091 | Don’t Let the IRS Win: The Real Cost of Late Tax Planning

Patrick: [00:00:00] Have you ever wondered why no matter how hard you work or how much you grow your business, it feels like you’re still handing over way too much of your hard earned money to the IRS? You’re not alone. And the truth is most entrepreneurs don’t have a real tax strategy. They have a CPA who’s looking in the rear view mirror filling out last year’s paperwork, but nobody proactively helps them plan to keep more of what they earn.
Welcome back to another episode of the Vital Wealth Strategies Podcast. I’m your host, Patrick Lonergan, and today I’m sitting down with one of our own advisors here at Vital Wealth, Ryan. John. Ryan has a unique background as both an attorney and a financial advisor, and he brings a powerful perspective on how high earning entrepreneurs can stop overpaying the IRS and start building real lasting wealth.
In today’s conversation, Ryan and I break down the four cornerstones of a true tax strategy cashflow tax. Investments and protection and why? Getting this right can [00:01:00] completely change the trajectory of your business and your personal finances. You’ll hear why most tax planning fails, the exact tools we use with our clients to forecast cash flow and avoid costly mistakes.
And the three levels of tax strategy you can start implementing to save big while keeping your business protected and thriving. If you’re tired of feeling like you’re playing defense with your taxes, this episode will open your eyes to what’s really possible. And why having a proactive strategy could mean hundreds of thousands of dollars staying in your pocket instead of going to the IRS.
Stick around at the end, because we’re not just talking theory here. We’re sharing real actionable strategies you can start putting into place this year. And if this conversation sparks something for you, if you’re ready to finally stop guessing and start building a tax strategy designed for entrepreneurs like you, head over to vital strategies.com/tax.
That’s where you can take the first step towards creating a plan that helps you keep more of what you earn, grow your wealth, and protect the business you’ve worked so hard to build. [00:02:00] This is one of those episodes that could change the way you think about taxes forever. Let’s dive in. Welcome to the Vital Strategies Podcast.
Today on the show is our very own Ryan Johns. He’s an advisor with us on the the Vital Team, and today we’re going to get into the topic of tax strategy, how to build a tax strategy, and what it really takes to do one well and why. I’ll say most CPAs, advisors, that type of thing. Really sort of miss when it comes to building a tax strategy.
And to walk us through. All that is Ryan. Ryan, thank you for joining us. Absolutely nice to
Ryan: be here today.
Patrick: Yeah, this is going to be fun. So I, I think about the problem that entrepreneurs have with overpaying the IRS and generally there is no plan. Uh, it’s very reactive. The CPA looks in the rear view mirror and goes, okay, let’s just document everything that happened last year, get it on the tax return in a way that’s compliant and we will be good to go.
And the frustrating part about that is CPAs are, their business model is just [00:03:00] not designed to be proactive with the strategy. They don’t have the time or the bandwidth to. I be sitting down with, with entrepreneurs six months before the end of the year, just making it all work. And so then there’s internal pain that the entrepreneur experiences, just the stress and the anxiety, fear of audits, feeling sort of blind to the options.
And then philosophically we feel like, you know, I’m taking all this risk, I’m creating jobs, and then I’ve got this, I dunno, for lack of a better term partner that’s taking 30 to 50% of my. My net income in the form of taxes, and it feels like I’m getting penalized for growing a successful, healthy business that’s really driving the economy here in in the United States.
So I’m looking forward to digging into these these things today. Ryan, can you just give us a little bit of your background? You’re sure an advisor, also attorney, but I think that’ll be
Ryan: Yeah, absolutely. So my role at Vital Wealth is as a lead advisor, I’m primary contact with our entrepreneur clients to help quarterback their tax strategy, cash flow planning, and.
Kind of connect with all of their professionals they have in their network. [00:04:00] Um, got my accounting degree many years ago, it seems like now. I spent some time as a litigation attorney and have spent a little over a decade as a, a financial advisor. Um, financial planner and investment manager. Yeah.
Patrick: That’s awesome.
And we just appreciate, I’ll say your, your depth of experience and everything from the, the legal field. It’s always nice to get your thoughts and opinions on. Even though you’re not practicing law, but just, uh, that’s right. There’s always a caveat. That’s right. Your background and experience is just really valuable when it comes to, to looking at those things, so I appreciate it.
So, Ryan, I’d like to get into what I’m gonna call the four cornerstones of, I’ll say an entrepreneur’s planning and just to, to review those. It from our perspective, it all starts with cash flow. We have to understand both the, uh, the business cash flow and the client’s personal cash flow. You know, they might have money coming in from different areas.
That could be wages, could be profits, it could be real estate income, investment income, lots of lots of different things [00:05:00] from an income perspective. And then once we understand the cash flow, we move to the tax. Then once we have tax dollars and we’re not, or we’ve saved tax dollars, we’re not sending it to the IRS, now we look at investment, like where can we invest those dollars to, to build wealth.
And then finally there’s a, a protection piece of that that includes both legal structures and I’ll say insurance and yeah, protection, you know, vehicles like that. So. Ryan, can we start off with cashflow? Can you explain to us why, why cashflow is so important to understanding how to build a a good tax strategy?
Yeah,
Ryan: yeah. I mean, obviously when we think about individuals and their need to have liquidity and make sure they’ve got an emergency fund, for instance, everybody would agree that’s important. Even individuals, you know, husband and wife, they might agree that’s important, but not find the time to make sure that they’re tracking well with liquidity.
It’s even more important for our entrepreneurial clients because it’s not just the home front that is dependent upon proper liquidity, it’s the business. [00:06:00] And to compound that, the business is also the source of the family’s liquidity, right? So it just kind of rebounds, it compounds the problem. Um, so before you can talk to somebody even about tax strategy, and that’s what we typically get excited about at our office, you’ve gotta understand where the dollars are moving, what’s the minimum liquidity?
Um, need that you have to keep the family afloat and then to also keep the business afloat, which is what’s passing on that liquidity to the family.
Patrick: Yeah. Yeah. This is great. And Ryan, just the other day I was looking at this cashflow map that you built out that was just, it was really cool. It was like a visual representation of where all the dollars were coming from and we had, you know, wages coming outta the business.
Then we had, you know, profits outta the business and there’s real estate income. And then that was on sort of one side of the map. And then on the other side we see things like lifestyle expense, like what does it cost to just maintain our, our lifestyle. Then there’s the tax liability, and we always do two versions of this.
It’s like [00:07:00] before planning and after planning. So there’s the before planning, tax liability, and then, then can you explain what else sort of goes on that map that we show people?
Ryan: Yeah. So you know, if you think about it from left to right, we’ve got our income pieces on the left flowing into our core cash accounts, cash management accounts.
Then on the right we call out all of our expenses, and of course, living expenses is one that is, it’s a big area. We try to help clients really crystallize what those living expenses are, and that can be painful for some. But the cashflow map is just this really beautiful, pretty iteration of all of those moving pieces in an easy to understand format.
So you’ve got your living expenses. Another thing that’s coming outta there is taxes, and that’s usually a very large number for our clients and we’re trying to, to work with that. You then have planned savings and you think of this as automated savings you might be making to a brokerage account. Maybe there’s some college savings accounts for kids.
It can also be 4 0 1 Ks of course, but any, any ongoing [00:08:00] planned savings that we’re investing in the future, and then we may have planned gifts as well that’s coming out of cashflow. And then a lot of times with our clients, we’re able to see what we call unallocated cashflow. It’s what’s left over at the end.
Sometimes we work with clients where that’s a small number and we’re trying to help reign in expenses, but a lot of times there’s funds available that’re not being put to work.
Patrick: Yep. Yep. I love it. And I think the cashflow map is just sort of a, a, a beautiful thing. It’s got all the entities on there, attorneys like it ’cause they can see like, okay, here’s, here’s where all the dollars are moving and where they’re coming from.
And so that’s, that’s awfully valuable. Next. Can we talk about the cashflow calendar? And we don’t need to get into Sure. All the details to how it works, but really what is the, what is the purpose of the Cashflow
Ryan: calendar? Yeah, so I would say, as I mentioned a second ago, when we think about living expenses, we might call out a single annual number on that cashflow map.
There’s likely a lot of work that went into crystallizing that number from a [00:09:00] budgetary standpoint. The Cashflow calendar incorporates that same expense number and puts it up against the income inflows. Ultimately leads to a forecast or estimate of how much cash we have in our bank accounts, business and personal at the end of each month.
Um, so we’re incorporating the expenses in the income. We’re also adding in any irregular expenses. And so, you know, I had a client recently who bought a home and there’s major renovation that’s going to be happening. That was unexpected. Well, we know now it’s not a recurring expense, but we put that on the cashflow calendar.
We know it’s coming in a few months. Then we have other maybe more regular things on there as well, like, um, savings for something out in the future that comes onto the cash flow account or decreases cash on hand. But we’re able to use that to look out two or three or four or five months, even 12 months and say, if everything happens the way we’re expecting, here’s how much cash we have in the bank in December, let’s say.
Patrick: Yeah, [00:10:00] I think that’s, that’s great. And one of the things that we also find, you know, when we think about the cash flow map, one of the limitations is, I’ll say those and, and you highlighted this, but I think it’s different for different clients, the fluctuations in monthly income, right? We, we might have some clients that have a seasonal business, we might have other clients that have very smooth monthly cash flow.
And so like those seasonal businesses, we might have income consolidated in. Big chunks of the six months of the year, and we might actually have negative income for outside of those months. And so if we, if we try to just look at the cash flow calendar purely from a, an annual figure, like a linear perspective, it can give us a inaccurate view of how people’s cash flow is actually playing out.
So I, I think that’s fantastic. And Ryan, you mentioned when we were starting to talk about cash flow, about liquidity, another term for just cash on hand. Margin of safety. Yeah. Can you tell us how the, the cash flow calendar looks at that number and make sure that we are staying, [00:11:00] I’ll say safe there.
Ryan: Yeah.
We like to think of it in terms of a minimum amount of cash you should have on hand. And I think that resonates for a lot of people that would say, yeah, that’s when we talk about emergency funds or something, here’s our cash cashflow minimum. But on the other side of that, we have the maximum amount of cash we want on hand.
In other words, if we get above that point, we think we have too much. That’s the idea of making sure that we’re being good stewards of what we have and putting cash to work. It helps us frame a conversation with business owners who might be business owners. I think typically say, I understand my business.
I know how to make money there. I don’t want to be safe and have funds set aside to make sure that that still happens, but I’m hesitant to do anything else with the cash possibly because I, I understand the business more so. And so what that maximum does is it’s, it. Kind of sets a benchmark or a bookend, I guess, on the upper end to say if we get above this amount, we should feel comfortable investing that long term, whether it’s going into the general markets, whether [00:12:00] we’re identifying a piece of real estate or something else.
We should feel comfortable getting it out of cash and taking some risk
Patrick: with it. Yeah. Yeah. That’s great. And I think one of the interesting things that. You brought up is like, okay, let’s say we’re gonna buy a piece of real estate with, let’s say we have a, a piece of real estate on the, the agenda and it’s before clients come to us, they haven’t seen the cashflow calendar before.
And so the interesting thing about the cashflow calendar is that piece of real estate might work well uh, today. Like I might have the down payment for it to, to make it work. But then we fast forward six months and that number, our cash on hand could go into the red, you know, because. Of estimated tax payments because of, you know, another acquisition or investment we wanna make, and all of a sudden we’re flipped upside down.
And the cool thing, it really lets us see into the future and go, okay, how are we going to manage that, that issue that’s gonna pop up six months from now? And so we’ve sort of prioritized sources of liquidity, right? Um, you know, on [00:13:00] that, that calendar to go, okay, here’s where we’re gonna go get those things, and then let’s just have a strategy for.
Making sure that we’re, we don’t get in the red because the number one reason businesses go outta business is they run outta cash and they get into that danger zone, they hit a, a bumpy spot, and all of a sudden it’s like, uh, we’re, we’re in trouble. And on the opposite end of that, when we think about how a business can thrive in a tough situation is, let’s say we’re in a recession, uh, that hasn’t happened for quite a few years.
Uh, I feel like 2008 was the first, last real recession. We’ve, we’ve been through and it’s been 17 years, but. Recession comes along again, you know, there’s opportunity to buy assets at a significant discount. So first goal is survive that recession. Second is thrive out of it. And, uh, if we’ve got cash on hand and liquidity to be able to do that, that’s, that’s an exciting place to be.
I
Ryan: think that’s a great observation too, in terms of thinking about the minimum cash we want on hand and the maximum. ’cause if we’ve got the cashflow calendar dialed in and we know the different things we’re expecting to happen [00:14:00] and then a recession hits. Now we should have some confidence in that maximum number so that if we have more cash on hand than that in a recession, that should give us permission to go, well, we can.
We can invest the surplus. Mm-hmm. And we can bring it down to the maximum. Or if we feel really good about the defensive nature of our own business, maybe we take it down to the minimum. But that should give you permission to invest in a difficult market, which is when things are on sale.
Patrick: Right? Yep.
Absolutely. Good. So. Ryan, we’ve talked a lot about cashflow. Can we talk about how we, we’re gonna get into the li different levels of tax planning here in a second, but can we talk about how we fit tax strategy into the cashflow calendar?
Ryan: Yeah, I mean, as I think about it, when we’re building out the cashflow calendar, as I said, we’ve got the income added in and that can be a nuanced conversation with each entrepreneur because as you mentioned, income is different, it can be variable.
So we dial that in. We dial in those expenses. Then all of what I would [00:15:00] call the irregular expenses we add in separately. So if you’ve got a real estate purchase like we just talked about, that’s in there. Well, these, the tax strategies that we start to get into some require an investment, so it’s gonna impact your cash flow.
So those tax strategies will have their own entry or spot. If they’re monthly, we’ll have monthly entries. Some, a lot of them happen one time a year. Towards the end, we will build those pieces in, and then let’s say it’s all happening in November. You will see in November the impact on the cash balance from all of those tax strategies that require a disposition of
Patrick: cash.
Yep. Yep. That’s great. And one of the cool things about both the Cashflow Map and the cashflow calendar, when we start to create the map, you know, we create that second version of the cashflow map and on there we’re starting to allocate those dollars to tax strategy. And we might even be shifting some dollars from, let’s say, going into a brokerage account to going into a tax strategy.
And the cool thing about that is we can [00:16:00] now start to calculate that new tax number. And you know, on average we save our clients $280,000 of income tax. And so, you know, if they were paying 800, 900 a million dollars in income tax and we bring that number down to 600 from a million, you know, uh, now we have 400,000 of additional dollars that we can move to wealth building and that starts to show up.
On the cashflow map, but where it really starts to pay dividends is cashflow calendar. We can go, oh cool. We can see, you know, the tax number come down. We can see we maybe don’t have to make that last quarterly payment or last two quarterly payments ’cause we, you know, did a good job of, of tax planning for the year.
Now for our clients, we like to smooth out those quarterly payments so we’re not paying big dollars at the beginning of the year and nothing at the end. But if somebody comes to us in the middle, middle of the year, that’s how we can be strategic with that. And we also like to work with the CPA. Just make sure that they get eyes on on the strategy.
Yep. And they’re like, yes, this, this all sounds good. So I think when we think about the [00:17:00] cashflow calendar, it’s probably the most important thing we do for our clients is we update that for every single meeting, but making sure that the worst thing we could do is create a tax strategy that runs somebody outta cash.
And so it’s like that, that strategy that we’ve developed on the tax side works nicely with their cash flow. Yeah. So Ryan, anything to add to. Cashflow planning before we get into different types of tax strategy, I
Ryan: think I would just share that we have had this happen with clients and with a client recently where we look at the cashflow map, pre-tax planning, and then we look at the cashflow map with the strategies incorporated and the adjusted tax figure and the unallocated amount actually increases.
So we take, we’ll deploy, let’s say, you know, several hundred thousand dollars to these different strategies if that’s what’s appropriate. The amount of free cash on hand increases. So you actually improve your liquidity situation in some circumstances.
Patrick: Yeah. Yeah. That’s [00:18:00] great. Okay, so now let’s move to, we’ve alluded to some of this, but let’s just remind people of our, uh, our different levels of tax, right.
Strategy. So, do you wanna walk through. Level one strategies. I think we’ve got almost a couple variations of level one strategies. Yeah. But do you wanna start, just identify level one.
Ryan: So when we think about level one tax strategies, some of these are items that you can do on your own and some might require a little bit of a professional consultation.
Uh, but all of them do not require any movement of, well, I should say not movement of money. All of the level one strategies don’t require investment of funds.
Patrick: Yeah. Yeah, that’s good. Oftentimes we think about level one strategies as good administration and bookkeeping, and it might be moving dollars from our right pocket to our left, you know?
Yeah. But we still have full access to those dollars. Can you give us some examples of maybe some strategies that people could, could execute on their own?
Ryan: Sure. So, um, the home office deduction is one that we always talk to clients about. We wanna make sure that that’s being [00:19:00] optimized in, in many cases. I think that’s just taking the time to do the work to identify all of the related expenses.
Make sure it’s calculated properly and that information is provided in an easy format to your CPA. So they’re ready to go.
Patrick: Yeah. Yeah. That’s great. And then I think there’s strategies that need professional help. Can you walk us through a few of those different ideas and maybe why we need a pro to help us execute
Ryan: on when you mention it, the first one that comes to mind that needs professional help is gonna be entity selection.
And whether you’re making the S selection. It’s not as simple as as saying, well I’ll make the S selection and it’ll automatically save money on tax. There tends to be a sweet spot or a threshold of income where the costs associated with filing an A return for an S corporation are offset and eclipsed by the tax savings.
Right. And it’s not as easy necessarily as just taking a look at the p and l.
Patrick: Yeah, yeah. No, that’s good. And I’m gonna just outline for our listeners really quick why [00:20:00] somebody would make an S selection. So. Generally I start off my business as an, it might just be an LLC, it might be a sole proprietorship.
I think our thought is generally like start an LLC, uh, and don’t maybe make that a selection right away. And the reason being, like you said, I have to file a tax return for that, that entity. And so it, it’s gonna cost me, I don’t know, 7, 8, 900. To a few thousand bucks to get that, that tax return filed, depending on complexity.
But if I’m not making much profit there, okay, all of the dollars that are, are coming through to me, I’m paying payroll tax on, on the, the pass through entity. But if that’s 50, 60, $70,000, that’s sort of okay. Now, once I start getting up to a hundred thousand dollars, I might wanna set my wage at, let’s say, 60,000 and take a distribution of 40,000.
I won’t pay payroll tax, which is 15.6% or is it 15.9 i, I forget. It’s always 15 point something. We can look it up, but I don’t pay that on the $40,000. And so you start to think about that and [00:21:00] it’s like, okay, you know, there’s, uh, $6,000 in payroll tax I saved, which is not a small amount of money. And so it’s like at some point it makes sense to, to make that s selection.
Now we’ve seen people making a couple million dollars that didn’t make that s selection. The way it works is there’s a social security max wage that you’ll pay the full payroll tax on up until the top of that wage, and then it goes to from 15% in some change down to 3% in some change, or 2.9 or 2.8. And so we’ve seen people paying that 2.8 almost voluntarily.
I feel like their CPA should be charged with malpractice ’cause they had a couple million dollars of. Of income that was all being assessed at this, you know, 2.8% wage tax and uh, Medicare surtax or Medicare tax. And it’s like, this is insane to me. You know, like we, we should, we can wipe out a huge tax bill here, almost 30 grand by just making this X selection and which takes about 15 minutes.
So we think [00:22:00] that one definitely needs professional help and you need somebody to be able to look at your numbers and help you figure that one out. So. Okay. That, that’s good. Can you give us another example of another. We’ll say good administration and bookkeeping strategy.
Ryan: Yeah. I think, uh, the other two level one strategies that come to mind for me would be the home rental to your business under the Augusta Rule.
I mean, that’s a very powerful one that I, I find most of the clients we talk to haven’t discussed it with their CPA.
Patrick: Yeah, yeah, yeah. And that, that one like is fantastic. The, the iris. Under code section two 80 Ag. You don’t need to know that, but you can point your CPA to it. It says you can rent your personal residence out for 14 days and you don’t have to claim it as income.
Now, I’m not that interested in our clients going and renting their house out on Airbnb to some random stranger, ’cause who knows what you’re gonna get. But if I have a business purpose for having a meeting at my house, let’s say employee appreciation advisors, vendors, team meetings, you know, um. There’s a number of reasons I could, I could do that.[00:23:00]
I can take 14 days a year and go, all right, what does my house rent for on Airbnb? Let’s use that figure and let’s, let’s get a tax deduction for that. Now, this has to be legitimate use. You have to document, it has to be, you know, ordinary and necessary. So ordinary means it’s an ordinary expense, not three x with the normal expense is, and that’s where we, we like to use comparables off Airbnb to get, uh, an example there or.
Pure space or VRBO, we like to get some way to verify the value. And then necessary is I needed to run my business. And, you know, those, those team meetings and uh, client appreciation and that type of thing, all, all fall into that category. So, uh, we think those are just good uses and let’s just use round numbers.
If I can rent my house out for a thousand dollars a day, most of our clients have nice homes. Um, that’s $14,000 a year that I get to deduct. And if I’m in, you know, a 37% tax bracket, you know, that’s, um. Uh, it’s a pretty healthy number. I might say five grand in, in income tax just by, by using that strategy, moving money from my [00:24:00] business to myself personally.
Right now, we, we go through how to, you know, document all that on the p and l, but just great strategy. Uh, yeah, I can save five grand.
Ryan: I think that’s one that you can do yourself. I know that the clients we work with appreciate that we’re doing the legwork to find the comparable properties, right? Making sure that they’ve got a legitimate lease and that we’re identifying dates that they’ve used their, uh, their home for business purposes.
Patrick: That’s good. Any other ideas on things that might be good to have professional help to execute on?
Ryan: I would say, um, the qualified business income deduction is something that is not a do it yourself item. There’s a calculation that has to be made to make sure that you’re doing it in an, an optimizing way, and it’s also, you can’t complete it properly until you’ve incorporated all of your other tax strategies.
Patrick: Yeah, yeah. The QBI I deduction is a confusing one. There’s. So many different rules around it. Uh, definitely need your CPA involved. Even when we calculate it for our clients, we like to get the CPA’s eyes [00:25:00] on it and make sure that they’re seeing what we’re seeing. But there’s, it starts off and you get 20% of net income up to a certain threshold, then it goes away.
Then above a certain threshold, it’s the lesser of two numbers, 20% of net income or 50% of your entire employee pool’s wages. So oftentimes, if you have a lot of employee wages, it’s the 20% of net income number. But the interesting thing is, if, let’s say you don’t have any employees, everybody’s a a 10 99 contractor and you’re making a million dollars a year, the more wage you pay yourself, it reduces that net income number down.
So there actually is a sweet spot where you can calculate that wage and net income number to be identical. And that’s what we try to do. Now, it’s, it’s never gonna be perfect because we don’t know exactly how all the expenses are gonna shake out. Before the end of the year, and we have to run the wage before the end of the year, but we can get it awfully close.
And so that’s a number that we’ve seen. A hundred thousand dollars of savings, $200,000 of savings by just getting that [00:26:00] number correct. And so it’s often overlooked by CPAs ’cause they’re not looking at your, any of your books until February, March, April. And so, uh, that’s, that’s one of those things that needs to happen before year end.
And like Ryan said, it needs to happen. Right. That’s the last tax planning move you make is the, the running the, we’ll call it the bonus for the QBI deduction if it applies, so, all right. That’s great.
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Ryan: Another thing that we think about with level one planning is tangible property regulations. When you hear that, what do you think of and what are the, the different strategies and concepts that we need to be thinking about?
Patrick: Yeah, that’s, that’s great. We really like these and I, I think there’s an opportunity for anybody that owns real estate or has assets that can be depreciated.
Especially with the big beautiful bill that came out, we’re back to a hundred percent bonus depreciation for anything that’s a 15 year depreciation schedule or less. And then that is a surprising benefit when it comes to thinking about development. And so when we think about a cost segregation [00:28:00] study, that’s probably the most common, uh, tangible property regulation.
We can take a building, for example, and have it, the component parts of it segregated out. We have an engineer come do that, and we’re of the opinion that we’ve seen cheap. Cost segregation studies, and we’ve seen some that are, uh, done well that cost a little more money, and those produce well in excess of the difference in costs.
So we, we think those are worthwhile, but you have some engineers come effectively look at the property and the bigger, the more complex property, the longer it takes and more it costs. But you can typically take about 30% of the value of the property and depreciate that on a shorter time schedule. So. If I have a million dollar property that could create $300,000 of deduction that I get to take today.
Now there’s some rules around that with how I can take advantage of that, that full thing. And that’s beyond the scope of our conversation here, but that one’s a good one. And then there’s partial asset disposition, which is a pretty cool Yeah. Uh, strategy. And that ties back to the cost segregation [00:29:00] study.
So let’s say we had a client that had a chiller on their building that had a value of like $40,000 that stopped working and they threw it out well. The nice thing is, is when you’ve got a value on it and you get rid of it, you can deduct that entire cost to that thing when you throw it away. And then when you put the new one in, you can start to depreciate that again.
So it’s always nice to have those component parts broken down. ’cause if you do any remodel or reschedule or remodeling or, you know, redevelopment of your property, you can get some pretty nice deductions for, for throwing away a bunch of stuff. So, uh, those are, I think, are a, a good overview of level one.
Now let’s move on to level two. Can you talk us through level two strategy?
Ryan: Yeah. Yeah. So when we think about level two, moving on from level one where you don’t have to invest any dollars level two’s gonna require some investment. And so this is the first stage in our tax planning levels where we, uh, we do impact the cashflow calendar.
We have to pay attention to that, but it’s also saving for the future. So a good example of a level two strategy is incorporating a [00:30:00] 401k or other qualified plan if you don’t already have one. Or if you do have one, and we see this often, making sure that it’s optimized for your situation. It’s not uncommon for us to have a client that we start working with who says, yeah, we have a 401k, um, but I was only able to put $2,500 into it last year or every year.
I get a letter from, uh, the 401k company telling me that we’ve gotta make additional contributions to other employees because we’re out of compliance.
Patrick: That’s great. And I, it’s, it’s shocking how often we see that, you know, we, we think 401k is a great tool to get a number of dollars in. It is straight down the middle of the fairway as far as tax planning goes.
Sure. We think those, those dollars set aside into an investment can grow nicely over time. And so when you’re building wealth outside of your business, I’ll say, which we think is, is valuable for entrepreneurs. Um, and then, you know, when we design those properly, we get a tremendous amount of money into those plans between, you know, our [00:31:00] profit sharing piece plus our, um, our earner contributions.
Yeah. Those are healthy amounts.
Ryan: And, and it’s not just for large businesses. So when we’re talking about entrepreneurs and, oh, I have a compliance issue because I, I over contributed to myself, well, what about sole proprietors? What about people who own their own business?
Patrick: Like we’ve got a client we just talked to today that he owns his own business, but he doesn’t have any employees.
And so he has a solo 401k that can do some pretty cool things with self-directing that, which is um, which is pretty neat. And then, um, I think then moving on to, I’ll say additional strategies. One thing that’s pretty interesting, we’ve got a client that has two businesses that are completely different.
One’s in telecom, one’s in real estate, and in. One business, he is contributing to a 401k and the other business, he’s contributing almost equal amounts to a sep. And so he’s, he’s able to fund both of those plans because he is got two separate businesses. And the way he’s got [00:32:00] those designed is he doesn’t have employees in either one.
So, uh, he’s, he’s getting lots of contribution in, in there. Ryan, what would an example be of a strategy that sort of a supercharged 401k? You know, if I’ve got extra dollars that I want to get in that still. Fits into this level two strategy. What are your thoughts on that? Yeah.
Ryan: Uh, if we have a client where we can optimize the 401k contributions and profit sharing, and we’ve maxed it out, there still can be room.
And what we like to talk about is, uh, cash balance pension plan, and we could have an hour long conversation about the ins and outs of a cash balance pension plan. But, um, as you said, lesson number one, there is, it’s an like an amplified 401k. That the owners can get quite a bit more into a tax deferred investment option.
That’s probably the simplest way to explain that. You do go through and identify, Hey, what other employees do we have? What are their ages and compensation levels? And there will be some contributions to those employees as well, but we [00:33:00] often see 80 to 90% of the contribution amount into a plan like that going toward the business owners.
So it’s a very powerful tool.
Patrick: Absolutely. And, and I would say we’re probably only seeing 80% when there’s dozens, if not 50, a hundred employees. You know, like sure mean it’s a pretty small number. And you know, the interesting thing about it, a cash balance plan is it’s pension plan. And so if my workforce is younger, um, you know, I can put less dollars in theirs because they’ve got a longer runway to, to have that produce that income form.
If I’m older, I can get significant dollars into my my plan. And there’s also some unique design things that can happen too. There’s some vesting that can happen if people don’t stick around those dollars. Just come back into the plan and are used for right future funding, which I think is great. And we also can look at this, and again, going back to the entrepreneur that doesn’t have employees or has very small number of employees.[00:34:00]
This can be a tremendous way to get a number of dollars, both for you and your spouse into the, the plan, you know, you might be able to get. Ryan, can you give us an example of like, per individual, let’s say somebody’s about, I dunno, 50 years old mm-hmm. Roughly how many dollars they could get into, uh, cash balance
Ryan: plan.
Yeah. If, if we have a husband and a wife, um, and no other employees, you could be looking at 150 to $200,000 per person into a cash balance plan. So it’s pretty powerful.
Patrick: Yeah. Yeah. So, you know, in that example there it’s like $400,000, you know, we’ve seen maybe up to half a million. You can actually pre-fund the plan.
You can get more dollars in if you need deduction this year. And it’s like, okay, great. This is a, a clear strategy to get a half a million dollars into a plan that I don’t have to send to the I-R-S-I-R-S with state and federal tax might be funding, you know, 40, 50% of my retirement plan contributions, which are uh, which is great.
So. Very good. Anything [00:35:00] else on, I’ll say the level two strategies, because I might have one additional idea that I can throw in there, but do you have any thoughts?
Ryan: Yeah, I would say, um, there are a few different options where you can make an investment and have some tax advantages in the year that you make the investment.
There’s different vehicles, different structures. But you know, you think about maybe you’re investing a hundred thousand dollars into an oil and gas program, for instance. Mm-hmm. And depending upon your state tax level, um, if any, you might save on that example, you might reduce your taxable income by about $40,000.
Patrick: Yep. Yeah. So with a $50,000 investment, I’m getting a $40,000 tax reduction. Yes. Is that about right? Yes. Yep. That’s, I always like when I get, you know, 80, I think maybe upwards to 85% of the investment on an oil and gas, I can, I can deduct, which is, uh, that happens through depletion, you know, the oil well depletes [00:36:00] and the IRS gives us a benefit for that on the tax side.
And then there’s also depreciation, which is also, uh, an advantage as well. So those things are both fantastic opportunities. And then, you know, we’ll, we could get into a whole discussion. We’ve got an episode actually on. Cash balance plan. We’ve got an episode on oil and gas that, uh, talk about all the benefits of that and then the, the opportunities there.
Yep. And that was the, the additional thought I had too was oil and gas on, on level two. All right, so next, let’s move on to level three planning. Level three planning is we’re combining sections of the code to create tax efficiency, and there’s a number of different strategies here. I think one, the easiest ones for people to understand is what we’re gonna call captive insurance.
Okay. Right. Captive’s a great example for a few reasons. First, it isn’t specifically outlined by the code to say, yes, you can create this. What is outlined is my insurance premiums are tax deductible and there’s nothing stopping me from owning the [00:37:00] insurance company that’s insuring the, the risk out there.
So I can own the insurance company and I can fund those premiums. I get a tax deduction. And the nice thing about premiums that come into an insurance company is they’re not taxable. Uh, ’cause there’s potential claims out there. So. The code is set up to make all of those things legitimate. Where there becomes a problem is people abuse these strategies.
They go, you know what I’m gonna do? I’m gonna create an insurance company because premiums aren’t taxed, and then I’m gonna use it like my personal checkbook, and I’m gonna set it up in some, you know, offshore country that isn’t gonna regulate this thing, and, uh, I’m gonna write it any way I want. And so the IRS looks at those and they go, okay, we’re gonna put this strategy on what’s called the dirty doesn’t list.
Like, hey. We’re gonna look very closely if you execute on a, a captive insurance company. Okay? So, uh, that’s sort of all of the disclaimers about captive, but when it’s used appropriately, it can be a fantastic opportunity for somebody to mitigate some, some risks because they’re low probability, high impact risks.
They’re [00:38:00] priced by a third party administrator, and then. That is all run by a third party. Um, you know, we, we use a few different captive administrators. Uh, we’ve also had clients bring a captive to us that are, uh, an absolute joke on how they’re administered. And not surprisingly, the administrator for one in particular I’m thinking of, is in prison for all sorts of problems that helping a client evade, um, federal prosecution.
So. Moving money around. So it’s like that’s not the type of character you want on your side when they’re setting up a strategy that the IRS is already gonna look closely at. So, um, Ryan, can you talk us a little bit about the cost of setting up, I’ll say a level three strategy? ’cause you’ve been involved in a number of level three strategies for clients.
The cost of setting up a level three strategy versus let’s say something like a cash balance plan.
Ryan: Yeah, I mean, when you think about, I’ll start with a 401k plan, especially if you’re dealing with a solo K for a husband and wife, like you mentioned. The cost to set that up is gonna be minimal. [00:39:00] If you have a larger company and you’ve gotta have a third party administrator in there, they’ve gotta draft the document.
You know, maybe you’re talking a, a few thousand dollars to get that 401k set up. When you look at a a cash balance plan, there’s some compliance testing and ongoing things that happen. Um, and so your setup might be, you know, $3,500 and maybe there’s ongoing compliance of $2,500 a year. And it varies depending upon the size and complexity.
Um, when you get into a, a private insurance company or some of these other level three strategies, the cost to set it up can be significantly higher. Mm-hmm. Um, you might be looking at closer to 50 or $60,000 to set up a captive insurance agency in the first year, and then there’s some ongoing costs as well.
But because of that, and I think this is probably where you’re headed, you don’t look at doing a captive insurance company if you’re gonna try to set aside a hundred thousand dollars in premium.
Patrick: No, that’s exactly right. Because when I compare the cost to the tax, [00:40:00] why would I create all these strings associated with my, you know, my captive?
’cause it has strings associated with it. Like, I can’t use it like my checkbook, right? And it’s gonna cost me 50% tax effectively if it costs me 50 grand to set it up, right? It’s a hundred thousand dollars investment there. There’s, you know, I’m out 50 grand. Like, it doesn’t, doesn’t work. I’d rather just pay the tax on those dollars and, you know, uh.
Probably be dollars ahead and have less restriction on my, my money. So I think that’s a, that’s a great point. Generally, we like to see captive funding start at 300,000 and go up from there because it doesn’t seem to make a whole lot of sense below that.
Ryan: And, and the nice thing about it, but this is also part of the reason for the cost, the nice thing about it is you don’t, you don’t set one of these things up haphazardly and say, well, let me just put $300,000 in here and I’ll have a general liability policy.
What happens is we’re, we’re helping, we’ve got, uh, professionals that we work with that are helping to look at all areas of general liability, look at claims history, and then there’s [00:41:00] actuaries that take a look at all of this, and they’ll look at additional levels of insurance that might be appropriate for your business in your industry, and then they’ll price out the premium specifically for that company.
So there’s a lot of, it’s nice because, you know, it’s being done legitimately and looked at, but there’s costs associated with having these professionals. Take a very close look at your business and design a custom insurance plan for you. Right?
Patrick: Absolutely. And, and again, you think about, you know, having a captive, there’s other businesses, it has to be a minimum of 10.
Oftentimes it’s hundreds if not thousands of businesses that are all pooled together, and the claims have to be administered through that process. That’s right. Somebody has to look at the claim, approve the claim, pay the claim, and all of that costs money. And so it’s like that’s where. All of these, these expenses come in and you want that done well, right?
Like you, you want this to be, you absolutely want that done. Well, a legitimate insurance company. And,
Ryan: and also to your point, you’re gonna be part of a pool of other companies. Mm-hmm. And so you would like the underwriting and the [00:42:00] process to be appropriate so that the other people you’re pulled with, the other companies you’re pulled with, they’ve had all of their books and claims looked at too, and they’re an appropriate level of risk for the pool.
Patrick: Yeah. Yeah. This is great. Now we’ve covered cashflow and tax strategy, and we’ve talked about the importance of cashflow planning to be able to figure out how to really decide how to fund my tax strategy. Now, when we fund these tax strategies, let’s just keep the the captive example going, right? Um, so I now put the dollars into the captive.
What happens to those? What? What do I do with those?
Ryan: That’s a great question. They don’t necessarily have to sit idly by, right? You pay the premium in, and you can get into the specifics. There might be a certain amount that’s reserved for setting up the company and, and there’s potential claims. And so there can be some restrictions.
But generally the funds that are put in there can be invested.
Patrick: Yeah.
Ryan: They can be invested in a diversified [00:43:00] portfolio. They can be working for you and earning funds just like any of your other investment account.
Patrick: Yeah, absolutely. And so when we think about. I’ll say the levels of tax strategy and, and where we’re at so far, it’s like, so to, to create an effective tax strategy, we had to have somebody help us understand cash flow, make sure that we weren’t running ourselves out of cash by funding these tax strategies.
Then the dollars go into the strategy and they have to be invested. And it’s like, okay, who am I gonna find to be able to do that? And one of the nice things about the way we’re organized is we can. Help clients invest those dollar and you know, it’s, it’s not easy. Like you can’t go to Schwab and invest those dollars in your captive insurance company.
Schwab’s like we, that’s good point. Don’t do that type of investment. So it’s like, you know, you gotta find a custodian that, um, is able to, to, to manage those pieces for you. And so yeah, that’s, that’s I think all important. And, and most of these strategies, whether it’s cash balance plan, they’ve got an investment component and 401k, same thing.
A lot of the level three strategies have an investment component. And so. [00:44:00] Just making sure that somebody can sort of manage all those pieces is, is awfully important. Yeah. You know, ’cause it’s, somebody might just tell you, yes, go set up a cash balance plan. And you’re like, okay, great. Now how do I execute on this?
Right. You know, even if I have it set up now I gotta figure out how to invest the dollars. And that’s a, that’s an important piece. Your CPA typically isn’t going to be able to handle on their own. They’ve gotta Right. Direct you to somebody that can help you. You execute. Um, great. Now, uh, when I think about there’s, there’s the investment component and then the final piece is what I’m gonna call protection.
You know, and we think about protection happening in a few different ways, but we’re starting to see how all of these pieces overlap and we’ve already touched on one level of protection, um, that that can be classified as the s selection. I can make an S selection with my LLC or I can just decide to set up an S corp from the get go.
And so like entity structure is awfully important. Just also to bring that around, like a captive insurance company is typically a C [00:45:00] corporation, and so it’s like I have to set up a new C corporation to. Uh, to make all of that work. And we’re seeing the entity piece fall into the equation here on the protection side.
It, it is overlapping the tax strategy. And then we, again, the captive has been a good example all the way through here to see the protection piece be handled by the captive. So we’re creating a level of protection. We’re offloading some risk to the, the pool and sort of addressing that in the. Protection piece.
And, and the cool thing about, you know, all of these different strategies, and we’ve sort of talked about, one, I think our, you know, our library of podcast episodes is, you know, sort of, we’ve, we’ve dove deep into lots of these different topics and different strategies. But the interesting thing about all of these strategies is there is no cookie cutter answer.
You know? Right. Wish there was. It’d make our jobs a lot easier if it was just like. Here’s the plan that everybody takes, right? Right. But everybody’s lives are different. Their goals are different. Where they wanna build wealth is different. [00:46:00] You know, we, we have some strategies. If somebody is like, Hey, I don’t care about building wealth outside of my business.
I want to double down on accelerating the growth inside my business, great. We’ve got tax strategy that can help you with that. If people are like, Hey, I wanna build wealth outside of my business, I’ve got enough risk here, great, we can help with that. That’s where Cash Balance Plan and some of these other strategies come into play.
So. It is interesting to see all of these different pieces come together. Once you align with the client’s goals, help figure out, you know, what’s important to them, not just professionally from a wealth building perspective, but also personally and where they want to go with, uh, I’ll say life in general.
Yeah. So we talked sort of briefly about investments and the protection piece. Anything to add to, to either of those?
Ryan: I think I would say that to your point, there isn’t a cookie cutter approach to how you set it up. And then beyond that. Many of these strategies need ongoing support in management, whether it’s in management of the investment accounts or goals of the, uh, of our client changing [00:47:00] over time and having to adjust the strategies.
We’re dealing with a situation, uh, presently where we’re having to, at a captive insurance company and understand, is it still serving the same role and doesn’t need to be updated or changed? And that’s you’re gonna want to have the right people in your corner to help you identify the most advantageous options.
So it’s a, it’s also a moving target, I would say.
Patrick: Right? And, and I think you bring up a really good point, like we’ve helped a client execute on these strategies and now we’re helping them wind down some of these strategies because where they’re at in the business, they’re looking to take on some investor dollars and it just doesn’t make sense with new ownership to have some of these strategies in place.
And so we’re reassessing the tax landscape and how we’re going to execute on
Ryan: this. And, and the good news is we’re gonna be able to identify. Some really advantageous ways to continue utilizing the strategies. We just have to figure out how to update them to make them match with the new lifestyle and the new situation.
Patrick: Yeah, yeah. Yeah. Ryan, this has been great. So I, I think one of the other key things that we [00:48:00] need to highlight with this conversation is whether we like this or not, we have clients that call us in September, October, November. We just talked about everything that goes into good tax planning. Yep. And not that we can’t get it done.
I think we had a client, I don’t remember when they engaged with us, September, October of last year that we helped save over a million dollars of income tax. Yeah. I think maybe like
Ryan: middle to end of September.
Patrick: Yep. Yep. So that’s, and we try not to work the last two weeks of December. That’s not always the case that we That’s not the easiest thing.
Yeah. We, ’cause we have so many. Most people think of tax planning happening, you know, January, February, March. That’s not when any of the tax planning happens in our book. From our perspective, it all needs to happen before December 31st. Even if you’re participating in a strategy that you can execute after the year, you need to make sure everything else is busted up.
Yeah. Um, you know, before the end of the year. So, uh, that’s, that’s we think the most important time for people to, uh, start their [00:49:00] tax strategy is. As soon as possible. You know, January is the best time to start executing on the Yeah. The tax strategy for that year. Right. Not, not the previous year, but that year.
So, um,
Ryan: but,
Patrick: but yep, go
Ryan: ahead. To your point, there does come a time when our hands are somewhat tied. Yep. And, yep. There’s not a magic answer there probably, because it depends on the strategy and us, you know, getting information from the client and understanding their situation. But we wanna talk to you before
Patrick: November, right?
Absolutely. So I, I think the, the disclaimer is our calendar is filling up. That’s a, a good problem for us. It’s not so great for somebody that’s wanting to have some, um, some tax strategy before, you know, the end of the year. So if you’re listening to this and you’re like, I’m having a great year. You know, we’re north of a million, 2 million, 3 million, $10 million of net income to the each owner, like, now is the time to.
To reach out, you can do that through vital strategies.com/tax. That’s probably [00:50:00] the best way to get ahold of us. There’s a quick survey there and we’ll, we’ll reach out. But, um, you know, this, this is the time of year. Ideally, you know, the latest we like to start is, I’ll say July 1st. ’cause we got six months of runway for the year.
We can forecast through the back half of the year and we, we have time to vet the strategies. ’cause you know, we, we talk about captive insurance sort of casually. There’s a lot that’s going on with that. We’re starting a new business. Yes. We need to understand it. There’s strings associated with it. It’s not like I can put dollars in this year and, you know, decide not to fund it next year and not have some consequence to that.
So, um, you know, these are, these are all things we need to like, be mindful of, not just in the short term but the long term as well, and make sure that they, they align with goals If. If we don’t execute on one strategy, we need to start looking at the second or the third or the fourth, and we start to lay all those out pretty quickly for clients, and we identify which ones we think will fit best according to goals.
But, uh, you know, sometimes we, we do change course there. So yeah, I think the, the short answer is like. [00:51:00] The best time to do tax planning is right now. That’s right. It was probably in January to get started in the process. Um, but yeah, don’t, don’t delay. If you’re looking at making moves, now is the time to, to connect and we’ll get you started.
So yeah, Ryan, this conversation’s been great. I appreciate just all the, the value add to the team, your insight for our clients. Uh, you do a great job sort of leading those engagements and making sure that we’re not just building more wealth and paying less tax for clients. But, uh. You do a great job staying focused on, you know, what are the most valuable things in life.
We have lots of great conversations about, um, you know, where we’re at in our faith and all those other things, and it’s kind of nice to keep track of, um, you know, it’s, it’s not all about the dollars and cents. Absolutely. So I appreciate all your perspective on that.
Ryan: Yeah. Thanks for having me today.
Patrick: Yeah.
That’s a wrap on today’s episode of the Vital Wealth Strategies Podcast. Thank you so much for tuning in and spending your time with us. I truly hope you found value in this conversation with Ryan, and that we gave you some fresh ideas on how to take control. Of your taxes and keep more of what you earn.
If you did, I’d love it if you shared this [00:52:00] episode with another entrepreneur who could use these strategies to grow their wealth and protect their business. And remember, you’re a vital entrepreneur. You’re vital because you’re the backbone of our economy, creating opportunities, driving growth, and making an impact.
You’re vital to your family, creating abundance in every aspect of life, and you’re vital to me because you’re committed to growing your wealth, leading with purpose, and creating something truly great. Thank you for being part of this incredible community of vital entrepreneurs. If you’re ready to stop leaving money on the table and start building a tax strategy that works as hard as you do, visit vital strategies.com/tax today and take the first step towards keeping more of what you earn.
I appreciate you and I look forward to having you back here next week on the Vital Wall Strategies Podcast, where we help entrepreneurs minimize their taxes, master their wealth, and optimize their lives.