every five years, seven years, you’re typically putting new debt or refinancing the debt, and the lender looks at it and goes, Hey, the value of this asset’s down, you’re going to have to put another 50 to a hundred thousand dollars into this property before we’ll rewrite the loan if you don’t have proper liquidity.

That can be a massive problem. So hopefully that answers your question about how to get into real estate investment. But we think step one, have proper liquidity in place. Step two, fund an investment portfolio, just stocks and bonds. And then step three would be fund the real estate investments after that.

All right. Our next question is from Blake. Having built a comfortable income through my architectural consulting business, I’m interested in passive income streams. Can you discuss the most effective way to create passive income that compliments my active business earnings?

Blake, I like this question. I think just about everything applies from the previous question that we answered for Casey about getting involved in real estate. Real estate can be an opportunity to diversify your income as far as truly passive. It’s definitely more passive than an active business, but still takes some management.

So, I think real estate can be a fantastic opportunity. And then from there, if I really think about passive income, portfolio income, the truly passive income where I can just sit on a beach and collect checks, that can be done really well through a portfolio of investment assets that the dollars are just coming to you.

I think to go back to real estate for a second, the last part of your question was compliments my active business earnings. If you have real estate, and let’s just pretend you’re married for a second and your wife can be a real estate professional. We talked about this earlier, but the depreciation, the phantom losses that come from real estate can complement those active business earnings really well.

They can write off all of the income that comes out of the real estate plus sort of trickle down into your active business earnings and really offset a lot of that tax that would be owed. So we think real estate’s a fantastic. Piece of any wealth building portfolio for all of those reasons. But again, if we were looking for truly passive income, if I had to pick one, the one that I don’t have to worry about really is the investment portfolio that can be designed in a way that creates an income for you, that you really don’t have to worry about anything.

Finally, our last question around wealth building is from. Achieving Financial freedom is a major goal of mine, but as a startup owner, it often feels like all of my resources are tied up in the business. How can I start allocating funds toward my personal financial freedom without jeopardizing my business growth?

Cameron. I think this is a great question. I understand the tension. The goal is to make it go and early on in the business it can be so challenging to just keep the business afloat. It needs every dollar that’s available, and the least amount of cash you can pull out of it the better.

Okay. With that being said, I think there’s a level of discipline that sometimes we see business owners as their income grows, the money just hits their bank account and it gets spent. So we think automation makes all the sense in the world. One of the reasons the 401k for the traditional employee has worked so well is the dollars never hit their bank account. The money comes straight out of their paycheck, goes into the 401k gets invested.

And then they hit retirement with a million, $2 million in their investment account. It works really well because of that automation. So I would say start automating, even if it’s a small amount, automate some dollars going into an investment account. We think Charles Schwab is a great place to do that.

You can set those up 50 bucks every month, every week, and then before you know it, you keep dialing that number up. We’ve got clients putting 50 grand a month into strategies that are just automated. So I think that’s the key, is building something that happens automatically. I also look at, as your business grows, you’re going to start paying more tax even if you reinvest in the business.

So one of the best strategies we can do is take some of those dollars and instead sending it to the IRS. We allocate it to wealth building. Then we are doing a couple things. We’re reducing the tax bill and we’re moving dollars outside of the business. That can help set you up for financial freedom. So.

Cameron, keep up the good work. Starting a business is not easy, and we want you to be successful there, so keep grinding.

Thank you for listening to the Vital Strategies podcast. The episode today was a lot of fun. We were looking at all of the questions that you had for us. Again, if you have additional questions, please go to vitalstrategies.com/questions.

Follow the Vital Strategies Podcast wherever you listen to podcasts, and if you’re enjoying the content and have a few minutes, we’d appreciate it if you would rate and review the show. We look forward to having you back next week. Where we will help you pay less tax so you can build more wealth and live a great life.