Welcome to EWA’s Fin-Lyt podcast. EWA is a fee -only RIA based at Pittsburgh, Pennsylvania. We hope all listeners of this podcast will benefit as we deep dive into complex financial topics that we will make simplified for you.
And we hope that this really serves as a catalyst so that you can make the best financial planning decisions for your family and also save time. Welcome, everybody. On today’s episode of Fin-Lyt we’re going to be talking about tax strategies for small business owners.
So specifically, we’re going to be talking about some tax strategies here with Ben and Chris from the EWA team. Some of the unknown strategies that are out there. So just to get started, we are first going to talk about the difference between entity structures.
So typically, we’re going to be talking about a business owner has the option of what kind of business entity they want. There’s many ramifications being a sole proprietorship versus an LLC, an LLC partnership, or an S -Corporation.
So just to narrow it down here, we’re going to talk about the really the S -Corporation being one tip that we have for business owners and the reason S -Corporation is a good entity. From a tax perspective is that let’s just say there’s a business owner that has essentially a million dollars of profit.
That’s including the compensation he pays himself. So if this business owner was a sole proprietorship, all million dollars would be subject to federal taxes, which start at 7% and go all the way up to 37%, which is graded.
And the second one, assuming Pennsylvania would be a Pennsylvania tax, which would be a 3 .07% flat tax across the board, there would be local tax here in Pennsylvania, and then there would also be Medicare and Social Security tax.
So the three that potentially could be avoided if you’re an S corporation, so for example, if Ben here was a sole proprietor, he would pay Social Security taxes on the first $160 ,200 of that million, and then he’d also pay Medicare taxes, two sides of that, on the entire million dollars, that’d be, you know, $29 ,000, 1 .45 on the employee side, 1 .45 on the employer side, that’d be $29 ,000 of taxes, and he’d also pay local taxes, so Ben lives in Shadyside, which has about a 3% local tax, that’d be another $30 ,000 of tax he would pay.
But instead if Chris were an S corporation, and let’s just say hypothetically, we set up the W -2 to be $100 ,000, so that was his salary, and the other $900 ,000 we set up to be a distribution, Chris would save a lot of taxes, and how he would save those taxes is he would only pay Social Security…
taxes on the 100 ,000 of W -2. So 60 ,200 where the cap is, he would avoid 6 .2% on the employee and 6 .2% on the employer side to 12 .4% of 60 ,000. That’s over 7 ,000 he would save in Social Security tax.
He would also avoid the Medicare tax, the 2 .9% of the 900 ,000. That’s over 26 ,000 of taxes saved right there. He’d avoid the local taxes, the 3% on that 900 ,000 of the distribution. So essentially the salary would get taxed on all levels, but the distribution would avoid of that 900 ,000.
60 ,200 that would avoid Social Security taxes. All 900 ,000 would avoid local taxes. All 900 ,000 would avoid Medicare taxes. And so adding this up, and just in that example there would be over 60 ,000 a year of taxes saved easily.
Now the downside of doing that for Chris is there’s potential in audit risk. So Chris, talk to us about that, the audit risk that could come into play. Let’s say you were a doctor, a cardiologist on average that makes half a million dollars out there and you were paying yourself 100 ,000 a year in a private practice.
Why would that be problematic? First problem would be me being a cardiologist. Good point. Beyond that, if you’re too aggressive with it, the IRS, they know that. They know what the going rate for a cardiologist is, and if you’re paying yourself a $20 ,000 W2 for a doctor, it’s going to raise some flags.
So generally we want to have the W2 portion that’s something that is relative to what you’d be earning if you’re working at a hospital or somewhere else, just to make sure we’re not getting audited and having to pay penalties or anything for underpaying on those taxes.
Okay, so let’s say hypothetically that you’re a cardiologist, as scary as that sounds. The average salary, let’s say for cardiologists is 400 grand. And so you’re saying we’d want to pay the salaries for a grand.
So there’d still be a significant tax saving. on that 600 now, assuming that million dollar total net number to you as the 100% owner of this S -Corporation, would still save, now there’d be no Social Security tax saved because we would have paid you all the way through the 160 plus beyond, but we’d still save Medicare tax and local tax, so almost 6% combined, assuming you live downtown Pittsburgh, which I know you do.
So there would still be 6% of 600 ,000, $36 ,000 of tax savings. Now Ben, what would be the other problem from a retirement plan perspective for Chris if he only paid himself 100 ,000 and he was trying to max out a 401K or cash balance plan?
What problems would arise for him? Yeah, really the big issue that would come into play there is that all, in terms of your 401K, that’s strictly based on your W -2 income, so if Chris pays himself a super low W -2 salary and takes a lot of distributions that make up his compensation, he could be limiting himself.
based on what he can put into his 401k if his W2 income is low. For sure. So if he was trying to max out, Chris is obviously, are you under 50? I can’t tell with that beard. Yeah. Got some white hairs coming, but still under 50.
Chris is under 50, for everyone that didn’t know that. So there’s $66 ,000 a year that he can put into a 401k. And that’s made up of a couple components. So Chris, break those components down. Yeah. So the full amount that can technically go into the 66, like you said, the typical max that people think of whenever they think of how much can I put in, it’s what’s called your elective deferral.
And that’s what you can do is either pre -tax or Roth, and that’s $22 ,500. But if your plan allows, so if you’re self -employed and you’re designing the plan, you can write in the ability to do either after -tax contributions or profit -sharing contributions to fill that difference between 66 and 22 .5.
So if you had a plan for profit -sharing and you only paid yourself $100 ,000, we’d run into issues. Profit -sharing is capped at 25%. So 25% of 100 is 25. You add that to the 22 .5, and you’re in a total of 47 .5.
So we’re not able to max out the 66. However, an after -tax is a dollar -for -dollar basis. So you could pay yourself $100 ,000 and do $22 ,500 in the Roth, hypothetically, and then do the rest up to that 66 in the after -tax, and then immediately convert that to Roth.
So we’d have no problem maxing out a 401k, $100 ,000 salary if we want to do what’s referred to as the mega -back to Roth, where we’re running into issues if we’re trying to get the tax deduction now and trying to max out that profit -sharing.
However, in that $100 ,000 example, we could do a mix of all three. We could do the 22 .5 Roth. We could do the profit -sharing of 25, and we could do the difference, then an after -tax, and convert that to a Roth inside the plan.
So many ways around that, but the key thing here is that S corporations are very advantageous from a tax perspective, but we don’t recommend to be overly aggressive and make sure you pay yourself a salary.
that is industry standard. So if you get audited, which you’re already at a high risk of being audited because of being a million dollar income earner, you do so and you have guardrails around that that the IRS will not have issues with.
And so we found if you can prove here’s the average salary of a owner of this kind of practice, pay yourself that, you’re still gonna have a ton of tax savings from being an S corporation. So where people run, so obviously there’s a tax component.
Now let’s say this S corporation has multiple owners. So the S corporation has three owners, let’s say 160%, the other two are 20%. Is there any flexibility in distributions, Chris, when those profits get distributed?
No, so the S dividend, the portion that’s being paid out above the W2 that has to be split proportionally amongst the other partners based on whatever their percentage ownership is. So it’s rigid. If you were that cardiologist that over 51% of control, you have control of the big decisions of the company.
However, you wouldn’t have control of how the profits are distributed. So even if you want to take those profits all for yourself, or you want to pay someone higher, if you want to distribute the money, it’s rigid.
It has to be the 60, 20, 20 in that example. So the way around that as an S corp is then you could bonus the money as a W2. But then it’s like, well, why are we an S corp? Because on the bonus, it’s really just like a W2.
You’re going to pay all those taxes that you were trying to avoid by doing the distribution. So you have to be aware, if you’re doing an S corp, it’s very rigid. If you have other partners involved, the distributions at least can be are rigid.
And the percentages of actually the company owned, the way around that would be the bonus. But then you have to question yourself, well, why be an S corp? Because the whole reason for being an S corp and paying the extra fees and extra filings, running this payroll company to run the actual payroll, is to save the taxes.
So you have to evaluate the flexibility. The aspect of not having the flexibility for the distributions versus the tax efficiency of an S corporation. So one way around that would be an LLC partnership, where you do have the, you could be 60, 20, 20, and the person that has majority control could distribute 100% of the profits to anybody.
There’s total flexibility in the LLC partnership. But the greatest tax savings of what we talked about would be not in a sole proprietorship, not in a, just a straight out LLC, would be in the S corporation for this specifically.
So let’s discuss next the, let’s jump right to the 401K and cash balance plan. So, because we started to discuss that already. So the, you know, 401K and cash balance plan, Chris talked to us a little bit about the ability to fund the cash balance plan.
Like let’s say, I know we have the sheets here. Like if there’s a 40 year old business owner that has structured the 401K and max out 66 ,000 in the 401K, how much in addition to that, they put into a cash balance plan that’s all attacked right off?
Yeah, so these are all, these are based off of tables the IRS puts out. So if you’re 44, you could do for the first year contribution 139 ,000, that’s all a deductible contribution for the business. Yeah, and the nice thing about a cash balance plan, it’s a hybrid plan, it’s a bucket of money, all participants in your company will be part of that and the actuary keeps track.
But the nice thing is it’s one account and you can put a vesting period on it. Generally, the IRS wants to see a permanency test of this so that you have, you know, you can have it for 10 years, but they generally want to see it’s at least there for five years.
Now, if the business has cash flow problem, it shuts down, there’s an exception to that. Once you roll it, you can roll it out to an IRA in percentages to all the participants. But we’ve seen if you’re a high income or any business owner, this is a very, a very good strategy.
I think very underutilized, a lot of our clients utilize this to save a ton of taxes. There’s asset protection features to it. They do it when they have, you know, in their highest business income earning years on top of their 401k, and then once it’s out, you know, we roll it to IRA to be able to have more flexibility and to be more aggressively invested because the one thing about a cash balance plan is there’s actual real assumptions that generally end up in like a 40, 60, 50, 50 portfolio.
So it’s a huge tax deduction, but while it’s operating as a cash balance plan, you’re not going to get as big of a growth as if you were on all the stock allocation, right, etc. Okay. So let’s, so 401k as a business owner, let’s say you have multiple businesses that are totally unrelated.
Could you have multiple 401ks? Yeah, absolutely. What do you need to watch out for though? Is it common control interests, I believe? So if you’re the owner of one company and another, there could technically be tests that could exclude your ability to make those contributions.
Yeah, there’s tests you have to make across the board. There’s common ownership, there’s employees if there’s crossover, so we need to work with a third party administrator to determine that. We have lots of clients that have multiple 401ks.
Talk to us about the 402g limit. So technically if you had two 401ks, you could put 66 into one and 66 into the other, but you have to be careful about one thing and what is that one thing? Yeah, so that’s going back to the elective deferral we were just talking about.
So that’s the 22 ,500 that you can put in regardless of how many plans you have. That’s capped no matter what. So if you’re already maxing out the 22 ,5 via Roth contributions in one plan, you can still do the full 66 in another, but that either has to be after tax or profit sharing contributions.
So hypothetically you could have a medical practice, let’s say that you’re putting in a Roth 22 ,500, you’re putting in a profit sharing of 30 ,000 and you put the rest into an after tax to convert to a Roth.
So that plan gets fully maxed out to 66. The second plan you could do all as an after -tax contribution and then also convert that to Roth as well. So you could have 66 and one, 66 and other, as long as the 401ks are allowed to coexist next to each other with the two different businesses that you’re involved with.
Pretty cool. So OK, well, let’s move on. So next tip we have is around very appropriate to start talking about this with the FedEx golf tournament starting. This isn’t the FedEx golf tournament, though this is the playoffs.
This is actually we’re going to be discussing the masters in a quick second about the Augusta rule. But then continue. Yeah, you stole you stole the you stole the intro from me. So just take it from here.
Yeah, so the next tax tip, which is like you guys said, but underused, maybe under discussed, is called the Augusta rule. And this is based off of the masters golf tournament that happens in April every year.
And how this came to be was in Augusta, Georgia. They host the Masters every year in April. And over a seven to 14 day period, you’d have all the golfers, all their caddies, all their staff, everyone who puts together the tournament and all the fans, you know, to send down to Augusta for a two week period.
And there’s only so many hotels, and there’d be hundreds of thousands of people that would visit the city. So people would start renting out their homes to all these guests to accommodate everybody. So what the Augusta rule says is that you can rent out your home for up to 14 days, and that rental income that you pool together over that 14 day period, you do not have to pay taxes on.
So how does this make sense for a business owner back to tax tips for small businesses? You can rent out your home to your business for business purposes for again, up to 14 days throughout the year.
Whether that’s a monthly meeting, you know, a biannual or annual meeting, or an end of the year meeting, again, you can have 14 days where you can rent out your home to your business, and all of the income that you receive from that rental is not considered taxable.
So just walking through an example of this, let’s say you have a million dollar home, and again, a lease needs to be drawn up, and appropriate rent needs to be charged, a good general rule of thumb is somewhere around 0 .1% of the home’s fair market value.
So again, if you have a million dollar home, that would equate to about $1 ,000 a day of rent. If you follow that strategy and you rent out your home for 14 days, $1 ,000 a day, that’s $14 ,000 worth of rental income, and if you’re in the highest tax bracket at 37%, normally you’d be subject to a $5 ,000, tax liability on that income, but since you’re under that 14 day limit, that $14 ,000, you’re not subject.
to federal tax. So literally, and most business owners do business in their house. So it’s literally this is a bookkeeping where you have your business account in QuickBooks, set up a transaction, 1 ,000 a month.
Let’s just say you have a recurring team strategy meeting at your house where you keep board notes and everything. So 1 ,000 a month goes from your business account to your personal account. And if that was running through payroll and you’re that million -dollar income earner, that would be coming out at a 37% federal tax rate.
That comes to you where it is 0% tax rate because of this Augusta rule. So the Augusta rule, obviously, many good things came out of it. One is this easy tax savings for business owners that properly utilize it for legitimate business.
I would say the second good thing that came out of it was a policy that we had to start at EWA during stock market hours not having TVs on. Because the Augusta rule, there was some watching of golf during business hours.
So we were able to calibrate into it really good. strategy there for our firm as well. Well, I think I have any comments on that. Yeah, I just think a lot of our employees were trying to better understand the rule.
The rule is called the Augusta rule. So by kind of watching the masters, we’re able to get a hand on this. And actually, I’d like to take this a step further. Chris and I were more kind of learning by doing kind of guys.
So maybe next time we’re actually going down to Augusta to the masters to kind of see this rule in action. Again, kind of a conversation for a future day. But talking about it gives us a good understanding, but actually experiencing it, I think Chris would be.
Hey, if you guys can get tickets for me as well, we’re in, we’re going, no PTO docs, everything. Yeah, I agree. Hands -on experience is always the best. So you guys get the tickets and we’ll do it. All right, we’ll talk about it.
All right, perfect. Hope you’re enjoying this week’s Finland by EWA podcast. One quick disclosure before we talk about hiring your children on payroll, which can save a tremendous amount of taxes for your family -owned business.
We wanted to point out that this is a state -by -state specific thing. So make sure to talk with your attorney and look into the labor law rules in your state specifically before implementing this strategy.
Some states allow this, some states do not. So again, check with your attorney, check with your CPA, and we’re also happy to discuss with you. Now back to the show. So what’s next? What’s the next tax tip do we have?
Chris, let’s hand it to you. You work with a lot of business owners, Ben does as well. So Chris, what’s another strategy for business owners that have kids? Yeah, so this is one, like all these that we’re talking about, underutilized, but you can actually hire your children.
And for the 2023 tax year, if you’re paid less than $13 ,850, you don’t have to file a tax return. So that number, if it sounds familiar, it’s the standard deduction for single people. So as long as you’re under, as a kid, if you’re earning that income, it’s 0% tax savings.
So a lot of our clients that have business owners, businesses and also have kids, though, if there’s stuff around the office that they can help with small tasks or even for advertising, some kids will be models for the company and we’ll process a one -time payment of that amount for $13 ,850, and it’s immediately.
If the business owner is in a 37% bracket, that’s an immediate 37% tax savings on the $13 ,850. Does that have to go to the kid or could that be utilized in the financial plan in some way? Yes. It’s going to be rerouted in a couple transactions.
In reality, the majority of our clients, I believe, use this strategy. It’s not like it goes to the kid and the kid’s spending it on Legos. It’s going to the kid and then going where? That’s a good point.
The second step, generally, we’ll have the kid max out or athirae. If you have the earned income, that opens the ability to fund for this year $6 ,500 into a athirae. And then beyond that many of our clients who have kids also want to plan for their education So they’ll have a 529 plan established So that remainder the difference between the 13850 and 6500 that goes to a 529 plan So so the parents were already contributing the 529 plan so instead of you know contributing 10 ,000 that the parent would have had to earn almost 14 ,000 to get to the 10 They can pay the kid 10 and then reroute it directly into what they were already planning and so like per kid as you said What’s 37% of 13850 hard to about right now?
I mean it’s almost 5 ,000 per kid per year that you can save see if you have three kids It’s just an easy 15 a year again talk to us about the audit risk We never recommend doing this unless it’s actual legitimate work So you give the example modeling sets that you know if the company has a social media page and their kids on it That’s legitimate business use Other examples, you know The client recently that their their kids are gonna come in and keep track of the all the drinks in the office and restock that and like Create Excel spreadsheets to track that that’d be a good example one of our clients You know does the the garbage does some cleaning?
Have their kids do all that kind of stuff. So as long as it’s legitimate work when this is a legitimate Strategy, you know and and a completely underutilized but a great strategy that we recommend For clients that want to involve their kids in the businesses.
Yeah, and you can even go That 13 850 is the amount that you can do without having to file a return, but you could also so the next That 13 850 is tax -free and then then come up to 22 ,000 for 2023 that that incomes a 10% bracket So even if you’re a business owner in the 37% bracket You could go above that still that above that 13 850 and they’re still tax savings.
It’s good. You can pay your kid like 30 grand Like 13 850 of that’s 0% federal taxes than the rest of that would be a 10% tax. That’s a lot better if again and you’re utilizing that money to max out the 529 plan, for example, and you’re going to do that with your own money.
You’re just maxing out the 529 plan now with a 10% tax hit versus a 37% tax hit. The only downside is, actually, if you go above that, your kids are going to, depending on what kind of entity you have, will pay FICA taxes.
So they’re going to pay the Medicare and the Social Security. So it’s not an exact like 10 versus 37. It would be like a 10, because the parent would have been, or even maxed out in the Social Security, whereas the kid, that would have to be reintroduced.
But there’s still a significant, sometimes, like 15%, 20%, 25% tax savings, even if you go above that. But if a kid’s just modeling, it would be tough to go above $13 ,850 if a kid’s just taking out trash one hour a week.
So look at hourly rates of what you would pay and how much the kid is actually doing to determine this. But at least the $13 ,850, if the kid can do enough work, they get that 0%. That’s an amazing. So talk to us about, like, how much the implementation of this.
Like if someone was interested in doing this, like what would they have to do to actually implement this? Yeah, so it has to go through payroll. You know, it has to all be by the book. So we coordinate that.
We want to have a clean paper trail. So we want to show the payment going to the child. And then generally from there, we’ll have the payroll company just wire it directly to the Roth IRA to the 529.
Just make sure everything’s clean. Or alternatively, we could set up a bank account for the kid with a parent, like a custodial account, have the payroll go there and then have the money then automatically drafted from the kid’s bank account into the Roth or into the 529.
Either way. So yeah, kids just officially go on payroll. And then from there, it’s really, it can just be automated. Which is really cool. So one time set up. And then so obviously we want to have commerce.
Highly recommend, consult with your CPA. Talk about the risks, the pros and the cons. But if we can make this actual legitimate, they’re doing work. They’re getting paid at an hourly rate. It’s a great way to save taxes above and beyond the regular ways.
So one quick side note. Again, hope you’re enjoying this week’s Finlitt by EWA podcast. Next up, we’re going to talk about different ways for using your car as a deduction in your business. And specifically the Section 179.
So as a quick disclaimer, Section 179, if your car is over 6 ,000 pounds, you can deduct in 2023 up to 28 ,900 of a value. Under the current tax code, there are bonus rules. And the bonus is not capped.
And the bonus allows in 2022, how you to take 100% of the deduction. But this is getting phased out 20% per year. So now that we’re in 2023, if you have a vehicle, you can do 80%, which includes the regular Section 179 plus the bonus rule.
So if you have $100 ,000 car, you can deduct $80 ,000, 80% and $100 ,000 in 2023. And this will continue to get phased out 20% until along with other rules in 2026 get phased out. Now back to the show.
All right, so next tip is around cars. So Ben, talk to us about the different options for how a business owner could use their car for a tax write off. Yeah. What are the options they have and how do they work?
Yeah, so I would say, generally speaking, there are three main options that we see day to day with our business owner clients in regards to their cars. The first one, pretty simple, if you’re leasing a business car, you can deduct that payment.
That’s a common strategy we see. The second one is just using the standard IRS mileage rate, which in 2023, as we’re filming, is $0 .65 per mile driven. And again, this is strictly for business miles.
So what does it mean by a business mile? driving to a client meeting or driving to a speaking engagement or driving to anything business related. That is not your normal commute. So driving to and from your place of work would not count as a business mile.
So in this example, let’s say over in 2023, you drove 10 ,000 business miles. You could say 65 cents per mile. Boom. It’s a $6 ,500 tax write off based on your business travel throughout that year. The third one and something that we’ll talk about in greater detail here is called section 179, which is in reference to a specific section in the internal revenue code that allows you to take an accelerated deduction based on the amount, the percentage amount that you use your business car in a calendar year.
So how this would work. There’s a, there’s a couple of caveats. Number one, your car needs to be over 6 ,000 pounds. And the actual deduction that you need to be using it for has to be used for business purposes.
So as an example, let’s say you have a $100 ,000 car and 90% of the time it is used for business purposes. And again, this is tracked through clean books and records, mileage reports, all of that 90% of the time it’s used for business purposes.
So that would be a $90 ,000 deduction that you would be able to take in that calendar year. And again, if you’re a business owner that’s in the highest tax bracket at 37%, that’s a $33 ,000 tax savings by simply performing that right off and getting that 37% tax break on the $90 ,000 deduction that you’re taking.
Which is five times higher than mileage deduction for someone driving 10 ,000. That’s, that’s correct. And you can do either the mileage deduction or section 179. You can’t, you cannot double dip. You can’t do both.
So let’s, let’s real quick then let’s talk about, so someone that’s doing the mileage has to create a huge like log of miles, which could be a pain in the the butt. Someone that does a lease inside and you have to do the lease inside the business can deduct the lease payments and then obviously like repairs and certain expenses.
Or the third option is the section 179 where you just write off the car. A couple things of that you do have to keep books and records if you’re using this for business and personal. So one way to work around would be if you have one car for personal use and then one car in the business you could write off 100% of that section 179 if it was owned by the business and solely for the business.
So that’s one work around. If you’re doing a percentage like using it for everything then you do have to keep clean books and records of you know if it’s 90% of your example proving that you have 90% if you ever get audited.
Easy to do usually business owners you know lives are so intertwined personally and professionally a lot of the majority of what you do is you know is for business. So with that being said let’s just go through some examples.
So you said $33 ,000 tax right off for the section 179. Now, in five years, if that person goes and sells the car, the $100 ,000 car, they’re now selling it for $30 ,000. That $30 ,000, and then they try to do it again, which they obviously can do.
If they sell that $30 ,000 and buy a new $100 ,000 car, that $30 ,000 gets recaptured. So the next time around, they get the deduction on the $100, they have to repay tax on the $30, so now it’s only a $70 ,000 deduction.
Now, if they kept that car forever and just drove it into the ground and they bought a second car in the business, then they could get the full ride off. But I just want to be clear, if you sell that old car and do it again, which you absolutely can do, there’s a recapture, but if you don’t sell that car and you do it in a car, then you can drive in the ground and get the full ride off as well.
So let’s go through some examples. So the biggest thing, and you can just Google Section 179, but it’s a BMW, which there’s a couple cars that would qualify. What are those? I believe the X5. X5, X7, Audi, the Q8, Q7, the escalated Cadillac would qualify, Tesla Model X would qualify, you know, the Lincoln has the navigator that would qualify, just trying to give some real world examples.
Yeah, I think most, like if you own a, like a lot of the trucks, you know, if you own a business that, I don’t know, like landscaping or something like that, if you need a pickup truck, those will qualify.
One of our clients, Sprinter Vans, those qualify. So anything over 6 ,000 pounds, most car companies have one line that’s gonna be a heavy vehicle. Sometimes they have two, like the BMW, the X5 and the X7.
So just check the curb weight. And then so the other rule, when does this have to be, this is key. So if someone’s trying to do this for 2023, what’s the, like an IRA for 2023 as a cutoff of like April 15th of 2024, that technically you can still go back and get that for 2023?
How does section 179 work? Like when does the car have to be purchased and put in use? Yeah, it has to be put in use. in the calendar year in which you plan on taking the deduction. So if you buy the car, you know, let’s say you buy the car in 2023, but you actually, I’m sorry, let’s say you buy the car in 2022, but it doesn’t actually get put in use until 2023.
You can’t claim Section 179 back in 2022. It has to be done in the calendar year in which you buy the car and actually put it in use. So if you’re trying to do this for 2023, you got it, you got it. You order a Tesla and it’s on a two month backlog.
You better act. That car has to be here and put into use before December 31st of 2023. If you’re trying to do it for 2024 and make sure it doesn’t get put into use before 12 31 or else, you know, you’re going to only be able to go for that deduction in a year, maybe where your income is lower if you’re trying to time it.
So make sure the timing is is good there because a lot of cars because of the COVID still backlogged take one, two, sometimes we’ve even seen three months to be put into place. And then that’s that’s really the main point of this and a huge point is this.
should be done in a year in which you have a high taxable income, or you have high profits and you want to lower that income, particularly if you’re in that 37% tax bracket. So it does take some foresight planning to say, hey, we need to get this car in place in this calendar year for this.
Otherwise, if you don’t time it right, and you could be trying to do a tax deduction in a year in which you didn’t even mean to be doing it. So that’s why you got to be super strategic in when you put the car into use.
OK, perfect. We’ll welcome any questions on that. And obviously, work with the CPA. There’s some CPAs we find are really aggressive. We don’t recommend to be really aggressive. And some CPAs are like any little bit of risk.
Like, no, let’s don’t do that. The reality is if you’re a high income earner, the risk of you getting audit, because one of these strategies goes up very little. And as long as you have it, this also forces you to keep clean books and records.
And generally, it allows you, if you’re doing all these strategies, it makes you proactive on everything. So we find that people, clients that do do all these strategies have the best books, the best records, the best audit proof because of the systems that are put into place.
So I think that’s a huge misconception is I don’t want to get audited. Well, this doesn’t really change your chance of being audited. If you’re a high income earner, the high risk is most likely going to look at you if they do.
But just try to save as much taxes as possible all within a legal structure. And when there’s a gray area, work with professionals, work with an advisor, work with a CPA. Generally, we see biases sometimes between attorneys, CPAs, and advisors.
They all view things. So make sure you have a trusted quarterback that can communicate with all those professionals to come to an agreement and alignment that ultimately you as the client make the final decision on.
So just a couple other quick tax tips. So what are some other ways, you know, we talk a lot about A -S -A. So Chris, give us the, our business owner that has a health insurance plan. Talk to us briefly.
about the advantage of having an HSA potentially as an option? Yeah, so if you have a high deductible health plan, you’re eligible to fund an HSA for this year in 2023. We’ve the limit’s 7 ,500. So that’s the only type of account that’s triple tax -free.
So you get a tax deduction when you put the money in, it grows tax -free. And then whenever you take it out, it’s also tax -free. The caveat, however, is the distribution has to be used for a qualified medical expense.
But unlike the other account that’s typically brought up with HSAs, which is an FSA, HSAs roll over year to year. And that balance is yours until you spend it. So for a lot of our clients, we view these as another long -term savings account that’s very tax -efficient because inevitably, whenever you get to retirement age, there’s going to be some sort of medical cost that comes up, whether it’s prescriptions, copays.
Most common is Medicare premiums you can use to pay out of the HSA. If we can do a good job in the accumulation years of funding these accounts, we’ll have a big tax -free bucket that can be used for those costs later on the road.
And avoid tax -back hikes and avoid extra Medicare surcharges, so that the distribution of views for medical don’t have to, don’t go into your modified just gross income, just huge. So just bringing down the math, I mean, so someone that was doing this would pay, let’s say Ben’s paying 300 bucks a month for a health insurance plan, and it’s a low deductible plan.
And so if he’s healthy that year, he basically just wasted 300 bucks a month. If I chose a HSA plan, maybe I’d pay him 150 a month, I’d just save $1 ,800 a year. Now if I have a serious health concern, now I have to go out of pocket a lot more than Ben’s.
Maybe I have to come out of pocket $5 ,000. So now that $1 ,800 savings doesn’t look so good when I had to come out of $5 ,000 out of pocket. That’s a $3 ,200 behind now. But if I max out an HSA, which next year is over 8 ,000, and I’m in the highest tax bracket, that’s almost 3 ,000 I save right there.
So that basically puts us at a break even. So if I’m in a high deductible plan, saving the monthly premiums, also maxing out the HSA, taking that tax right off, even if I reach my out of pocket maximum compared to Ben, I’m basically gonna be in most plans we’ve analyzed at a break even compared to Ben.
So the key is if you have the cash flow to max out that HSA and get that tax right off, even on a bad year health wise, you’re still gonna be in a similar position in a low deductible. Psychologically you have to come up with, okay, I’m gonna max this HSA, if something comes up, I’m not gonna use that HSA, I’m gonna let compounding growth and that tax free environment work for me.
I’m gonna pay for those medical costs out of pocket. So I also have to be disciplined and have that emergency fund or cash that aside to pay those medical costs out of pocket to have the greatest effect on having a high deductible plan for my family and also max that HSA and doing exactly what Chris said.
And just one other note on the HSA, just to put a bow on that. Be sure it is actually invested in equities, particularly if we’re pursuing the strategy that we just discussed. A lot of times, those contributions are done just directly through your employer or they’re through like your employer’s online portal and they could be sent to just a cash account.
So you could think that your HSA is growing tax -free, invested in equities for the long term and if you’re not diligent in checking that, it could just be sitting in a cash account. So it’s really important to make sure that if you’re pursuing the strategy that we just outlined in which the HSA is growing for the mid and long term, we want to make sure that there’s equity exposure.
No question. That’s a great point, Ben. So a couple other things. So we had a whole podcast on real estate. I’m going to point everyone, if you’re a business owner and you own real estate, there’s tax benefits to that.
But there’s this whole, just real briefly, reference last couple weeks ago by the time this is published episode on the real estate, we go into detail. There’s a difference between in a universe of tax rates, there’s an active tax rate, which is that federal 10 up to 10.
at the 37, there’s the passive tax rates, which if you’re long term, are going to be capital gain rates or short term, would also be this active rates. As far as getting a good deduction on your real estate stuff, like depreciation and expenses, even cost segregation, all that stuff, that’s going to help you only if you’re an active participant in that real estate, if you’re looking to offset your W2 or active income.
If you’re not, the real estate’s great, but it’s only going to help you offset other passive income, but you don’t have any other passive income that’s really not going to do you good until later. So again, go back and reference that real estate episode.
We go extremely detailed into how the taxes and complexities around real estate investing work. But I do want to bring that up, because that’s a huge strategy of properly utilized for business owners that have multiple real estate units that works the best, or if they potentially, if you have a spouse that’s able to take that active role and you’re marifying jointly, then you can, that active role of the one spouse handling the real estate, all that tax benefit can go and really help the W2 or the distributions of an S corporation, for example, of the doctor, the other spouse.
That can be an extremely tax efficient strategy to do. So other tax related stuff, obviously there’s lots of charitable stuff you can do. One other recent one that we’ve run into is what’s called an EITC credit.
This is specific in Pennsylvania, but essentially if there’s certain schools, you know, I think a K through A or K through 12 that qualify and you can make a two year commitment. And essentially, if someone owed $10 ,000 in Pennsylvania state tax, they could contribute 9 ,000 to that school.
And 90% of their contribution would offset their state tax as well. So if you’re charitable inclined and want to help, you know, have a certain school that would qualify, this is an easy way. Basically, not avoid state taxes, but to redirect your state taxes specifically to a school that you’re passionate about.
about and then come out of pocket is a little bit for your state tax. And it’s called an EITC credit, which is a strategy that we’ve recommended to a lot of business owner clients as well. But then, Chris, thanks so much for joining any last minute tax tips in general for business owners?
No, I think we hit on a lot of the big ones today. So I think this was super useful in making sure that all these options are presented and, you know, a lot of these are just underreported and under discussed, so making sure that everyone’s super educated on what their options are.
Awesome. Well, Chris, can you speak to specifically, there’s some pretty big tax advantages. I know you’re considering personally between being like a single and then married finally and jointly. So is this why you’re considering some of these personal considerations because of the tax rates or can you talk to an audience a little bit about?
How this works? Yeah, so we’ll keep it strictly business year from a tax standpoint. If you’re single, you have half the runway on the tax bracket. So for the 10% bracket, if you’re single, 22 ,000 of incomes, the cap for 10% versus 44% for married.
So not that you want to get married strictly for tax benefits, but it certainly, certainly helps. So just hypothetically, if there’s a million dollars as a single income earner versus a million dollars, same between a married couple, the married couple we’ve analyzed would pay like, I think it’s like a little bit over $30 ,000 less in federal taxes just for the fact that they’re married versus single.
So some big tax benefits, depending on what kind of tax bracket you fall into. And at certain income levels, it’s like relevant, but in those high income levels, it becomes a huge ordeal. So thanks for bringing that up, Chris.
All right. Well thanks for joining us on this week’s episode of FinLit. Please reach out if you have any questions. And if you haven’t done so already, please hit subscribe. Make sure you follow the podcast depending on what platform and please rate as well.
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Welcome to EWA’s Fin-Lyt podcast. EWA is a fee -only RIA based at Pittsburgh, Pennsylvania. We hope all listeners of this podcast will benefit as we deep dive into complex financial topics that we will make simplified for you.
And we hope that this really serves as a catalyst so that you can make the best financial planning decisions for your family and also save time. Welcome, everybody. On today’s episode of Fin-Lyt we’re going to be talking about tax strategies for small business owners.
So specifically, we’re going to be talking about some tax strategies here with Ben and Chris from the EWA team. Some of the unknown strategies that are out there. So just to get started, we are first going to talk about the difference between entity structures.
So typically, we’re going to be talking about a business owner has the option of what kind of business entity they want. There’s many ramifications being a sole proprietorship versus an LLC, an LLC partnership, or an S -Corporation.
So just to narrow it down here, we’re going to talk about the really the S -Corporation being one tip that we have for business owners and the reason S -Corporation is a good entity. From a tax perspective is that let’s just say there’s a business owner that has essentially a million dollars of profit.
That’s including the compensation he pays himself. So if this business owner was a sole proprietorship, all million dollars would be subject to federal taxes, which start at 7% and go all the way up to 37%, which is graded.
And the second one, assuming Pennsylvania would be a Pennsylvania tax, which would be a 3 .07% flat tax across the board, there would be local tax here in Pennsylvania, and then there would also be Medicare and Social Security tax.
So the three that potentially could be avoided if you’re an S corporation, so for example, if Ben here was a sole proprietor, he would pay Social Security taxes on the first $160 ,200 of that million, and then he’d also pay Medicare taxes, two sides of that, on the entire million dollars, that’d be, you know, $29 ,000, 1 .45 on the employee side, 1 .45 on the employer side, that’d be $29 ,000 of taxes, and he’d also pay local taxes, so Ben lives in Shadyside, which has about a 3% local tax, that’d be another $30 ,000 of tax he would pay.
But instead if Chris were an S corporation, and let’s just say hypothetically, we set up the W -2 to be $100 ,000, so that was his salary, and the other $900 ,000 we set up to be a distribution, Chris would save a lot of taxes, and how he would save those taxes is he would only pay Social Security…
taxes on the 100 ,000 of W -2. So 60 ,200 where the cap is, he would avoid 6 .2% on the employee and 6 .2% on the employer side to 12 .4% of 60 ,000. That’s over 7 ,000 he would save in Social Security tax.
He would also avoid the Medicare tax, the 2 .9% of the 900 ,000. That’s over 26 ,000 of taxes saved right there. He’d avoid the local taxes, the 3% on that 900 ,000 of the distribution. So essentially the salary would get taxed on all levels, but the distribution would avoid of that 900 ,000.
60 ,200 that would avoid Social Security taxes. All 900 ,000 would avoid local taxes. All 900 ,000 would avoid Medicare taxes. And so adding this up, and just in that example there would be over 60 ,000 a year of taxes saved easily.
Now the downside of doing that for Chris is there’s potential in audit risk. So Chris, talk to us about that, the audit risk that could come into play. Let’s say you were a doctor, a cardiologist on average that makes half a million dollars out there and you were paying yourself 100 ,000 a year in a private practice.
Why would that be problematic? First problem would be me being a cardiologist. Good point. Beyond that, if you’re too aggressive with it, the IRS, they know that. They know what the going rate for a cardiologist is, and if you’re paying yourself a $20 ,000 W2 for a doctor, it’s going to raise some flags.
So generally we want to have the W2 portion that’s something that is relative to what you’d be earning if you’re working at a hospital or somewhere else, just to make sure we’re not getting audited and having to pay penalties or anything for underpaying on those taxes.
Okay, so let’s say hypothetically that you’re a cardiologist, as scary as that sounds. The average salary, let’s say for cardiologists is 400 grand. And so you’re saying we’d want to pay the salaries for a grand.
So there’d still be a significant tax saving. on that 600 now, assuming that million dollar total net number to you as the 100% owner of this S -Corporation, would still save, now there’d be no Social Security tax saved because we would have paid you all the way through the 160 plus beyond, but we’d still save Medicare tax and local tax, so almost 6% combined, assuming you live downtown Pittsburgh, which I know you do.
So there would still be 6% of 600 ,000, $36 ,000 of tax savings. Now Ben, what would be the other problem from a retirement plan perspective for Chris if he only paid himself 100 ,000 and he was trying to max out a 401K or cash balance plan?
What problems would arise for him? Yeah, really the big issue that would come into play there is that all, in terms of your 401K, that’s strictly based on your W -2 income, so if Chris pays himself a super low W -2 salary and takes a lot of distributions that make up his compensation, he could be limiting himself.
based on what he can put into his 401k if his W2 income is low. For sure. So if he was trying to max out, Chris is obviously, are you under 50? I can’t tell with that beard. Yeah. Got some white hairs coming, but still under 50.
Chris is under 50, for everyone that didn’t know that. So there’s $66 ,000 a year that he can put into a 401k. And that’s made up of a couple components. So Chris, break those components down. Yeah. So the full amount that can technically go into the 66, like you said, the typical max that people think of whenever they think of how much can I put in, it’s what’s called your elective deferral.
And that’s what you can do is either pre -tax or Roth, and that’s $22 ,500. But if your plan allows, so if you’re self -employed and you’re designing the plan, you can write in the ability to do either after -tax contributions or profit -sharing contributions to fill that difference between 66 and 22 .5.
So if you had a plan for profit -sharing and you only paid yourself $100 ,000, we’d run into issues. Profit -sharing is capped at 25%. So 25% of 100 is 25. You add that to the 22 .5, and you’re in a total of 47 .5.
So we’re not able to max out the 66. However, an after -tax is a dollar -for -dollar basis. So you could pay yourself $100 ,000 and do $22 ,500 in the Roth, hypothetically, and then do the rest up to that 66 in the after -tax, and then immediately convert that to Roth.
So we’d have no problem maxing out a 401k, $100 ,000 salary if we want to do what’s referred to as the mega -back to Roth, where we’re running into issues if we’re trying to get the tax deduction now and trying to max out that profit -sharing.
However, in that $100 ,000 example, we could do a mix of all three. We could do the 22 .5 Roth. We could do the profit -sharing of 25, and we could do the difference, then an after -tax, and convert that to a Roth inside the plan.
So many ways around that, but the key thing here is that S corporations are very advantageous from a tax perspective, but we don’t recommend to be overly aggressive and make sure you pay yourself a salary.
that is industry standard. So if you get audited, which you’re already at a high risk of being audited because of being a million dollar income earner, you do so and you have guardrails around that that the IRS will not have issues with.
And so we found if you can prove here’s the average salary of a owner of this kind of practice, pay yourself that, you’re still gonna have a ton of tax savings from being an S corporation. So where people run, so obviously there’s a tax component.
Now let’s say this S corporation has multiple owners. So the S corporation has three owners, let’s say 160%, the other two are 20%. Is there any flexibility in distributions, Chris, when those profits get distributed?
No, so the S dividend, the portion that’s being paid out above the W2 that has to be split proportionally amongst the other partners based on whatever their percentage ownership is. So it’s rigid. If you were that cardiologist that over 51% of control, you have control of the big decisions of the company.
However, you wouldn’t have control of how the profits are distributed. So even if you want to take those profits all for yourself, or you want to pay someone higher, if you want to distribute the money, it’s rigid.
It has to be the 60, 20, 20 in that example. So the way around that as an S corp is then you could bonus the money as a W2. But then it’s like, well, why are we an S corp? Because on the bonus, it’s really just like a W2.
You’re going to pay all those taxes that you were trying to avoid by doing the distribution. So you have to be aware, if you’re doing an S corp, it’s very rigid. If you have other partners involved, the distributions at least can be are rigid.
And the percentages of actually the company owned, the way around that would be the bonus. But then you have to question yourself, well, why be an S corp? Because the whole reason for being an S corp and paying the extra fees and extra filings, running this payroll company to run the actual payroll, is to save the taxes.
So you have to evaluate the flexibility. The aspect of not having the flexibility for the distributions versus the tax efficiency of an S corporation. So one way around that would be an LLC partnership, where you do have the, you could be 60, 20, 20, and the person that has majority control could distribute 100% of the profits to anybody.
There’s total flexibility in the LLC partnership. But the greatest tax savings of what we talked about would be not in a sole proprietorship, not in a, just a straight out LLC, would be in the S corporation for this specifically.
So let’s discuss next the, let’s jump right to the 401K and cash balance plan. So, because we started to discuss that already. So the, you know, 401K and cash balance plan, Chris talked to us a little bit about the ability to fund the cash balance plan.
Like let’s say, I know we have the sheets here. Like if there’s a 40 year old business owner that has structured the 401K and max out 66 ,000 in the 401K, how much in addition to that, they put into a cash balance plan that’s all attacked right off?
Yeah, so these are all, these are based off of tables the IRS puts out. So if you’re 44, you could do for the first year contribution 139 ,000, that’s all a deductible contribution for the business. Yeah, and the nice thing about a cash balance plan, it’s a hybrid plan, it’s a bucket of money, all participants in your company will be part of that and the actuary keeps track.
But the nice thing is it’s one account and you can put a vesting period on it. Generally, the IRS wants to see a permanency test of this so that you have, you know, you can have it for 10 years, but they generally want to see it’s at least there for five years.
Now, if the business has cash flow problem, it shuts down, there’s an exception to that. Once you roll it, you can roll it out to an IRA in percentages to all the participants. But we’ve seen if you’re a high income or any business owner, this is a very, a very good strategy.
I think very underutilized, a lot of our clients utilize this to save a ton of taxes. There’s asset protection features to it. They do it when they have, you know, in their highest business income earning years on top of their 401k, and then once it’s out, you know, we roll it to IRA to be able to have more flexibility and to be more aggressively invested because the one thing about a cash balance plan is there’s actual real assumptions that generally end up in like a 40, 60, 50, 50 portfolio.
So it’s a huge tax deduction, but while it’s operating as a cash balance plan, you’re not going to get as big of a growth as if you were on all the stock allocation, right, etc. Okay. So let’s, so 401k as a business owner, let’s say you have multiple businesses that are totally unrelated.
Could you have multiple 401ks? Yeah, absolutely. What do you need to watch out for though? Is it common control interests, I believe? So if you’re the owner of one company and another, there could technically be tests that could exclude your ability to make those contributions.
Yeah, there’s tests you have to make across the board. There’s common ownership, there’s employees if there’s crossover, so we need to work with a third party administrator to determine that. We have lots of clients that have multiple 401ks.
Talk to us about the 402g limit. So technically if you had two 401ks, you could put 66 into one and 66 into the other, but you have to be careful about one thing and what is that one thing? Yeah, so that’s going back to the elective deferral we were just talking about.
So that’s the 22 ,500 that you can put in regardless of how many plans you have. That’s capped no matter what. So if you’re already maxing out the 22 ,5 via Roth contributions in one plan, you can still do the full 66 in another, but that either has to be after tax or profit sharing contributions.
So hypothetically you could have a medical practice, let’s say that you’re putting in a Roth 22 ,500, you’re putting in a profit sharing of 30 ,000 and you put the rest into an after tax to convert to a Roth.
So that plan gets fully maxed out to 66. The second plan you could do all as an after -tax contribution and then also convert that to Roth as well. So you could have 66 and one, 66 and other, as long as the 401ks are allowed to coexist next to each other with the two different businesses that you’re involved with.
Pretty cool. So OK, well, let’s move on. So next tip we have is around very appropriate to start talking about this with the FedEx golf tournament starting. This isn’t the FedEx golf tournament, though this is the playoffs.
This is actually we’re going to be discussing the masters in a quick second about the Augusta rule. But then continue. Yeah, you stole you stole the you stole the intro from me. So just take it from here.
Yeah, so the next tax tip, which is like you guys said, but underused, maybe under discussed, is called the Augusta rule. And this is based off of the masters golf tournament that happens in April every year.
And how this came to be was in Augusta, Georgia. They host the Masters every year in April. And over a seven to 14 day period, you’d have all the golfers, all their caddies, all their staff, everyone who puts together the tournament and all the fans, you know, to send down to Augusta for a two week period.
And there’s only so many hotels, and there’d be hundreds of thousands of people that would visit the city. So people would start renting out their homes to all these guests to accommodate everybody. So what the Augusta rule says is that you can rent out your home for up to 14 days, and that rental income that you pool together over that 14 day period, you do not have to pay taxes on.
So how does this make sense for a business owner back to tax tips for small businesses? You can rent out your home to your business for business purposes for again, up to 14 days throughout the year.
Whether that’s a monthly meeting, you know, a biannual or annual meeting, or an end of the year meeting, again, you can have 14 days where you can rent out your home to your business, and all of the income that you receive from that rental is not considered taxable.
So just walking through an example of this, let’s say you have a million dollar home, and again, a lease needs to be drawn up, and appropriate rent needs to be charged, a good general rule of thumb is somewhere around 0 .1% of the home’s fair market value.
So again, if you have a million dollar home, that would equate to about $1 ,000 a day of rent. If you follow that strategy and you rent out your home for 14 days, $1 ,000 a day, that’s $14 ,000 worth of rental income, and if you’re in the highest tax bracket at 37%, normally you’d be subject to a $5 ,000, tax liability on that income, but since you’re under that 14 day limit, that $14 ,000, you’re not subject.
to federal tax. So literally, and most business owners do business in their house. So it’s literally this is a bookkeeping where you have your business account in QuickBooks, set up a transaction, 1 ,000 a month.
Let’s just say you have a recurring team strategy meeting at your house where you keep board notes and everything. So 1 ,000 a month goes from your business account to your personal account. And if that was running through payroll and you’re that million -dollar income earner, that would be coming out at a 37% federal tax rate.
That comes to you where it is 0% tax rate because of this Augusta rule. So the Augusta rule, obviously, many good things came out of it. One is this easy tax savings for business owners that properly utilize it for legitimate business.
I would say the second good thing that came out of it was a policy that we had to start at EWA during stock market hours not having TVs on. Because the Augusta rule, there was some watching of golf during business hours.
So we were able to calibrate into it really good. strategy there for our firm as well. Well, I think I have any comments on that. Yeah, I just think a lot of our employees were trying to better understand the rule.
The rule is called the Augusta rule. So by kind of watching the masters, we’re able to get a hand on this. And actually, I’d like to take this a step further. Chris and I were more kind of learning by doing kind of guys.
So maybe next time we’re actually going down to Augusta to the masters to kind of see this rule in action. Again, kind of a conversation for a future day. But talking about it gives us a good understanding, but actually experiencing it, I think Chris would be.
Hey, if you guys can get tickets for me as well, we’re in, we’re going, no PTO docs, everything. Yeah, I agree. Hands -on experience is always the best. So you guys get the tickets and we’ll do it. All right, we’ll talk about it.
All right, perfect. Hope you’re enjoying this week’s Finland by EWA podcast. One quick disclosure before we talk about hiring your children on payroll, which can save a tremendous amount of taxes for your family -owned business.
We wanted to point out that this is a state -by -state specific thing. So make sure to talk with your attorney and look into the labor law rules in your state specifically before implementing this strategy.
Some states allow this, some states do not. So again, check with your attorney, check with your CPA, and we’re also happy to discuss with you. Now back to the show. So what’s next? What’s the next tax tip do we have?
Chris, let’s hand it to you. You work with a lot of business owners, Ben does as well. So Chris, what’s another strategy for business owners that have kids? Yeah, so this is one, like all these that we’re talking about, underutilized, but you can actually hire your children.
And for the 2023 tax year, if you’re paid less than $13 ,850, you don’t have to file a tax return. So that number, if it sounds familiar, it’s the standard deduction for single people. So as long as you’re under, as a kid, if you’re earning that income, it’s 0% tax savings.
So a lot of our clients that have business owners, businesses and also have kids, though, if there’s stuff around the office that they can help with small tasks or even for advertising, some kids will be models for the company and we’ll process a one -time payment of that amount for $13 ,850, and it’s immediately.
If the business owner is in a 37% bracket, that’s an immediate 37% tax savings on the $13 ,850. Does that have to go to the kid or could that be utilized in the financial plan in some way? Yes. It’s going to be rerouted in a couple transactions.
In reality, the majority of our clients, I believe, use this strategy. It’s not like it goes to the kid and the kid’s spending it on Legos. It’s going to the kid and then going where? That’s a good point.
The second step, generally, we’ll have the kid max out or athirae. If you have the earned income, that opens the ability to fund for this year $6 ,500 into a athirae. And then beyond that many of our clients who have kids also want to plan for their education So they’ll have a 529 plan established So that remainder the difference between the 13850 and 6500 that goes to a 529 plan So so the parents were already contributing the 529 plan so instead of you know contributing 10 ,000 that the parent would have had to earn almost 14 ,000 to get to the 10 They can pay the kid 10 and then reroute it directly into what they were already planning and so like per kid as you said What’s 37% of 13850 hard to about right now?
I mean it’s almost 5 ,000 per kid per year that you can save see if you have three kids It’s just an easy 15 a year again talk to us about the audit risk We never recommend doing this unless it’s actual legitimate work So you give the example modeling sets that you know if the company has a social media page and their kids on it That’s legitimate business use Other examples, you know The client recently that their their kids are gonna come in and keep track of the all the drinks in the office and restock that and like Create Excel spreadsheets to track that that’d be a good example one of our clients You know does the the garbage does some cleaning?
Have their kids do all that kind of stuff. So as long as it’s legitimate work when this is a legitimate Strategy, you know and and a completely underutilized but a great strategy that we recommend For clients that want to involve their kids in the businesses.
Yeah, and you can even go That 13 850 is the amount that you can do without having to file a return, but you could also so the next That 13 850 is tax -free and then then come up to 22 ,000 for 2023 that that incomes a 10% bracket So even if you’re a business owner in the 37% bracket You could go above that still that above that 13 850 and they’re still tax savings.
It’s good. You can pay your kid like 30 grand Like 13 850 of that’s 0% federal taxes than the rest of that would be a 10% tax. That’s a lot better if again and you’re utilizing that money to max out the 529 plan, for example, and you’re going to do that with your own money.
You’re just maxing out the 529 plan now with a 10% tax hit versus a 37% tax hit. The only downside is, actually, if you go above that, your kids are going to, depending on what kind of entity you have, will pay FICA taxes.
So they’re going to pay the Medicare and the Social Security. So it’s not an exact like 10 versus 37. It would be like a 10, because the parent would have been, or even maxed out in the Social Security, whereas the kid, that would have to be reintroduced.
But there’s still a significant, sometimes, like 15%, 20%, 25% tax savings, even if you go above that. But if a kid’s just modeling, it would be tough to go above $13 ,850 if a kid’s just taking out trash one hour a week.
So look at hourly rates of what you would pay and how much the kid is actually doing to determine this. But at least the $13 ,850, if the kid can do enough work, they get that 0%. That’s an amazing. So talk to us about, like, how much the implementation of this.
Like if someone was interested in doing this, like what would they have to do to actually implement this? Yeah, so it has to go through payroll. You know, it has to all be by the book. So we coordinate that.
We want to have a clean paper trail. So we want to show the payment going to the child. And then generally from there, we’ll have the payroll company just wire it directly to the Roth IRA to the 529.
Just make sure everything’s clean. Or alternatively, we could set up a bank account for the kid with a parent, like a custodial account, have the payroll go there and then have the money then automatically drafted from the kid’s bank account into the Roth or into the 529.
Either way. So yeah, kids just officially go on payroll. And then from there, it’s really, it can just be automated. Which is really cool. So one time set up. And then so obviously we want to have commerce.
Highly recommend, consult with your CPA. Talk about the risks, the pros and the cons. But if we can make this actual legitimate, they’re doing work. They’re getting paid at an hourly rate. It’s a great way to save taxes above and beyond the regular ways.
So one quick side note. Again, hope you’re enjoying this week’s Finlitt by EWA podcast. Next up, we’re going to talk about different ways for using your car as a deduction in your business. And specifically the Section 179.
So as a quick disclaimer, Section 179, if your car is over 6 ,000 pounds, you can deduct in 2023 up to 28 ,900 of a value. Under the current tax code, there are bonus rules. And the bonus is not capped.
And the bonus allows in 2022, how you to take 100% of the deduction. But this is getting phased out 20% per year. So now that we’re in 2023, if you have a vehicle, you can do 80%, which includes the regular Section 179 plus the bonus rule.
So if you have $100 ,000 car, you can deduct $80 ,000, 80% and $100 ,000 in 2023. And this will continue to get phased out 20% until along with other rules in 2026 get phased out. Now back to the show.
All right, so next tip is around cars. So Ben, talk to us about the different options for how a business owner could use their car for a tax write off. Yeah. What are the options they have and how do they work?
Yeah, so I would say, generally speaking, there are three main options that we see day to day with our business owner clients in regards to their cars. The first one, pretty simple, if you’re leasing a business car, you can deduct that payment.
That’s a common strategy we see. The second one is just using the standard IRS mileage rate, which in 2023, as we’re filming, is $0 .65 per mile driven. And again, this is strictly for business miles.
So what does it mean by a business mile? driving to a client meeting or driving to a speaking engagement or driving to anything business related. That is not your normal commute. So driving to and from your place of work would not count as a business mile.
So in this example, let’s say over in 2023, you drove 10 ,000 business miles. You could say 65 cents per mile. Boom. It’s a $6 ,500 tax write off based on your business travel throughout that year. The third one and something that we’ll talk about in greater detail here is called section 179, which is in reference to a specific section in the internal revenue code that allows you to take an accelerated deduction based on the amount, the percentage amount that you use your business car in a calendar year.
So how this would work. There’s a, there’s a couple of caveats. Number one, your car needs to be over 6 ,000 pounds. And the actual deduction that you need to be using it for has to be used for business purposes.
So as an example, let’s say you have a $100 ,000 car and 90% of the time it is used for business purposes. And again, this is tracked through clean books and records, mileage reports, all of that 90% of the time it’s used for business purposes.
So that would be a $90 ,000 deduction that you would be able to take in that calendar year. And again, if you’re a business owner that’s in the highest tax bracket at 37%, that’s a $33 ,000 tax savings by simply performing that right off and getting that 37% tax break on the $90 ,000 deduction that you’re taking.
Which is five times higher than mileage deduction for someone driving 10 ,000. That’s, that’s correct. And you can do either the mileage deduction or section 179. You can’t, you cannot double dip. You can’t do both.
So let’s, let’s real quick then let’s talk about, so someone that’s doing the mileage has to create a huge like log of miles, which could be a pain in the the butt. Someone that does a lease inside and you have to do the lease inside the business can deduct the lease payments and then obviously like repairs and certain expenses.
Or the third option is the section 179 where you just write off the car. A couple things of that you do have to keep books and records if you’re using this for business and personal. So one way to work around would be if you have one car for personal use and then one car in the business you could write off 100% of that section 179 if it was owned by the business and solely for the business.
So that’s one work around. If you’re doing a percentage like using it for everything then you do have to keep clean books and records of you know if it’s 90% of your example proving that you have 90% if you ever get audited.
Easy to do usually business owners you know lives are so intertwined personally and professionally a lot of the majority of what you do is you know is for business. So with that being said let’s just go through some examples.
So you said $33 ,000 tax right off for the section 179. Now, in five years, if that person goes and sells the car, the $100 ,000 car, they’re now selling it for $30 ,000. That $30 ,000, and then they try to do it again, which they obviously can do.
If they sell that $30 ,000 and buy a new $100 ,000 car, that $30 ,000 gets recaptured. So the next time around, they get the deduction on the $100, they have to repay tax on the $30, so now it’s only a $70 ,000 deduction.
Now, if they kept that car forever and just drove it into the ground and they bought a second car in the business, then they could get the full ride off. But I just want to be clear, if you sell that old car and do it again, which you absolutely can do, there’s a recapture, but if you don’t sell that car and you do it in a car, then you can drive in the ground and get the full ride off as well.
So let’s go through some examples. So the biggest thing, and you can just Google Section 179, but it’s a BMW, which there’s a couple cars that would qualify. What are those? I believe the X5. X5, X7, Audi, the Q8, Q7, the escalated Cadillac would qualify, Tesla Model X would qualify, you know, the Lincoln has the navigator that would qualify, just trying to give some real world examples.
Yeah, I think most, like if you own a, like a lot of the trucks, you know, if you own a business that, I don’t know, like landscaping or something like that, if you need a pickup truck, those will qualify.
One of our clients, Sprinter Vans, those qualify. So anything over 6 ,000 pounds, most car companies have one line that’s gonna be a heavy vehicle. Sometimes they have two, like the BMW, the X5 and the X7.
So just check the curb weight. And then so the other rule, when does this have to be, this is key. So if someone’s trying to do this for 2023, what’s the, like an IRA for 2023 as a cutoff of like April 15th of 2024, that technically you can still go back and get that for 2023?
How does section 179 work? Like when does the car have to be purchased and put in use? Yeah, it has to be put in use. in the calendar year in which you plan on taking the deduction. So if you buy the car, you know, let’s say you buy the car in 2023, but you actually, I’m sorry, let’s say you buy the car in 2022, but it doesn’t actually get put in use until 2023.
You can’t claim Section 179 back in 2022. It has to be done in the calendar year in which you buy the car and actually put it in use. So if you’re trying to do this for 2023, you got it, you got it. You order a Tesla and it’s on a two month backlog.
You better act. That car has to be here and put into use before December 31st of 2023. If you’re trying to do it for 2024 and make sure it doesn’t get put into use before 12 31 or else, you know, you’re going to only be able to go for that deduction in a year, maybe where your income is lower if you’re trying to time it.
So make sure the timing is is good there because a lot of cars because of the COVID still backlogged take one, two, sometimes we’ve even seen three months to be put into place. And then that’s that’s really the main point of this and a huge point is this.
should be done in a year in which you have a high taxable income, or you have high profits and you want to lower that income, particularly if you’re in that 37% tax bracket. So it does take some foresight planning to say, hey, we need to get this car in place in this calendar year for this.
Otherwise, if you don’t time it right, and you could be trying to do a tax deduction in a year in which you didn’t even mean to be doing it. So that’s why you got to be super strategic in when you put the car into use.
OK, perfect. We’ll welcome any questions on that. And obviously, work with the CPA. There’s some CPAs we find are really aggressive. We don’t recommend to be really aggressive. And some CPAs are like any little bit of risk.
Like, no, let’s don’t do that. The reality is if you’re a high income earner, the risk of you getting audit, because one of these strategies goes up very little. And as long as you have it, this also forces you to keep clean books and records.
And generally, it allows you, if you’re doing all these strategies, it makes you proactive on everything. So we find that people, clients that do do all these strategies have the best books, the best records, the best audit proof because of the systems that are put into place.
So I think that’s a huge misconception is I don’t want to get audited. Well, this doesn’t really change your chance of being audited. If you’re a high income earner, the high risk is most likely going to look at you if they do.
But just try to save as much taxes as possible all within a legal structure. And when there’s a gray area, work with professionals, work with an advisor, work with a CPA. Generally, we see biases sometimes between attorneys, CPAs, and advisors.
They all view things. So make sure you have a trusted quarterback that can communicate with all those professionals to come to an agreement and alignment that ultimately you as the client make the final decision on.
So just a couple other quick tax tips. So what are some other ways, you know, we talk a lot about A -S -A. So Chris, give us the, our business owner that has a health insurance plan. Talk to us briefly.
about the advantage of having an HSA potentially as an option? Yeah, so if you have a high deductible health plan, you’re eligible to fund an HSA for this year in 2023. We’ve the limit’s 7 ,500. So that’s the only type of account that’s triple tax -free.
So you get a tax deduction when you put the money in, it grows tax -free. And then whenever you take it out, it’s also tax -free. The caveat, however, is the distribution has to be used for a qualified medical expense.
But unlike the other account that’s typically brought up with HSAs, which is an FSA, HSAs roll over year to year. And that balance is yours until you spend it. So for a lot of our clients, we view these as another long -term savings account that’s very tax -efficient because inevitably, whenever you get to retirement age, there’s going to be some sort of medical cost that comes up, whether it’s prescriptions, copays.
Most common is Medicare premiums you can use to pay out of the HSA. If we can do a good job in the accumulation years of funding these accounts, we’ll have a big tax -free bucket that can be used for those costs later on the road.
And avoid tax -back hikes and avoid extra Medicare surcharges, so that the distribution of views for medical don’t have to, don’t go into your modified just gross income, just huge. So just bringing down the math, I mean, so someone that was doing this would pay, let’s say Ben’s paying 300 bucks a month for a health insurance plan, and it’s a low deductible plan.
And so if he’s healthy that year, he basically just wasted 300 bucks a month. If I chose a HSA plan, maybe I’d pay him 150 a month, I’d just save $1 ,800 a year. Now if I have a serious health concern, now I have to go out of pocket a lot more than Ben’s.
Maybe I have to come out of pocket $5 ,000. So now that $1 ,800 savings doesn’t look so good when I had to come out of $5 ,000 out of pocket. That’s a $3 ,200 behind now. But if I max out an HSA, which next year is over 8 ,000, and I’m in the highest tax bracket, that’s almost 3 ,000 I save right there.
So that basically puts us at a break even. So if I’m in a high deductible plan, saving the monthly premiums, also maxing out the HSA, taking that tax right off, even if I reach my out of pocket maximum compared to Ben, I’m basically gonna be in most plans we’ve analyzed at a break even compared to Ben.
So the key is if you have the cash flow to max out that HSA and get that tax right off, even on a bad year health wise, you’re still gonna be in a similar position in a low deductible. Psychologically you have to come up with, okay, I’m gonna max this HSA, if something comes up, I’m not gonna use that HSA, I’m gonna let compounding growth and that tax free environment work for me.
I’m gonna pay for those medical costs out of pocket. So I also have to be disciplined and have that emergency fund or cash that aside to pay those medical costs out of pocket to have the greatest effect on having a high deductible plan for my family and also max that HSA and doing exactly what Chris said.
And just one other note on the HSA, just to put a bow on that. Be sure it is actually invested in equities, particularly if we’re pursuing the strategy that we just discussed. A lot of times, those contributions are done just directly through your employer or they’re through like your employer’s online portal and they could be sent to just a cash account.
So you could think that your HSA is growing tax -free, invested in equities for the long term and if you’re not diligent in checking that, it could just be sitting in a cash account. So it’s really important to make sure that if you’re pursuing the strategy that we just outlined in which the HSA is growing for the mid and long term, we want to make sure that there’s equity exposure.
No question. That’s a great point, Ben. So a couple other things. So we had a whole podcast on real estate. I’m going to point everyone, if you’re a business owner and you own real estate, there’s tax benefits to that.
But there’s this whole, just real briefly, reference last couple weeks ago by the time this is published episode on the real estate, we go into detail. There’s a difference between in a universe of tax rates, there’s an active tax rate, which is that federal 10 up to 10.
at the 37, there’s the passive tax rates, which if you’re long term, are going to be capital gain rates or short term, would also be this active rates. As far as getting a good deduction on your real estate stuff, like depreciation and expenses, even cost segregation, all that stuff, that’s going to help you only if you’re an active participant in that real estate, if you’re looking to offset your W2 or active income.
If you’re not, the real estate’s great, but it’s only going to help you offset other passive income, but you don’t have any other passive income that’s really not going to do you good until later. So again, go back and reference that real estate episode.
We go extremely detailed into how the taxes and complexities around real estate investing work. But I do want to bring that up, because that’s a huge strategy of properly utilized for business owners that have multiple real estate units that works the best, or if they potentially, if you have a spouse that’s able to take that active role and you’re marifying jointly, then you can, that active role of the one spouse handling the real estate, all that tax benefit can go and really help the W2 or the distributions of an S corporation, for example, of the doctor, the other spouse.
That can be an extremely tax efficient strategy to do. So other tax related stuff, obviously there’s lots of charitable stuff you can do. One other recent one that we’ve run into is what’s called an EITC credit.
This is specific in Pennsylvania, but essentially if there’s certain schools, you know, I think a K through A or K through 12 that qualify and you can make a two year commitment. And essentially, if someone owed $10 ,000 in Pennsylvania state tax, they could contribute 9 ,000 to that school.
And 90% of their contribution would offset their state tax as well. So if you’re charitable inclined and want to help, you know, have a certain school that would qualify, this is an easy way. Basically, not avoid state taxes, but to redirect your state taxes specifically to a school that you’re passionate about.
about and then come out of pocket is a little bit for your state tax. And it’s called an EITC credit, which is a strategy that we’ve recommended to a lot of business owner clients as well. But then, Chris, thanks so much for joining any last minute tax tips in general for business owners?
No, I think we hit on a lot of the big ones today. So I think this was super useful in making sure that all these options are presented and, you know, a lot of these are just underreported and under discussed, so making sure that everyone’s super educated on what their options are.
Awesome. Well, Chris, can you speak to specifically, there’s some pretty big tax advantages. I know you’re considering personally between being like a single and then married finally and jointly. So is this why you’re considering some of these personal considerations because of the tax rates or can you talk to an audience a little bit about?
How this works? Yeah, so we’ll keep it strictly business year from a tax standpoint. If you’re single, you have half the runway on the tax bracket. So for the 10% bracket, if you’re single, 22 ,000 of incomes, the cap for 10% versus 44% for married.
So not that you want to get married strictly for tax benefits, but it certainly, certainly helps. So just hypothetically, if there’s a million dollars as a single income earner versus a million dollars, same between a married couple, the married couple we’ve analyzed would pay like, I think it’s like a little bit over $30 ,000 less in federal taxes just for the fact that they’re married versus single.
So some big tax benefits, depending on what kind of tax bracket you fall into. And at certain income levels, it’s like relevant, but in those high income levels, it becomes a huge ordeal. So thanks for bringing that up, Chris.
All right. Well thanks for joining us on this week’s episode of FinLyt. Please reach out if you have any questions. And if you haven’t done so already, please hit subscribe. Make sure you follow the podcast depending on what platform and please rate as well.
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