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Alternative Wealth is a podcast focused on advanced tax planning & wealth preservation for business owners, entrepreneurs, and high income earners hosted by Ryan Kolden. Weekly guest interviews, plus shorter deep-dive episodes about business planning, tax mitigation strategies, alternative investments, personal finance, and retirement strategies. Covering everything from private equity, venture capital, hedge funds, private credit, & real estate to tax-efficient exits & captive insurance corporations, privatized banking, and different retirement strategies.
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Ryan Kolden:
Let me walk you through some of the strategies that we go through with clients to help them reduce their tax liabilities and increase the cash flow for their businesses as well as their households. I'm Ryan Colden, financial planner and founder of Colden Wealth, and we advise business owners as well as highly compensated individuals and their families on advanced tax mitigation and wealth preservation. Having a higher income as well as a net worth requires a different approach to traditional tax planning. The correct tax strategy can have a significant positive impact on your wealth. Conversely, not doing any tax planning whatsoever can result in misplanning opportunities and paying more tax than what is necessary. So in this video, I want to give you a quick rundown and some strategies that you may have never heard about before, or that you've never considered before, that you can use to stop overpaying on your taxes each year. But before we do that, let's review two big ideas. And those things specifically are number one, ownership, and number two, the purpose of the tax code. So the first thing that I always like to point out when it comes to the taxation of an asset is that the ownership structure will largely determine the taxation of that asset. And I don't really think anyone will argue that point too much. Let me give you a quick example. Let's start with the brokerage account. With the brokerage account, we put post-tax dollars into it. It grows, and then we sell those assets. And we realize short or long-term capital gains based upon the individual as well as the timeline. And in the next case, let's say that we had those same dollars, right? But instead of being in a brokerage account, we had it inside a traditional IRA structure. which would change the taxation of those dollars. Same dollars, different tax structure. And the same thing again. If I had those assets inside of a Roth account, again, same assets, different tax structure. The point is, is that the ownership structure of an asset will play a large part in determining its taxation. And I would argue that improper ownership at the sale or liquidation of that asset will result in unnecessary taxes. This is the 1st, big idea to understand as it pertains to strategic tax and a tax in the state planning. Now, the 2nd thing that I want to point out is how is the purpose of the tax code. Now, if you take a step back and you look at the tax code, 1 of the 3 main purposes of the tax code, and this is per Congress is behavior modification of taxpayers. Congress rewards taxpayers for taking certain actions and penalizing others for doing things that they don't deem as necessarily a net benefit on society. In my opinion, here are just some of the main behavior modifications that Congress uses the tax code for. So the first one is starting businesses. And the reason they do that is because they want to encourage people to be producers of goods and services and provide employment. In return, this is going to go ahead and increase the economic output of the country, which means more taxes collected for the government. It is well known that business owners have the potential to receive significantly more favorable tax treatment relative to a W2 employee. The second thing that Congress is encouraging again, and this is my opinion, is starting families. More Americans, more little Americans, means more in the future producers and consumers of goods and services. This means, again, increased economic output and more taxes collected. And just an example of this in very simplified means is that when you're married, you receive a higher standard deduction compared to being single. If you have children, you can receive additional deductions for the more children you have. And again, that's just a gross simplification. Investing in real estate. So Congress wants to encourage investing in real estate in order to provide housing for people that need it. Anybody who actively owns or manages real estate knows how difficult it is to do so. dealing with tenants, state and local regulations, maintenance, et cetera, et cetera, right? And because of this, the government offers incredible tax breaks for real estate investors to encourage them to provide housing rather than the government having to step in and do it itself. Investing in infrastructure. So, the government wants to encourage developments in green energy and other technologies. If you think about it, when it comes to buying an electric vehicle, you're entitled to some sort of tax credit. If you buy a gas vehicle, you pay the normal price, which is just another form of a tax if the alternative is to get a tax break. Congress offers investment tax credits to encourage Americans to invest their money in certain technologies. and infrastructure, such as solar tax credits for both individuals as well as businesses. Long-term investments in American businesses. The long-term capital gains rate is historically lower than ordinary income taxes. Congress is also trying to encourage the long-term investment in American businesses. The long-term capital gains rate is historically lower than the ordinary income tax rate. Holding assets for greater than a single year receives preferable tax treatment over a short-term holding period, which is taxed the same way as ordinary income is. Now, certain investment structures permit depreciation to be passed along to an owner's via K-1, and we'll talk about that more later. Finally, the last kind of incentive I want to point out is donating to charity. The services and benefits provided by a charity do a net good for society. If qualified 501 C3 charities were not able to support themselves, who would that fall on? it would be the government. And again, in my opinion, the tax code rewards philanthropy so that these services don't become a responsibility of the government. This is social engineering at its finest. And with all of that out of the way, let's get into some of the strategies business owners and highly compensated individuals can use to lower their tax bill. The first strategy that we're going to talk about is charitable giving. Now, most people know that donating to charity provides a deduction. but they're not aware of the math behind it. When it comes to donations, you have the option of giving cash, public securities, property and ownership, and privately held businesses. Let's look at two gifting scenarios. Scenario number one. Let's say that you're going to give a cash gift for this scenario. Cash gifts typically generate tax deductions in the amount of that gift. So $1 given to charity results in a $1 deduction. Scenario number two, let's look at donating an appreciated asset. So when it comes to donating appreciated assets, you generate a deduction for the fair market value of that asset. For example, let's say you bought $1 of XYZ public stock and several years later it's now worth $10. If you donated that share of XYZ stock to charity, you would receive a deduction on the fair market value, which in this case is $10, although you only paid a single dollar to purchase it. In Scenario 2, which is the stock donation, you're going to receive a deduction of $10 rather than the $1 in Scenario 1 where you gave cash. Scenario 2 is significantly more cost efficient than Scenario 1. Also, in Scenario 2, you avoided having to pay capital gains as well as the net investment income tax. Now, There are certain limits that apply to charitable deductions, but the point is, is that charitable deductions have the ability to help you do well by doing good, enriching yourself while doing a net good for society. This concept has many useful applications, everything from business transactions to estate planning and income tax planning. The 2nd strategy that I want to talk about is pay structure for highly compensated employees. Now, this strategy is specifically for highly compensated professionals, people like medical professionals. Most people have an understanding that being a business owner provides some tax benefits. But what do you do if you're a highly paid W-2 employee? One option that you may consider is going to your employer and asking them if they'd be willing to pay you as a 1099 contractor rather than a W-2 employee. The reason that an employer may consider this or be willing to do this is because it actually can be cheaper and less of a regulatory burden for that employer. And the reason that you may want to consider doing this is because then you can create your own business entity and have your employer pay the business entity via 1099 for your services. And now because you're running a business, you're entitled to claim certain deductions that you were not able to do so before. Therefore, potentially helping you decrease your tax liability. I'm going to go more in depth on some of these deductions, things like retirement plans, the Augusta rule, tax looks and status later on. Now, be warned, the disadvantage of doing this is that you're not going to be entitled to your employer's employee benefits. So, you're going to be on the hook for creating your own health and retirement plan. The good news is, is now that you have your own business, you can set it up so that you can contribute significantly more to your retirement plan than a traditional plan. And again, more on this later. The third thing that I want to talk about is tax selections. So, most people think that having an LLC is going to offer them tax savings. And this is only true if they make a tax selection for that LLC. An LLC is simply a legal structure. And by default, the IRS will treat that as a single member LLC as a disregarded entity, which is the same as a sole proprietorship for tax purposes. For multi-member LLCs, the IRS will default to treating them as a partnership. Now, if you have an LLC with no tax election, you're paying for the administrative fees of keeping that LLC open, and you didn't actually gain much tax benefit compared to being a sole proprietor. So, when it comes to tax elections for an LLC, you have a couple of structures that you may want to consider. But two main elections that most people talk about are the S-Corp and the C-Corp. What you ultimately pick is going to depend on what you're trying to achieve. So please consult a tax professional. But generally speaking, somebody may want to consider selecting an S corp so they can minimize their self employment taxes of 15.3% on a portion of their earnings. Now, if you're a founder, or you're wanting to raise a significant amount of capital and go for a big exit, a C-Corp election could be something worthwhile to consider. And when it comes to C-Corps, they can receive something called Qualified Small Business Stock, or you'll hear people call it 1202 QSBS. QSBS falls under IRC section 1202, which allows the sellers or the owners of the QSBS who have held their shares for greater than five years to exclude up to $10 million or 10 times the adjusted basis. Fair warning, there are very strict requirements when it comes to qualifying for QSBS, so please check with your tax professional to see if there's something worth considering. The fourth strategy is something called a non-qualified retirement plan. Now, most business owners have traditional retirement plans in place for their employees as well as their self, things such as a 401k, SEP IRA, or profit sharing plan. However, these plans limit the amount that can be contributed by highly compensated employees as well as the business owner, him or herself. And because of this, traditional retirement plans are not sufficient for attracting top talent and retaining key employees. So, What can an entrepreneur do to number one, attract and retain key personnel? Number two, create significantly more dramatic tax savings than traditional retirement plans. And number three, minimize the cost of administering the retirement plan. And this is where a non-qualified retirement plan can really shine. A business owner may seriously want to consider implementing a non-qualified plan to address these issues. The objective of the non-qualified plan is to maximize contributions in favor of the business owners, as well as the key employees, while also receiving substantial tax savings for doing so. Strategy number five, section 274, business meetings. In the normal course of business, some companies, due to their structure, are required by law to hold meetings for their entities. Other companies hold meetings for a variety of reasons, things like educational workshops, Christmas parties, developing promotional relationships, or even regular staff meetings. Traditionally, business means are held on office premises or in rented spaces, such as a conference room at a hotel. The expense for conducting these meetings in an outside venue can be very, very significant with the national average cost approaching 1500 dollars per day. And this cost is based upon accommodation for the attendees while providing 2 meals break expenses. Audio visual and Internet access, et cetera, et cetera. Now, as long as these meetings are documented in qualified business expenses, meaning that they are number one reasonable, number two ordinary, and number three necessary, these expenses are tax deductible for your business under tax code 274. Additionally, in order to qualify for the tax deduction, your business entity will need to be organized as something other than a sole proprietorship, such as an LLC, an S-corp, C-corp, or partnership. Now, documentation and reasonableness of the expenses are critical, so please consult with your tax professional. Section 274 is great for businesses who have a decent amount of employees, as well as people as businesses who don't want their employees in their home. There is, however, another option under Code Section 280A that we're going to talk about next. The sixth strategy is Section 280A, the Augusta Rule. Section 280A, or more commonly known as the Augusta or the Master's Rule, allows you to rent your home for up to 14 days per year without having to recognize personal income on that rent. This could cover up to 12 monthly business meetings per year, plus a semi-annual and annual meeting if you desire. Here's an example of how this could work. Your business would rent your home or apartment from you, the homeowner, at the fair market value of the area median expense for up to 14 days per year. The total you spend as the business owner is written off as a meetings expense, while this same income to you as the homeowner is non-taxable rental income. The amount paid is based upon comparable spaces in your area. Taking area figures, and again this is just an example of $1500 per meeting, your business would spend $21,000 for 14 meetings. The estimated potential tax savings for your business to conduct these required meetings would be substantial with no tax due on that $21,000 paid to you for renting your home. Now, there are certain requirements for conducting these business meetings. You must keep evidence of any meetings such as appointment books, attendance roll, invitation emails, the business purpose via agendas, and any corporate resolutions or minutes created at the meeting. And remember, it's imperative that you maintain the correct documentation as well as ensure that you're charging the fair market value of comparable venues in your local area. overcharging yourself will result in an IRS audit, plain and simple. And as always, please consult your tax professional prior to executing the strategy. Strategy number seven, health savings account. Now, I know the strategy isn't going to sound as sexy as some of the other ones. However, a health savings account is commonly skipped over because people don't give it the respect that it deserves. Now, it seems that there's a very large and growing population of entrepreneurs and business owners who are as equally ambitious with their health as they are with their finances. For those entrepreneurs who are already paying cash out-of-pocket expenses for things like prescriptions, medications, getting their blood work checked, or paying for concierge medical services, you may be able to use an HSA to pay for these things while also receiving a tax deduction for doing so. That is right, you heard me correctly. The government will give you a tax deduction to take care of your health. They're incentivizing you to stay healthy and to save for medical care. That way you don't drive up the cost of the American health care system. Now, in order to qualify for an HSA, you have to be on what's called a high deductible health plan, which, depending on your health, may or may not be the correct kind of health plan for you and your family. An HSA is triple tax advantage, meaning you receive a deduction for the money that goes into it. It grows tax free, and when you take it out to pay for qualifying health expenses, medical expenses, it comes out tax free. You can see I put an emphasis on qualifying medical expenses. Please check with your accountant, your health care provider, or the IRS website to see what qualifies as a legitimate qualifying medical expense for an HSA. Strategy number eight, captive insurance structures. Captive insurance is a very simple concept. However, the majority of business owners don't even know that it exists. Approximately 90% of the companies in the S&P 500 have captive insurance programs. As a business owner or entrepreneur, you probably already pay an insurance company to cover some of the major risks in your business. And if you're like most business owners, you are actually most likely underinsured due to insurance being cost intensive with a low probability of expected payoff. Remember, we never hope to actually use our insurance policies. By creating your own insurance company to cover the risks in your business, you can reduce your out-of-pocket expenses, manage more risk than you otherwise could have afforded to before, and receive significant tax incentives for doing so. One of the major benefits of captive insurance structures is that you can share against risks that most traditional insurance companies don't offer coverage for. For example, business interruption coverage, tax audit coverage, reputational risk, and cybersecurity coverages are all things that you can set up through your own captive insurance structure. And when you layer these protections in on top of your preexisting insurance coverages, you strengthen your business from catastrophic events that otherwise would cripple your business and put you out of business. Be advised when captive insurance programs are not administered and operate correctly. It is going to draw the attention of the IRS. These are complex programs to run. So please consult a tax or insurance professional who specializes in captive insurance programs. Strategy number 9. Healthcare. In line with my commentary on employer-sponsored retirement plans, healthcare programs can be prohibitively expensive on you, the business owner or the employer. Fortunately, there are strategies available to you in order to increase the efficiency of your current healthcare benefit program. And in case you're not familiar, let me explain a concept of risk pulling very quickly. Risk pulling in health insurance involves combining the medical costs across a group of people, a pool of people, so to speak. The goal with risk pulling is to spread the risk of high health care costs across a large group of people. That way, no single individual has to bear the full burden of the costs. And you can take advantage of utilizing a private risk pool rather than relying on a traditional insurance company's risk pool. And in return, this can reduce your employee premiums somewhere in the ballpark of 20% to 40% while allowing your employees to participate in the health network of their choice. At the end of the year, any unused premiums are returned to you, the employer. Strategy number 10, A3B stock elections. If you're a founder or you have been granted a stock award, Section 83B of the Internal Revenue Code allows you to potentially lower your tax burden by paying taxes on the fair market value of the stock at the time of issuance. Now, in order to execute an 83B election correctly, you have to file an 83B election form with the IRS within 30 days of your stock award issuance to let them know that you've made this election. Now, before we talk about the 83B election, let's first cover the basics of Restricted Stock Units, or RSUs. Restricted stock can be very confusing, and I'm pretty sure it's confusing for most people because it has the word stock in it, which we tend to associate with capital gains treatment. Now, generally speaking with restricted stock units, it has the potential to be taxed twice. The first time when your restricted stock is vested or granted, it's going to be taxed as ordinary income. Regardless of whether or not you decide to hold on to that stock for the long run or sell it immediately, right then and there, you're going to owe ordinary income taxes on the fair market value for the year that the stock was issued. If you hold onto that stock after it vests and you decide to sell it at some date in the future, you will also pay capital gains on the sale in the future. The fair market value of the stock at the time of the grant becomes your cost basis, and you're going to pay capital gains on appreciation above and beyond that cost basis. RSUs are not eligible for the 83B election, and when it comes to RSUs, most companies are also going to likely require you to wait some specific period of time before that stock award becomes fully vested. In some case, it's many years. In this case, you will most likely not have a chance to receive the stock before it greatly appreciates. However, some companies may issue different type of stock awards things such as. Incentive stock options also known as non qualified stock options known as. Profit Interest Units, PIUs, and Restricted Stock Awards, RSAs, that qualify for the 83B election. By making the election within the first 30 days of issuance, you have the potential to have the income taxed on your stock award when it's potentially at the lowest point. And this is especially true if it's a startup. Before, though, that the stock has the opportunity to appreciate substantially. In the future, if you decide to sell your stock after it's greatly appreciated, it'll be treated as a capital gain rather than as ordinary income, affording you substantial tax savings. The bottom line is that stock awards can be very complicated if you're not familiar with them, so please make sure to consult a knowledgeable professional to help you make the right decision. Strategy number 11, the sale of highly appreciated or depreciated assets. When it comes to the sale of a business, equity stake, or property, you have several options in order to create a tax efficient exit. This can apply to any asset sale that's going to generate a capital gain. And before we dive into these strategies a bit deeper, I want to quickly cover potential tax liabilities generated by the sale of any asset. So let's go through a quick example. Let's say that you're a corporate executive making $1.2 million a year in income. You're married, living in the state of California, and you recognize a long-term capital gain of a million dollars on a stock sale. Based on your income, this would put you in the 20% long-term federal capital gains bracket. Now, for tax purposes, California makes no distinction between ordinary income and long-term capital gains. So in this case, your million dollar capital gain will be taxed at the highest ordinary income California state tax rate, which is 12.3% plus an additional 1%, 13.3%. Remember, depending on where you live, you may or may not owe capital gains at the state level. Again, every state is different. Now, if between federal and state income capital gains, if this wasn't already enough as a high income earner, you may also be subject to something called the net investment income tax or NIT, which is going to add an additional 3.8% tax onto the stock sale. Assuming that we don't do any proactive tax planning, if we add up our potential tax liability, we're looking at an effective long-term capital gains rate of about 37%, 20% for federal, 13.3% for the state of California, and additional 3.8% for the net investment tax. A couple of options for you to consider to help you manage your tax liability on the sale of assets are things like qualified opportunity zones, employee stock ownership programs, philanthropy, installment sales, and 1031 exchanges. This list is by no means all-encompassing, and there's a lot of strategies available to you other than what I just listed. As you can see, there's a lot of options available to you, and each strategy has its own pros and cons. Ultimately, the strategy that you pick and you decide that's going to be best for you is going to depend on what you want to achieve in your overall financial strategy. But I want to make sure that you at least know that you have these options in order to optimize your tax liability prior to the sale of a large asset. In order to achieve maximum tax efficiency, it's imperative to start consulting with a professional prior to the completion of the transaction, ideally anywhere between 3 to 12 months ahead of time, the earlier the better. Failing to perform the requisite tax planning ahead of time can result in missed tax planning opportunities, which results in you paying more taxes than necessary, as well as cause delays to that transaction. You may also be wondering why I lumped in real estate when I talked about the sale of a business as well as equity ownership. So let's go ahead and explore this a little bit deeper. As a real estate investors actively growing their portfolio, they commonly utilize one or a combination of strategies such as accelerated depreciation, real estate professional status, and finally 1031 exchanges. And they do this, they use these strategies to minimize their tax liabilities throughout their lifetime. When the real estate investor finally has a mature portfolio, they may face an increasing tax burden if they've fully run out of usable depreciation. If the investor no longer wants to acquire new properties or is considering selling off a portion of their portfolio, they're going to go ahead and come to realize that depreciation is a double-edged sword. You get to reap all the benefits of depreciation on the front end, but on the back end, that depreciation is going to be recaptured. which can add to your tax liability if you're not planning for it. Some of the strategies that I listed in this section can help real estate investors effectively manage their tax liability once they've run out of that usable depreciation. Additionally, these strategies can help investors exit their properties while mitigating their tax liability arising from capital gains and depreciation recapture. Strategy number 12, alternative investments. Now, the phrase alternative investment is a broad term that's used to reference any investment that falls outside of traditional publicly listed stocks and bonds. They normally include things like private equity, real estate, private credit, structured products and defined outcomes, hedge funds, commodities, and collectibles. It can also include things like investment tax credits. Now, certain private investments can provide certain tax efficiencies. For example, if you received dividends from a publicly listed ETF, you would most likely be issued a 1099 dividend at the end of the year reporting to the IRS the amount of dividend income you received that year. In contrast, assuming that you have the proper ownership stake in a private investment, such as real estate or private equity, depreciation or losses in the investment could be passed on to you, the investor, to write off against the income that you received on that investment for that year via a K-1. Strategy number 13, life insurance and estate planning. As your net worth and your income increases, you're probably starting to think about things such as the lifetime estate and gift tax exemption, as well as how to protect yourself from frivolous lawsuits. As you begin your estate planning journey, there's going to be a wide variety of asset protection, as well as estate structures for you to explore. Each option and structure is going to have its own set of tax consequences, fees to set up and run, to run this structure on an annual basis, And the option that you ultimately decide on is going to be unique to your estate's needs. And this can become very complex depending on your situation. So again, it's imperative that you seek counsel from a good estate and tax attorney. When it comes to financial planning for business owners, highly compensated executives, and ultra high net worth individuals, life insurance can play a major role in offsetting estate taxes, income replacement, business succession planning, and in some cases, protection from creditors. Although life insurance is one of the most efficient means of addressing these needs, One of the major disadvantages of traditional funding methods for life insurance is the large premium payments required, which can tie up liquidity and reduce the size of your estate. A solution to this is to finance the policy. However, be warned that this method can carry significant risks, so please make sure to consult with a financial professional to see which method of funding is best for your situation. Now, generally speaking, the cash value inside life insurance grows tax-free, can be accessed tax-free via a loan, and is distributed tax-free if structured properly. While creditor protection varies on a state-by-state basis, life insurance normally offers some level of protection from creditors. And when it comes to selecting the type of coverage your estate requires, you have a wide variety of options. Everything from your standard whole life insurance to index universal life insurance, and even private placement life insurance. A good financial professional or estate attorney would be able to help you work through this and help you identify which type of insurance is best for your situation. We finally made it. This is our 14th and final tax strategy, which is the pass-through entity tax as well as SALT. The state and local tax, or the SALT deduction, allows high-income earners who itemize to deduct up to $10,000 in qualifying property, sales, and income taxes that they've already paid to their state and local governments. many high-income earners are paying significantly more in state and property taxes than this amount. And because the SALT deduction is capped at $10,000 annually, some states have what's called the Pass-Through Entity Tax, or PTAT, which enables taxpayers with pass-through business income to potentially deduct more than their SALT cap. For business owners and entrepreneurs who own pass-through entities, and these would be things such as an S-Corp or partnership, PTET allows them to elect to pay state and local taxes at the entity level rather than on the individual level, allowing them to deduct more than the $10,000 federal SALT cap. Now, be aware that not all states have PTET, and the way PTET works varies from state to state. So, as always, be sure to consult a tax professional to see if this strategy is something that you should consider. Now to recap, it's important to understand that there's hundreds of potential tax strategies and they all serve different functions. Some of these strategies are for small business owners, some are for solo entrepreneurs, and some are for highly compensated professionals, and some are even for mid to large sized corporations. Not all of these tax strategies will be a good fit for your situation or even available to you. We're talking about advanced strategies that need to be customized for each business and each individual's specific needs. These are not strategies that you can implement yourself or you would even want to consider to implement yourself. Unfortunately, not all accountants and financial professionals are trained in tax strategy. All too often, business owners and high income earners think that their accountant is a tax strategist, when oftentimes they're just a tax preparer. There isn't anything wrong with this, but it can lead to missed planning opportunities. But if you've worked hard to build your business or career, I want to give you an opportunity to find out what's possible when you focus on proactive tax planning rather than reactive tax preparation. My goal with this video is to simply show you some of the lesser known tax strategies, how they function, and why you may want to even consider them in the first place. I don't know what your personal, your business goals are, your dreams or your vision for the future. But I do know that some of the most successful families in America, corporations and financial institutions are so concerned about tax planning that they dedicate a significant amount of time and resources to access the best tax strategies and professionals available to them. you can get upset that the tax code is designed the way that it is, or you can think of it as a playbook and learn how to use it to your advantage. And just a word of advice, don't put this off. With the way that the government keeps spending, I'm of the opinion that taxes will be higher in the future, and there's never been a better time to lock down your business and your personal tax strategy. Take care.