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My Favorite Tax Planning Framework

It’s not what you make - it’s what you get to keep.

I have helped thousands of entrepreneurs save hundreds of millions in tax by planning ahead.

My favorite framework for tax planning uses three mechanisms -

1. AVOID
2. DEFER
3. MINIMIZE

Let’s dig in and save:

Tax planning accomplishes these objectives, allowing you to take more home for your family and pay Uncle Sam last.

AVOID - avoiding tax altogether is the optimal outcome.

You would have had to pay tax, but because you took action you no longer have to. Genius!

Taxes are avoided by using exclusions in the tax code. Exclusions allow you to recognize income without tax - Look at the home sale exclusion, QSBS, and income from a Roth IRA.

Taxes are also avoided by careful structuring - when you die you get a step up in basis on 13 MM of assets that pass through your estate. This allows you to pass down appreciated assets without ever paying tax, and resetting the basis for your heirs.

You also receive a step up in basis at the end of 10 years of Opportunity Zone investing. All that winning without dying - what a deal!

If you donate appreciated stock you never pay tax on the gain, and get the entire amount as a deduction.

Tax credits also help you avoid taxes - buying tax credits is a big business and can save you millions in tax! R&D credits, the ERC, et al. Don’t miss these!

DEFER - the further you can push your taxes out, the smaller they become.

Calculating the time value of money shows us a dollar is worth more today than 10 years from now.

Planning is used to kick the can down the road, and make sure there will be available cash to pay the tax! Kicking the can could seem like a bad thing, but in a 5% risk free rate environment it's a win!

One of the most basic deferral examples is an IRA or other pension account.

The primary benefit of these accounts are that they compound tax free, and you enjoy the time value of money.

NEVER INTERRUPT THE COMPOUNDING.

You defer all the tax you pay until the end of the line. Hopefully at a lower future rate.

Another great example of this is a 1031 exchange - this is a section of the tax code that allows a taxpayer to trade real property and defer tax.

Ultimately you’d like to defer taxes all the way until death. Then you can exclude (avoid!) them altogether.

Installment sales are another great example. When you sell an asset and carry the note you are allowed to defer the taxes over the life of the note.

Also, cost segregation and bonus depreciation fit here. The deduction now is worth more than the deduction years down the road. RE Cost Seg on Twitter has more written about this than anyone!

MINIMIZE - this centers around the idea of a lifetime effective tax rate.

You want to pay the lowest overall percentage of tax on the dollars you earn in your lifetime.

Minimizing involves charting out your income over time and working to optimize by avoiding and deferring!

A good example of how folks minimize - One popular technique in Texas is buying a farm or ranch.

The farm provides consistant tax losses during your highest earning years - all while accruing value along the way that will be treated as capital gains on sale or stepped up on death.

People will also take extreme measures here - You can move to a low/no tax state.

If you really hate taxes you can move to Puerto Rico..

What is it worth to you?

Folks with impending Capital gains in high tax states may be able to use ING trusts to avoid some state taxes.

Generally, you do everything you can to avoid paying taxes and push them as far into the future as possible.

But there are times that you may want to accelerate tax forward.

I worked with a relatively young retiree physician once who elected to convert his entire IRA ($15+ MM) to a Roth IRA so he could never pay tax again.

This was a huge tax event in the highest bracket, but he wanted to never pay tax on social security payments and pay the lowest Medicare premiums.

So what do you do?

Based on my experience working with prospective clients, the planning problem will not solve itself.

CPAs need to know a lot about you and your goals to help you.

Planning doesn’t come along with a $750 tax return - it takes time, attention, and expertise.

You’ll probably need to take the lead in this work. You should treat this like any other problem that you would want to solve.

Work with your CPA if they are open to it.

If they aren’t then hire another CPA or tax attorney, either on a project basis or a go forward basis.

Be up front about your situation - that you want to create tax efficiency.

Things to consider -

1. The cost to set up new structures.
2. The risk to what you are doing.
3. The overall hassle. Is this worth doing with your time?

You and your pro can work together to answer these questions.

Tax planning isn’t necessarily appropriate for every wealthy taxpayer. Some would rather just pay the tax..

Never let the tax tail wag the economic dog.

Peter Mallouk said most folks spend the first half of their life building complex systems and the second half unwinding them.

There is not a set menu around this - it is an inexact science. Every situation is unique, and outcomes can drastically change with one variable.

So it is important to understand what you really want in life, and find the right pro to work to that end with you.

Until next time,

Mitchell

P.S. If you made it this far and enjoyed what you read, send this to a friend who might like it!

P.P.S. My friend Scott Hambrick and I have been working on a podcast! It’s called Stupid Tax - covering taxes, small businesses, and a whole lot more. This weeks' episode - Accounting - What is it good for??