Last week, we talked about why basic accounting is critical to small business owners - including the extreme real example of having the business valuation move by 7 figures in the wrong direction. If you missed it, check out the previous issues link at the bottom of this email. 👇

But accounting is the boring bit. Once we feel good about our reporting, nailing down the tax strategy is the next big project. 🏚️ That's because taxes are the average highest single cost over the taxpayers lifetime. Less tax = more cash = more opportunity.

I'm currently working on a "lifetime path of tax" that walks through basic tax planning foundations and common strategies that I'll share with all subscribers. But it's not fully baked yet, so today we're going to talk main categories of tax strategy:

1. Structure
2. Elections
3. Timing

For those who follow me on X / Twitter - you may recognize the below infographic I shared last year. We won't go through each one - instead we'll keep it high level.

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Structure

It starts with good structuring. And to make the best entity choice, it's important to decide with the end in mind.

The answer to "What type of entity should I be?" is always "How are you going to exit?" Your exit drives a major influence on entity choice - the other factors being "how are you making money and from where." 🤔

But before expanding on which type makes sense for different scenarios - educate yourself on the basics. Entity selection starts with the state. When your CPA asks what kind of entity you are, the answer "LLC" rarely means anything to them. CPAs see entity selection heavily through the federal lens. Check out the below chart:

This maps out what kind of entity you select at the state level and how it impacts what Federal (IRS) form you need to file. Note that an LLC can be everything for federal purposes - disregarded, partnership, C-Corp, and S-Corp. 🚰

When in doubt, attorneys usually advise my clients to create an LLC as it retains this flexibility. An Inc., on the other hand, limits your ability to ever be a partnership without an entity conversion. But I digress.

Here are some of the basic drivers of preference for each entity type:

• DBA / Disregarded Entity 🏃‍♂️ - small start-up that won't raise money; side hustle that will make under $100k; 1 or 2 rental properties owned by you 100%
• C-Corp 💻 - technology start-ups or other Qualified Small Business Stock (QSBS) eligible companies; public companies; companies with non-US residents as investors; CAPEX intensive companies looking to reinvest profits at a lower tax rate for compounding
• S-Corp 💰 - fee or simple income streams usually; simple ownership structure and single class of equity; all natural persons as owners (limited exceptions); no appreciating assets subject to debt
• Partnership 🏢 - appreciating assets or operational assets subject to debt; rental real estate; complex "waterfall" type equity; various types of investors

Again, an LLC is a state election and can be any of the above.

Getting the structure right is critical for any future tax planning to make sense, so always talk to a professional about your unique situation.

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Elections

In my head, this is the "compliance" part of tax planning. 📝

There are some check-the-box things that tax returns need - some are procedural, some are reactive, and some proactive.

A common one in the real estate world is the 163j Real Property Trade or Business election. This election is a special allowance for rental real estate assets that bypasses an interest expense limitation. Meaning, without this many rental properties can't deduct their full interest expense for tax purposes. But this comes with a trade-off on bonus depreciation-eligibility for some assets, so must be weighed carefully against future CAPEX spend.

Other elections are referred to as "methods" - for example moving from accrual to cash basis. In 2017, tax reform was passed that significantly increased the revenue thresholds that required businesses to file accrual basis. This was a windfall for a lot of my clients who could now defer paying tax on accrued income. 🫰

Last example are things like "aggregations" - this is when multiple "activities" or businesses are eligible to be lumped together for tax purposes. Two common aggregations are the 469 Real Estate Activity aggregation, and the 199A Qualified Business Income aggregation. Both of these are tremendous planning options that can create major tax savings if they weren't made.

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Timing

A foundational principle of tax planning is that tax brackets create arbitrage opportunity. 🔺🔻

You prefer to use $1 of deduction at a 37% tax bracket rather than at a 10% tax bracket. Likewise, you want to accelerate income in low overall income years and defer in higher. The game is all about matching high income with high deductions and low income with low deductions. 👉 👈

An example of this is timing of cost segregation for real estate properties. I work with some real estate syndicators who have worked into their operating agreement a crystallization clause - that once triggered creates additional equity for them. And when that happens, many times the allocation language in the agreement can imply that's a taxable event. To offset this, we delay the cost segregation study until after the crystallization event to match higher deductions (and deduction sharing) with this income event.

Another example is the use of charitable trusts. These trusts accelerate a charitable donation into a higher tax year, making the deduction more tax efficient than otherwise would have happened if given out equally by the donor personally over time. This matching of high deduction in a high tax year can create millions of dollars in tax savings. Note that these can be abused, so work with a trust and estate specialist before DIYing.

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The best tax advice happens when the client knows as much about tax as their CPA. Rather than make the CPA obsolete, it puts them speaking the same language and able to relate stories and lessons learned much faster. 🔤 So tax strategy generation is never something that can be 100% outsourced.

Once the strategy is set, it needs to be revisited regularly. And new opportunities and changes in the business environment can change an otherwise great plan. The strategy doesn't have to be complicated - even the basics of Structure, Elections, and Timing can lower your cost of capital meaningfully.

That's Step 1 and Step 2 - accounting and taxes. Next week we'll talk about forecasting and how to think about the future from a finance perspective.

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🔥 Latest News in Tax and Accounting 🔥

House Passes Budget Resolution - The House narrowly passed the budget resolution this week. Consider this an important step to agree on the amounts available to spend on tax reform. The amount to spend ($4.5T) comes with mandatory cuts ($1.5T), so now the real show begins on what's coming back, getting added, and going away. Link - Forbes​

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Tax Season at the IRS - With the drama of "abolish the IRS" floating around, apparently some Americans are choosing the wait and see approach to file their returns. Returns received and processed are down 5% from last year (approx. 1.7 million tax returns). The drop in refunds are due to a timing issue with the EITC and other credits so we'll watch for adjusted trends. Link - IRS and table below

IRS to Close > 100 Offices - The IRS announced they'll be closing over 100 offices, most of which include Taxpayer Assistance Centers (TACs). This is in line with (1) the already and soon to be more reduced workforce, and (2) the effort to cut costs for office space. Many of the IRS workers in these spaces will go remote or have workload reassigned. This isn't as great as it seems because closing the TACs hurt mostly lower income and elderly taxpayers who need these centers to help resolve their issues. Link​

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IRS Released Dirty Dozen List for 2025 - Every year the IRS updates their list of Dirty Dozen tax scams. Obvious ones are email and text phishing. Also included are fake charities - if you donate to an organization you need to confirm they are a legitimate 501(c)3 charity to claim a tax deduction. And the list wouldn't be complete without the reference to tax fraud all over Tik Tok. Full list here.

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