I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox π Also on YouTube at PlugAccountingandTax!
Next Step - Max Out Deductions or Max Out Income π€
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Last week was about cleaning up πΏ the books before year-end planning. This week is what we do with those clean numbers. Almost every year, a client sits down and says some version of this: "What can we do to wipe out my tax due?" Nobody likes writing checks. But we have to reframe that this year's bill is a small slice of the picture β€΅οΈ The Wrong Unit of Measure πWhen the goal is "zero this year," every decision gets judged against one tax return. But that's not my job - my job is to play the long game. The number I care about is the effective rate across years. Ideally, a lifetime. Tax brackets step up as income rises. So the same cash received can cost more or less depending on which year it lands. Income bunched into one year gets taxed at the top of the ladder. That same income spread across years π uses the lower rungs more than once. Example - Client has an average income year. Is growing his business so wants to avoid all tax payments whatsoever.
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Rushes to buy equipment and trucks before the end of the year to fund his growth. Pays tax at an effective rate of 10%. ($400k income - $300k CAPEX = $100k income x 10% tax = $10k tax)
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But the growth happens - and next year, his income has doubled. But with the leverage he took on last year, he doesn't have the cash to buy enough equipment to get the tax down. And he pays tax at an effective rate of 30%. ($900k income - $0 CAPEX = $900k income x 30% tax = $300k tax)
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Over those two years he paid $310k of tax on $1MM of income.
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If instead he'd deferred more CAPEX to the higher income year, year 1 would have been more like 15% tax rate ($400k income - $100k CAPEX = $300k x 15% = $45k tax) and year 2 would have been at a 25% rate ($900k income - $200k CAPEX = $700k x 25% = $175k tax).
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Total tax by deferring CAPEX = $220k. Tax bracket arbitrage = $90k.
Sometimes You Want to Accelerate IncomeThis surprises people. Deferring income is the reflex, but there are years when I'd pull income forward: A low-income year, where the 10% - 12%brackets would otherwise go unused are gold mines for planning.
A low-rate year can be a good time for a Roth conversion or capital gain harvesting among other things. An unused low bracket doesn't carry over. If you don't fill it this year, it's gone. The Toolkit for Shaping Taxable Income π§°All of this is timing and planning within the rules. Here's what I reach for: Income timing
Deduction timing
The TakeawayBefore chasing a zero tax bill, map three years: this year, next year, and the year of your next big event (a sale, a retirement, a property stabilizing). Then pick the lever that evens out the rate, whether that means deferring, or accelerating income. π«‘ Group Chat Worthy Posts π₯π²
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I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox π Also on YouTube at PlugAccountingandTax!
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