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Hard Mode πΉοΈ - Unflexible Tax Structuring
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"You will spend your 50s and 60s unwinding what you set-up in your 30s and 40s" - or so goes the popular tax adage. 𧡠Peaking in earning too young has a way of making you paranoid of tax. The aggressiveness that brings early success will often bleed into tax structuring - being willing to take positions to mitigate as much tax as possible. And many (often good) advisors and attorneys won't warn you against these structures because they're lucrative for them too. So you get a whole lot of people giving you confirmation of what often is a narrow or time-bound perspective. Today, we're going to look at three ways you can really make life harder on yourself when setting up a business structure:
Before we dive in - I wanted to share the most recent episode on Today in Tax Court. In this special edition, I work through the history of the US income tax code. Specifically with an eye towards small business and business owners. It was a fun one I've been working on for a while, so I'm excited to share it:
TrustsI'm all for estate planning - but it has to be kept at the right level and in the right measure. π A common set-up for entrepreneurs looking to estate plan is to just have a trust own a part of their business. While efficient in design, it usually only contemplates one exit - a sale. But not every exit will be a sale. Sometimes you'll want to recapitalize or leverage up, or change up ownership in another way. Having trusts as direct owners of the business makes this more complicated. You can still get similar estate planing effects by using income generated from the business to purchase low value, high potential assets and keep those in the trust. To keep flexibility π§ββοΈ, it's about keeping the trusts at the right level in your personal tax structure. β Non-ProfitsIt's not worth it. The brain damage it takes to defend the actual non-profit motivation against inevitable IRS scrutiny is such a distraction to the business. π§ You can achieve similar levels of tax benefit just be giving appreciated stock or just cash to qualified non-profits. Once value is inside a non-profit, you need to spend it on qualified mission-oriented expenses. You can't loan it back to yourself. You can't take a massive paycheck. And no one is getting a distribution from that. And when you sell, that value is stuck in the non-profit - many times resulting in a similar position as if you would have just given cash to another organization. It looks cool on the org. chart - but it's only a headache in practice. β ESOPsEmployee Stock Ownership Plans (ESOPs) are a popular exit opportunity for business owners who want to keep the company "employee owned." But most employees don't want real ownership - they want predictable ways to earn more cash. And ESOPs require substantially more energy to maintain and keep compliant to boot. If you thought having a 2-3 partners was bad, wait until you have 300. ποΈ It brings in a level of distraction and risk to the decision makers that is unnecessary and unproductive to the long-term health of the business. Out of the handful of ESOPs I've worked closely with, 75% or so have been unwound within 3-5 years. π ββοΈ β The name of the game in tax strategy is always optionality. Tax benefits will always come with trade-offs - primarily control and access. When you're drawing tax structures, keep in mind the best question to ask is "how hard will this be to unwind?" π«‘ π₯ Hottest Finance Posts This Week π₯β
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