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!
Smash or Pass [the Tax Bill] βοΈ
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Every December, I talk to business owners who are scrambling to cut their tax bill at all costs. Buy a new truck. π Don't deposit checks from customers. ποΈ Prepay invoices to vendors (my favorite as a vendor, personally). πββοΈ But when does it make sense to take the medicine and pay the tax? It all depends on (1) what you want to retire with, and (2) how you'll make it. Let's talk Tax Strategy 301. β€΅οΈ The Benefits of Paying the Tax - Low Tax-Cost of BasisPaying a π€ little tax now can save more π€² in taxes later. When you recognize taxable income, that establishes tax basis for you in that asset. And an under-appreciated concept in tax planning is tax-cost of basis. π° For example:
In a low income year, I accelerate another $10,000 of income from a discretionary bonus. After tax at 12%, that $10,000 turns into $8,800 cash.
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In the following year, I have a big income year and donate that same $8,800 cash to a charity. That $8,800 saves me 37% in taxes, or $3,256. The cost of that $8,800 was $1,200 - but the tax savings nearly tripled the cost.
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Compare that to if I recognized the $10,000 in a high income year AND donated in that same year. The tax rate applied to that income would be 37% - the same as the deduction rate. Making it a wash.
This is how you play the bracket game π - but where is the breakeven? Know Your Number and How You'll Get ThereStep 1 is knowing how much money you'll retire with. π¦ Once you have this, work backwards with Step 2. Step 2 is figuring how you'll get to that number. πΊοΈ This takes planning and foresight - something needed if you care about lowering your tax-cost of basis. There are many ways to build wealth, and a part of the strategy system we use is to put taxpayers in avatars πΎ (helping us identify commonly grouped tax strategies for any given taxpayer):
Which one you are - or what blend of them you are - drives what your "Lifetime Effective Tax Rate" (LETR). π€― Your LETR is the average tax rate you'll pay on income while you're on this side of heaven A W2 employee will compound wealth at an average higher tax rate than a real estate owner π’ - whose income events are more eligible for capital gains rates (lower than ordinary rates). Inheriting assets π₯ comes with a cost to the estate but not the person inheriting the property (unless it's retirement accounts). So that will come at a lower tax rate than a SMB owner. Putting It All TogetherOkay, so what if you don't have the time to put all this down and plot it out. Let's establish some likely averages for each type of wealth accumulation style that you can take into end of year meetings and know do you smash or pass (the tax bill). π²
Any time someone in a W2 job gets a chance at a big income event at 20%, there's a good chance they should pay the tax. π§ When a real estate owner has an opportunity for a major income / fee event, they should probably defer π as much as they can. You get the picture with these estimates - but they are just estimates. Everyone's case is different and everyone should talk to a professional before deciding anything. π£οΈ The TakeawayPaying the tax isn't always a bad thing. It can establish a very low-cost tax basis which can provide tax benefits triple that cost in a future year. But the critical component is perspective and a plan of how you'll get where you want to get to. π«‘ π₯ Hottest Finance Posts This Week π₯
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The Plug [Newsletter]
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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Ten years ago, I met with my business development partner and shared with him this idea of documenting and sharing the tax strategies each client was using. π It would make us intentional strategists - having to commit to strategies and execute on them. The idea floundered in that firm but it stuck with me. Fast forward to 4 years ago when I left Baker Tilly and shared the same idea with my now partner, Mitchell Baldridge. We doubled down into the idea and have built out work-up's and...
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