Not Your Fathers Tax GuideFINALconverted

Not Your Father’s Tax Guide

CHAPTER 15

In its infinite wisdom the income tax laws in this country include a
lot of built-in strategies that can reduce the overall tax burden for
those ‘in the know’. The problem with this is that they don’t teach
what those strategies are in school, and as far as I know it, there are
not that many ongoing classes in tax strategy out there. So, how is the
average Joe supposed to learn about it? They bank on the fact, quite
literally, that you won’t. Luckily, you’re reading this book, which

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means you aren’t one of the huddled masses yearning to be free.

Your ability to lower your taxes depends largely on your
understanding of how it all works in at least five key areas: entity
selection, tax strategies, real estate benefits, income deferral, and tax
free executive and employee benefits. I’ve discussed many of these in
other chapters, but they bare repeating in more depth, in this chapter.
And, it’s a very real possibility that only a few of those key areas will
apply to you in any large way. That’s okay….seriously. By maximizing
as much as you can and leveraging the loopholes that the government
has allowed to remain, you will be ahead of the game. Each of these
factors is okay on its own, no lie. But combined, their strength is
incredible.

What is a Tax Shelter?

Ask a dozen people to define a tax shelter and you’ll get 12 different
answers. That’s because the term is often a pejorative. In simplest
terms, a tax shelter is a legal way to reduce your overall taxable
income. That’s it. Depending on who you are, you would view the
use of the word ‘shelter’ as an illegal way to duck your fiscal
responsibilities. Others see it as an incentive offered by the
government to save. I fall into the latter camp as the government is
very good at closing all loopholes that don’t eventually benefit them.

In the past the term tax shelter had people conjuring Monopoly style
millionaires with handlebar moustaches and top hats using Swiss
bank accounts and smoking $100 dollar cigars. And that used to be

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true. Not so anymore, thanks in large part to the ongoing education
of the general public. In fact, most people ARE engaging in tax
sheltering, but don’t know that it is one. 401k anyone? That is a way
to shelter some of the taxable income that many working in
corporations utilize. IRAs? Yep, they are also a tax shelter. So, let’s
erase the negative connotation, shall we? It just doesn’t jive with the
reality of the service it offers.

Keeping it Legal

Okay, after the above rant, I feel I do need to specifically state that
there are ways that people do abuse the system. I’m not one of them,
and neither will you be if you follow the instructions listed in this
book. In order to avoid abusing the tax codes, and raising the ire of
the IRS, then you’ll need to know what they consider illegal activities.

A very classic example of tax abuse is when businesses over-claim
deductions, or they hide assets, or they create and abuse trust funds.
I’ll go into some of these in more detail in a bit. Just keep in mind
that what I’m going to lay out for you here are all of the LEGAL
ways that you can shelter your money.

What Having a Tax Shelter Can Do For You

Your assets that are sheltered mean that they are not only sheltered
from taxation, but they are sheltered from creditors. The earlier you
can shelter your money, the safer it is going to be. This also gives you
negotiating power should you need it.

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Taxes are bound to go up. They always do. Placing your money into a
tax shelter…well…shelters it from that. In general, the higher the
taxes go, the more invaluable a tax shelter becomes. And then, you
can drag the money out when the rates go back down, or you are in a
lower tax bracket.

Bonds LOVE tax shelters, so if you have some, they are a most
excellent commodity to stash. Bonds got a bad rap when the stock
market was zipping right along during the boom a few years ago.
After all, with stocks performing so well, why hold onto the bonds.
Of course, hind sight is what it is, but those that held bonds and
placed them in shelters (because the taxes on bonds is horrible), then
those investors came out smelling like cash roses (no those don’t
really exist. Sorry). Keeping bonds in a shelter is transformative for
the long term. Here’s the numbers: You’re currently in the 25% tax
bracket, and you’ve invested 10k for 30 years in some bonds (not
municipal). You’re getting 6% return on them. Unsheltered, when
those bonds mature, you’ll have made $37,400. Not bad. BUT, look
what happens when it’s been sheltered. Same scenario, but you place
the bonds in a tax shelter. You’ll end up with $57,400…which is 20k
more. Yeah, it matters that much. And if you have TIPS bonds, it is
paramount that you shelter them.

Having money in a tax shelter doesn’t count against you when your
children apply for FAFSA or other federal aid. With FAFSA monies,
each family, through the use of a golden ratio that no one can figure
out, is given an EFC (estimated family contribution). Money that is in

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a shelter is ‘invisible’ as far as FAFSA is concerned. They just count
what is immediately liquid.

Lastly, tax shelters tend to be progressive in nature. That’s because
there is a sort of trade-off. Your gains aren’t taxed year to year, but
when it comes time to take it out for retirement, it’s taxed at
whatever rate you are currently in (except the Roth IRA). And please,
don’t buy into the hype out there that uses scare tactics about the
whole 35% tax rate being slapped on the average Joe who has a 401k
and draws it out. That’s only true if your actual income (combined
with your spouses) equals up to $370,000 a year. In most scenarios,
you’ll only end up paying about 15%.

Legal and Illegal Tax Shelters

The IRS takes a mighty dim view of those who try to usurp the
system. While it might look awesome when Leonardo DiCaprio does
it on the big screen…..yeah, not so much in the real world. Catch Me
If You Can….not a good mantra. The IRS considers a legal tax
shelter as one that requires regular contributions and a certain degree
of risk to match that investment. Sometimes that can mean losses on
the short term, but good odds of long term gains. A good example of
this is someone who buys an apartment building in a low-income
neighborhood. The tax benefits that the owner would receive by way
of depreciation is considered a legitimate tax shelter. In all cases, the
tax benefits can’t be more than what the actual initial asset was. In
other words, you can realize more than what was invested, or was at
risk. For properties, using the same example, the IRS would look at:

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• Amount of money invested initially.
• The adjusted basis on that real estate.
• Losses (and the treatment of them)
• Loans that are given to a single entity.
As discussed in more depth in the Real Estate chapter, business
activity gains or losses are most often considered passive activity, and
this is only allowed to be used to offset income from other passive
types of activities. In other words, they can’t be used to offset the
cost of operations like wages, dividends, or interest. Now, if there are
excessive losses, then those can be carried over, or held onto until the
owner of the property sells.

If someone offers you a tax shelter that is ‘guaranteed’ to offer larger
write-offs than the amount you have originally invested….RUN. If
the IRS finds an individual has used a tax shelter abusively, they are
charged with paying the taxes owed, plus all of the fines, penalties
and back interest owed. Big Ouch.

Legitimate Tax Shelters

Legal tax shelters are wonderful to behold in all their glory. Okay,
maybe not so much. But, for many people, knowing that they have a
nest egg, and that this nest egg is SAFE, is golden. Here are some of
the more common tax shelters that the IRS considers legit.

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Retirement Plans

Individual retirement plans are one of the most utilized tax shelter in
the US today. This can be a 401(k) or a 403(b). This allows the bearer
to defer taxes until they retire. With the Roth IRA, funds are placed
into the accounts in an after-tax basis. The funds won’t be taxed
when they are withdrawn. This makes the Roth a heavy hitter with
retirement planning coaches.

Limited Partnerships / Flow-Through Shares

Enjoy the ‘flow’ with limited partnerships. Originally, the US created
this designation to encourage investment into certain volatile
industries in the US, such as oil or mining. The cost of the research
and development is offered as a deduction to the shareholders, which
allows investors to realize some immediate benefit from their
investment. Shareholders can claim losses as passive investment
offsets. Sorry, it can’t be used on earned income.

Own a Small Business

In earlier chapters I addressed all of the ways you can reduce your
overall taxable income. Much of that advice overlaps here, too.
Creation of a health savings account, setting up a Roth IRA, and
investing in real estate are all good ways to shelter your money. A few
of these bear a little more attention in this chapter.

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Let’s Talk About Health Savings Accounts

With the country’s healthcare system continually in disarray, most
small business owners have opted to take out the high deductible
plans, and then combine it with the health savings account (HSA).
You are under NO obligation to dip into it if you don’t want to, or
need to. Because of its designation, it is not taxed. Therefore, you can
leave the money in there until retirement age, when you are in a lower
bracket, and then withdraw it. You will still be taxed on it, but at a
much lower rate. The account can grow in value, offer tax deductions
through the regular contributions, and offer tax free earnings on the
contributions as well as the distributions. And, get this, it’s
transferable. When the HSA owner passes away, it goes to his or her
beneficiaries.

TAX SHELTERS TO EMPLOY

Use this space to brainstorm, or create an actionable tax strategy list.

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What you Need to Know about Taxes

It’s a no-brainer statement to say that financial plans will intrinsically
involve some sort of money transaction. When that happens, taxes
generally happen, too. If you can reduce, or even eliminate that, then
you keep more in your pocket. That’s the bottom line, here. So, the
goal should be to list your financial ‘transactions’ and then find a
shelter that works for it.

You need to know what your marginal tax bracket is. Most people,
sorry to say…and you don’t have to apologize if you’re one of
them….don’t know what their tax bracket is. This isn’t the same
thing as your average tax rate. The marginal tax rate is how much
your taxes increased or decreased in income. For example, let’s say
you have the average tax rate of 18%, but the marginal rate is 33%.
You now know that for every $3000 dollars of interest income you
make, it is going to cost you $1000 dollars instead of the $540 if you
just went by your average tax rate. Sound confusing? Here’s a free
marginal tax bracket calculator:
https://www.dinkytown.net/java/TaxMargin.html This calculator is
one of many out there that makes the math quick and simple. The
takeaway, here, is that you know what your marginal bracket is, and
then you can have a very real view of what the IRS is going to expect
you to ‘donate’ for the express purpose of having earned a living.

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Write Your Marginal Tax Bracket HERE:

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Your Retirement Plan (Retire in Style)

How you intend to retire will depend largely on who you are and
what sort of circumstances you are in. For example, a retirement tax
strategy will be different for empty nesters as compared to those who
are employees in a large corporation. Here are some good tax
strategies for you no matter what your designation.

Empty Nesters

By its very definition, your children are all grown and gone. You are
married, and most likely are living in a house that is waaay too big.
There can be real tax savings in downsizing that home. Up to
$500,000 of capital gain can be excluded on the sale of a house. That
means…no income taxes on the money you get from the sale of the

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home. Think of it…up to a half million bucks, tax free. That’s pretty
generous when it comes to the government…and it is one of the best
deals going right now. And, with the money you receive from the sale
of the home, you can reinvest in a smaller place, then pocket the
difference.

Corporate Employees

If you are the employee of a company that is a corporation (even if it
is your OWN corporation) one of your best bets is to set up that
HSA as mentioned earlier. You can put as much or as little per
month as you want to, which means if one month is lean, you can opt
to contribute less.

Small Business Owners

In reality, if you haven’t noticed, you probably fall into all of the
above categories, or will at some point along the line. Small business
owners have some of the greatest tax advantages on the planet if they
just know how to utilize them correctly. Set up a private pension
fund. Self-employed owners can deduct 100% of taxable income for
contributions that go into that pension plan. This works very well for
those owners who make more than $150k, don’t have many
employees (if at all), and are close to retirement age. The catch, here,
is that the pension plan has to be in effect in the year that the
deduction is going to be taken. The investment, itself, can be made in
the following year.

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The ‘Range Rover Rollover’ is another technique, with a clever name.
You can deduct up to $500k for the cost of capital assets purchased,
rather than electing to defer over time. Tax benefits on this type of
arrangement are actually even better when the asset is financed, but
you haven’t made any cash payments on it yet. For more information
on this, you can read IRS Section 179, which gives more details.

Lower Income Earners

Seriously? Low income wage earners can do tax shelters? To borrow
a phrase…yeah-hell yeah. Long term capital gains are now tax free if
you are below the 15% tax bracket. This is based on the taxable
income portion of your return, and not the AGI. This means that
more people will actually qualify for it. For most people, and not just
low income wage earners, the taxable income is around $10k lower
than the AGI (double that if you are married).

So, for example, supposed you are married and you both make the
combined income of $50,000 a year. And consider that you sell your
Harley for $25,000. This money that you just made on selling your
sweet ride? Completely tax free. Doesn’t count as your taxable
income.

Need a reason to have a retirement plan? How about low income
wage earners get tax credits for putting money aside. The federal
government will MATCH 50% of whatever you initially place into
the retirement account with a tax credit. “But Joe,” I can hear you
saying now. “I’m a low income earner. Dude, how can I afford to put

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money into a retirement account?” Simple, make a gift of an IRA
deposit to your kids, which gives you an immediate 50% return. So,
sell the Harley, which is tax free, sock that money into an IRA for
your kids, and the government will give you half of that amount as
their gift to you.

What is YOUR Retirement Strategy?

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Investors

My quick advice to you is down and dirty: for most of you, dumping
the taxable dividends and short term capital gains is where it is at.

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Get rid of those mutual funds that aren’t in a retirement plan, and
opt, instead, for the exchange-traded funds (which eliminate the
taxable distributions).

Next, my advice for you is to secure a deferred compensation plan.
The best way to do this is from an employee benefit package. This
can either be something the company you work for offers, or if you
ARE the owner, it should be something you look into offering
yourself (as well as other employees).

Life insurance has gotten a bad rap over the years. But, I’m here to
say that the cash value life insurance plans are excellent ways to
amass sizeable income that can be borrowed tax free as needed. Of
course there are the death benefits which means that upon your
departure from this realm, your beneficiaries will inherit the
funds…tax free. No pesky inheritance taxes. Don’t be tempted to use
an international insurance company. The IRS considers this a no-no.
Opt for the domestic life insurance companies.

As you can see, there are so many tax strategies out there, and my
main reason of touching up different strategies for different folks is
that tax strategies cannot be a one size fits all kind of deal. You really
need to find someone with the knowledge base to help you
customize a plan that works for you, no matter what stage of life, or
circumstances, you are in.

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Home Ownership (The Golden Egg)

Buying a home is always a big deal for most people, especially those
who don’t intend to own more than one. The good news is that it is
also a very smart investment. There are a number benefits that the
government extends to people who own their own homes.

Likewise, many of those benefits are also extended to those who own
rental homes. For example, one of the nicest benefits is the fact that
the imputed rental income isn’t taxed on the rental. In other words,
you don’t have to count the rental value of the home as taxable.
Now, you would still pay on the money you receive for rent on the
home, but the money you are able to gain in return for owning the
property more than offsets that.

Homeowners are able to deduct property tax payments, as well as
mortgage interest. Homeowners can also exclude the capital gains on
the sale of the home, too, as mentioned earlier. Let’s look a little
closer at all of the various deductions that your little golden egg can
produce for you.

Mortgage Interest

If you are able to itemize deductions (and you ARE aren’t you?) you
can reduce your income that is taxable by deducting the interest that
you paid on the mortgage for the home (this also includes any rental
or secondary properties). This is good up to a million dollars. And if
there’s home equity debt (up to $100,000) then that interest can also
be deducted. This is where not owning a home is really hurting you.

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If you currently rent a home, you have no ability to deduct interest at
all.

Property Taxes

If you are itemizing your deductions, then you can also reduce the
taxable income that you have by deducting the taxes you’ve paid in
on your home. This transfers the federal dollars to jurisdictions that
force a property tax on their residents (this is mostly a locally
mandated act, but sometimes states are involved too). Last year
alone, nearly $34 billion dollars were deducted on property taxes.

Rental Income

For those of you who have another property that you rent out, then
you can also realize some savings. As a homeowner of your primary
residence, you are effectively both the renter and the landlord. The
tax code treats homeowners the same as renters, which means that
the payments that you make throughout the year are NOT
deductible. There is another, very confusing term called imputed rent,
which basically is something that Washington came up with thinking
that it sounded really good, but in reality, makes no sense whatsoever.
It’s like instead of owning a car, you rented a car (for far more than
your car payments would have been), and the difference between the
two numbers is added to your income (or deducted depending on
which way it goes). This is a horrible and tragic act of Congress (one
of my all-time pet peeves). As this applies to your home, you are
basically going to be taxed on the theoretical income you might have

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gained from renting out something you own, rather than living in it
yourself. This notion is based on the notion that the income should
include all of the ‘value’ that you could receive from the home.
You’ve basically avoided paying for a service by owning in yourself.
Crazy? Yeah, I agree. End rant.

Sell Your Home

As mentioned earlier, taxpayers who sell any sort of asset usually have
to pay capital gains, but there is an exception to the rule: selling your
personal house. Homeowners, according to the tax code, can exclude
(read…not count) taxable income up to $250,000 (or double that if
you’re married) on the sale of their home. There are some criteria you
have to meet, but most of it is quite doable. That criteria is:

• Have to have lived in the home as a primary residence for at
least two out of five years

• Can’t have claimed the capital gains exclusion for another
house within the previous two years

Actionable Items

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Top Tax Shelter Strategies

Tax shelters exist for the sole purpose of reducing your overall
taxable income, many times until you are in a lower bracket and can
then withdraw it. Income taxes are frequently one of the largest glass
ceilings those who seek to build wealth will face. Without a good tax
strategy, which includes tax shelters, you won’t put a crack in that
ceiling any time soon.

I’ve worked with hundreds of individuals and companies and I can
tell you that most of them could have reduced significantly their
overall taxable income much sooner by adopting some type of tax
reduction plan earlier in the game. The IRS will not advertise all of
the ways in which you could shelter your money (why should they?).
This is why having a certified tax coach becomes such a necessity.
The tax codes are very, very complex.

And don’t stress too much about loss opportunities. In most
instances you can GO BACK and amend a prior tax return, claim a

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tax refund, or add in deductions that you were unaware of up until
now. The catch is that the amended return has to be filed within
three years from the date that it was originally filed.
Wanna know the secret to being wealthy? Three words: tax
deductible spending, and tax shelters. Here are the top ten strategies
for sheltering your money, as a quick summary.
Tip One: Deduct job related mileage, or car expenses.
.55 cents a mile. That adds up. Use Form 2106.
Tip Two: Get Paid for Being Nice
If you volunteer somewhere regularly, or give to charitable
organizations….it’s all deductible. Travel expenses to the volunteer
association, anything you spend in the course of working for them, all
deductible. In this instance, parking fees, tolls paid at toll booths, and
other fares (subway or bus fares), all deductible.
Tip Three: Get Paid to Learn
Deduct the cost of going to school. If this educational expense is for
additional knowledge or licensing, etc. that you need to improve your
skills needed in your present work, if your employer is requiring you
to take the classes in order to save our job, then you can deduct it.

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Tip Four: Home Offices Rock
If you work for a company that is not based in your area, then it’s
deductible. If you own your own company and work out of a home
office, it’s deductible.
Tip Five: Write Off the Losses and Grin
Even if you had gains on some sort of capital gains, the losses are
deductible, and then you pay no taxes on the positive returns. This is
particularly possible with REITs or stock that is based in utilities.
Tip Five: Retirement Plans
This is a biggie, folks. Max that puppy out. Stuff it as full as you can
each year. In some states you can actually deduct those contributions,
too. So, it’s a double whammy. You get the deduction, AND you’re
saving money for your golden years.
SEP Retirement
Most small business owners would do well to look into the SEP
(Simplified Employee Pension) plans. You can squirrel away a large
portion of your income into these types of plans, especially a Keogh.
The catch is that you can contribute up to 13% of your income in a
SEP, and up to 20% in the Keogh. Set up a SEP through any
investment group. They all have them.

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Keogh Retirement
The Keogh is different from the SEP in that it is considered a
defined contribution plan. It has a lot of very difficult paperwork, so
make sure when setting one up to locate a financial advisor who can
walk you through that. The other catch is that if you have employees
they must be allowed to participate if they wish.
Tip Six: It’s Nice to Give
Giving nice assets to your children is not only nice, it’s a great tax
shelter. You can give away up to $14,000 a year to each of your
children, or grandchildren, without anyone having to pay taxes on it.
Your spouse can also gift money, so conceivably, together, you can
gift up to $28k a year, per recipient. This reduces your overall estate,
and thus shelters it from taxation. Plus, if your child is under 14, then
they are in a lower tax bracket should the asset you give to them be a
stock.
Tip Seven: Know a Guy
It’s a bit of a shameless plug, but you have GOT to get a tax guy that
you can work with on your side. Put him or her on speed dial, talk
with them often. If they don’t like to meet with you regularly, find
another guy (gal).

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Top Strategies I Can Employ

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Year ‘Round Tax Strategies

C’mon…admit it… you don’t think about tax strategies until April
15th do you? Most don’t. It’s a shame really. If you will make ONE
change from reading this book, it will be to consider tax strategies as
a year ‘round, ongoing task, much like brushing your teeth.

Each month it will literally pay you to assess what additional tax
strategy you can employ, what tax strategies need bolstering, and

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which one needs rethinking. When you make an investment, or a
purchase, do you consider the tax advantages? You should. Someone
will pay you to do it. Consider the tax consequences of any decision
that is business related. In the long run, it can translate into
thousands of dollars, and that’s a conservative figure.
Questions to Ask My Tax Guy
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CHAPTER 16

Baby boomers have come to the crossroads in their lives. Do they
stay a little longer in their businesses, or do they move on to the ‘next
phase’ of their lives? Many are opting to head into retirement, to fully
enjoy the fruits of their labors, thus far, and many are even opting to
go into different occupations all together. This means finding a
successful way to leave without tanking the company completely. A

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change in leadership is always a tricky business, especially if your
business has been successful over the years. There’s a fair amount of
confusion over the semantics involved in exit planning, and many
believe that succession planning and exit planning are the same thing:
they are not. Not at all.

Succession planning is planning for a change in leadership and, often,
directions. Exit planning is your personal escape clause, one that
you’d do well to already have in place many years prior to your actual
break for freedom. This chapter will lay out for you, in as direct
terms as possible, how to plan for your own personal exit, and how
to make sure that when you do leave, the business is able to continue
on in capable hands.

Succession Planning

Succession planning, in a nutshell, is for owners who have made the
decision to leave their business. It focuses primarily on the
transferring of the leadership role to someone else. It is your strategy
for transition. If you haven’t already been thinking about a likely
successor, or have identified someone in the current business that
would be very good in the big chair, you need to start…now.

Many small business owners peg someone from their own family,
and then over the course of a few years, begin to teach them the
ropes; show them how to sit in the big chair. This can, and should, be
done over a longer length of time. This is not the case where a crash
course on how to lead the business is going to work. It will result in,

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#1: Understand your financial information.

This seems pretty straightforward until you realize that this means
you need to know from as objective a viewpoint, how the company is
actually performing.

#2: Manage debt

Again, a no-brainer, but this is a biggie. After all, who really wants to
buy a company that is drowning in debt? This significantly lowers the
value of your company, anyway. Strategic plans need to be in place to
manage the debt and not create a bottleneck with cash flow.

#3: Have a financial framework in place.

Building value in a company without having specific and detailed
informational goals is very ineffective. Performance goals, and even
limits as to what you will and won’t engage in, a type of threshold
where you won’t tread beyond, is so very critical.

#4: Have numbers that verify your claims.

You can’t just say you are a successful business. You need to be able
to back that claim up with numbers. This can be done, easily, with
increased cash flow numbers, increased productivity year to year, and
more assets that are worth something.

Keep in mind that very often financial controls might not grow at the
same rate as the business grows, and this can spell disaster for you.

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As a business grows the finances become even more important,
which means that the stakes have been increased, and as a result a
more structured and efficient way of measuring and keeping tabs on
the finances is going to be needed. If you don’t have a good tax
person now, get one.

I can spot a business that hasn’t planed properly a mile away because
they all have some similar characteristics. See if you don’t recognize
some of these in businesses that you know or have worked for.

• They are always fighting among themselves.
• The costs of their products or services are out of touch with

reality.
• They have more inventory than they are moving.
• Their financial records and tax strategies are s***.
• There’s been no agreement with employees or administration

to engage in a non-compete.
• The business has high turnover with all employees, on all

levels.

Exit Plans and Taxes

Here’s the best way I know how, to fully engage you in the exit plan
process. Of course, this is a broad spectrum presentation, and you’d
want to use this as a springboard for a very real discussion of exit
planning with your tax coach.

If you’ve got at least ten years or more before you ‘plan’ to leave your
company, here’s a laundry list of things to start doing…like right

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now. Immediately. Pronto.

• If you’re S-Corp, you have to have held the business for at
least five years so that the built-in gain tax will no longer
apply to you.

• Likewise, if you are a family run business, then you won’t
have a liquidity event and you’ll need more time to generate
retirement income and tax sheltered savings for yourself.
Also, if you are transitioning to another family member to be
the new boss, you’ll need time to start training them. Start
now. Immediately. Pronto.

• Set aside one day a week to go over your tax planning, exit
strategies, and evaluate any problems and their possible
solutions.

• Plan to see your tax person once every few months (or keep
them on speed dial…just saying).

If you are down to the wire, with only a handful of years left before
you plan on sailing off into the sunset, here’s what you need to think
about doing.

• Work on creating some tax leverage. Many companies utilize
a compensation package from a nonqualified deferred plan
standpoint. In other words, say you own stock in the
company that is easily worth $2 million. The owner would sell
his shares back to the company at slightly less than that and
receive, in return, a compensation package. This means that
the company gets a tax deduction (at least 25%). The only

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way this works, though, is if this plan was in place for at least
five years or more while the owner/employee was with the
company.
• You could do a defined benefit pension program. This is
where the old owner, you, receives payments from the new
owner, on a tax deductible basis. A defined benefit plan such
as this needs to be fully funded for at least five years for this
to be worth your while.
• Divert the last five years’ profits directly into retirement. This
works best for those who are family run businesses, but it can
work for smaller businesses as well. This is sometimes called
the ‘lifestyle exit’ approach. The trick, here, is to maximize
the savings without crippling the business.

If you have less than three years before you want to take off, you still
have a few options, though they are dwindling rapidly at this point.

• Many family businesses opt to include gifts of ‘shares’ in the
business. But, in order to do this, there has to be a defined
and written out value placed on those shares. This starts the
clock running with the IRS. This would be filed using the gift
tax return.

• Fix things up and improve them. Just like renovating a
bathroom or kitchen before a house is sold, so too, you
should improve what you can in your business so that it is
more attractive to potential buyers. These are called, capital
improvements.

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• Show massive productivity and success in the business
earnings. This will make the business very attractive to
potential buyers. No one wants to back a loser, or buy one,
unless you are being forced to sell at a lesser price, and who
wants that.

Let’s say you want to leave next year, or as soon as possible. There
are still some things you can do.

• Find a business broker. At this point, you will need the
assistance of someone who knows the sales ropes and can
help structure the sale. This takes time. Start now.
Immediately. Pronto.

• If you’ve decided to sell the business to an employee, or a
group of employees, this is called an ESOP, and it takes at
least a year to get done. This is because an honest appraisal of
the business has to be done, the ESOP has to be created, and
the official sales documents created and made legal.

Business Owners and Escape Plans

Most don’t realize, but just the type of business entity you are can
define what your exit strategy might be. Here are some special
considerations to factor into the mix when you are creating your exit
strategy.

S-Corp Owners

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If you don’t have a family member that wants to take over, or there
isn’t anyone, then you can create an ESOP (employee stock
ownership plan), which was mentioned earlier. The company would
set up the trust and then makes tax-deductible contributions of
shares of stock into it. These shares are given to employee
participants who are also vested over time. When the employee leaves
or retires, then the company buys the stock back at its fair market
value. When you use this as an exit strategy, it funds a total buy out
of the owner’s shares.

Another reason that this is a good tax strategy for your exit plan is
that whatever percentage the stock is held in by the ESOP, a
matching percentage of income is tax free on the federal level (and in
some states, too). This allows the S-Corp to be a truly tax free entity.
AND, if the S-Corp is completely owned by its ESOP, then none of
the profits are subject to income tax. The only addendum to this is
that the company has to give the ESOP a pro-rata share of the
distributions to the shareholders.

Giving the Business as a Gift/Sale combo

An out and out gifting of the business is not a great idea because
tying it up in a trust ties the hands of the future generation to be as
agile as they’ll need to be in order to make the business succeed.
Likewise, selling it to them may leave them cash strapped. There is a
middle of the road approach, however, that makes the best of both
options. Transfer ‘some’ of the assets as a non-taxable gift, then sell
the rest. This will leave working capital still in the company to fund

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operations.

An Exit Plan Checklist

▪ I have definable business goals that include my financial
retirement goals, and I know how many years I have to
continue working in order to get there, and the successor I
have in mind can do the job.

▪ I know the current value of my business assets, as well as my
non-business assets, and have a very clear idea of what my
company’s cash flow is.

▪ The plans for continued growth have been laid out.
▪ I have a plan in place to grow value, reduce taxes, and

minimize risks.
▪ I have identified the key players and their roles in the

operations of the business, as well as the exit strategy.
▪ I have a certified tax coach that I trust and regularly check in

with.
▪ I have contingency plans in place in case of unexpected

events.
▪ I have action items that I review each quarter that get me

closer to my goals.

Look, you already have a full time job running your business. Part of
that needs to include time for strategic planning, but it is also a smart
move to have a management team that assists in many of the other
facets that are inherent in running the business. A tax professional is,
if I may say so, an invaluable piece of that puzzle. The right one can

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have you sitting pretty when it comes time to ride off on your big
horse into the sunset, martini fully in hand.

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CHAPTER 17

In our father’s and mother’s day, the progression toward retirement
went something like this: work until you are age 65, get a gold watch
or nice crystal vase from the company where you worked for 30
years, and then live happily ever after on your nice company pension.
Not so much now. There are many reasons that this scenario isn’t a
real version of events. First, the rules have changed. Secondly,

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companies don’t keep employees on for life any more. Then there are
the new taxes that have come along to strip more of that nest egg
away from those saving for retirement. Did you know that in some
states Social Security income is actually taxable??!!

Things They Don’t Tell You About Retirement (But I Will)

Medicare. You assume it’s free, but it isn’t. While it’s a good idea to
enroll at age 65, you will be also required to pay premiums and co-
pays. And, Medicare doesn’t cover everything, in particular long term
care should you need it. That’s why Medigap was developed to fill in
the holes that Medicare created. Why they couldn’t just revamp
Medicare to cover these ‘holes’ makes no sense, I agree.

In many states the income that you receive from Social Security is
considered taxable income. Uncle Sam is going to want some of that
money, which you paid into the system in the first place, back.
Currently 85% of your social security benefits will be taxable,
depending on your income.

Any withdrawals from a pretax account (like a 401K or a traditional
IRA will also create an income tax bill. The good news is that there
are ways around this if you use a Roth IRA, or Roth 401k. Rest
assured, however, if you start early and work with a certified tax
planner, you’re going to avoid many of these pitfalls. This is why it is
a VERY good idea to have a retirement income plan. Setting up a
mixture of taxable accounts, tax deferred accounts, or even tax free
accounts, you can give yourself the necessary flexibility to manage or

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reduce the overall bite from taxes. And the good news is that since
you are 65 you automatically qualify for more tax breaks and bigger
standard deductions when it comes tax time each year.

Check with your state’s tax regulations because each state handles
taxation on social security in different ways. For example, Mississippi
doesn’t tax retirement income at all, while Tennessee taxes the
dividends or interest from social security income. There are various
tax maps by state available on the web.

The numbers are sobering. Fidelity investments did a study and
determined that the average couple in their mid to late 60s will pay
more than $200,000 out of pocket for healthcare costs during their
retirement years. This is not even considering the possibility of long
term care. That’s why the Medigap insurance policy is a very good
idea as it can cover some of those out of pocket costs. A new
program, which could change at any time, is the Medicare Advantage
program, which is a type of hybridization of Medicare. Another very
good option is a long term care policy, which can cover the event
that you need to go to an assisted living facility, or it can also pay for
a home health aide to come into the house to help out.

The Truth About Senior Rates

There are many, many senior discount rates out there, from hotels, to
trips, to discounts at restaurants. But are they all really good
discounts? You probably already know the answer to this: NO. It is
still all about comparison shopping. Find out the senior rate at the

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hotel, for instance, that you are interested in staying at, then go to a
discount hotel site to see what they are offering (senior discount or
not). Many times you will still find a better deal on the price than you
would have just taking their advertised senior discount.

The government has a ‘senior rate’ too. For example, when you turn
59 ½ you will not be penalized any longer for early withdrawal of
your funds from an IRA or 401k fund. And, if you’ve held your Roth
accounts for at least five years, then they are penalty free as well. This
is the good news. The bad news? When you are 70 ½ you will be
required (read forced) to withdraw money from those savings
accounts such as IRAs and 401ks. These are called RMD (required
minimum distribution). If you don’t, you will be assessed 50% of the
deficit. For example, you were supposed to take a RMD of $5000, so
your penalty for not taking that money out is $2500. There is a way
around this of course. You will take the RMD as required, but then
reinvest it (if you don’t really need it to live on) into a taxable account
where it can continue to make you money.

The Retirement Plan

Keep in mind that people are living longer these days. You could
conceivably live in retirement just as long as you spent working, so
you’ve got to make sure that you have enough income to cover that
time period. There are ways to protect yourself against living longer
than your money will last you, by doing a number of things. First,
you could keep stocks in your overall portfolio, which provides long
term growth and will protect you from the risk that inflation is going

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to eat away at your nest egg.

Another great strategy to incorporate is if you are married, have the
spouse that has the higher earnings delay taking the social security
benefits until they are age 70. This increases the benefits paid to you
by over 30% per month. This lasts the lifetime of both spouses, and
it is adjusted for inflation. Another good option to guard against
outliving your money is to take out an annuity. This is sometimes
easier for couples to do since it doesn’t require a large outlay of cash
up front in exchange for a larger payout at age 85.

Getting the Treatment

Tax treatment is how the government views the income that you
have, the assets that you have, at retirement. This situation definitely
affects investors, traders, and can in large part affect the ordinary
retired individual, too. Capital gains can cause major headaches if you
aren’t savvy in the way that you claim these funds. And it death
doesn’t even matter when it comes to taxes. If you receive monies
from an investment that was originally held by a deceased spouse you
will also inherit the capital gains taxes that went along with it, even if
you are in a lower tax bracket.

Qualified and Nonqualified Taxes on Dividends

Special qualified dividend treatments can actually result in an increase
in your after tax return. However, the catch, here, is that if your
income goes over a certain threshold, then there would be an
additional 3% surcharge placed come tax time for Medicare

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surcharges. As of 2013 married couples filing jointly with a MAGI of
$250k will be hit with a surcharge on that net investment income.

Dividends are money that you receive as a result of an investment,
such as a stock, bond, or other savings instrument. These dividends
come in two ‘flavors’: qualified and nonqualified.

Qualified dividends are those that fall between a tax bracket of 10%-
15%. They are also taxed at 15% rate for those that are in the 25-
39.6% brackets, and are taxed at a whopping 20% for those whose
income is in the 39% and higher brackets.

Nonqualified dividends are what most have, and they are taxed just as
if they were ordinary earned income. These are the dividends that
come from the interest and returns from stocks, securities, bonds,
and mutual funds.

Reality Checks (Real Life Scenarios)

Many small business owners have a 401K or something similar. One
of the first decisions you’ll have to make when you do retire is what
you will do with the disbursement from that 401k. You can either
leave it in the investment portfolio if you have at least $5k in it, and
you can keep it until the normal retirement age (65), or in some cases
(72). If you are younger than 65 and want to retire, then if you are at
least 55 you can start withdrawing funds without penalty, but you will
still be taxed on the withdrawals as if it were actual income. If you
roll that money over into a Roth IRA, then you’ll have more options
down the road.

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Rollover to a Traditional IRA

If you are forced to withdraw the money from your 401k, then a very
good strategy is to roll that over into an IRA of some kind. Many opt
for the traditional IRA at this point because you can preserve that tax
deferral by rolling the money directly into another new ‘custodian’.
The way to do this however, is ticklish. You can’t have your employer
or current custodian of the 401k cut you a check, or you’ll pay taxes
on it. Instead, the rollover has to be sent directly to the new IRA
company or account.

Company Stock

If you worked for another company, not your own, and you had
company stock, then there are special rules for how this is treated.
This is called net unrealized appreciation (NUA). If you take your
401k disbursement you can move the stock to a taxable account, then
roll the assets over to an IRA. You will pay regular income taxes but
the remaining NUA will be taxed when the stock is finally sold.
What’s nice about this strategy is that the profit from this will qualify
for the long term capital gain rate.

Mandatory Distributions

After a certain amount of time the government doesn’t have a vested
interest in your saving or holding on to your hard earned money any
more. It is set up so that you must take taxable withdrawals out of
your investment vehicles by April 1 of the year you turn 70 ½. You
will have to take these required minimum distributions (RMD) each

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year. This RMD is a floating number that can change every few years
and is based on life expectancy figures. You can take out more than
the RMD, but fail to take out the minimum and, as stated earlier,
you’ll lose half of it as a penalty. Not cool.

Roth IRAs

Most people have heard of Roth IRAs, but are confused as to how
withdrawals from one works. It is true that you have to have had the
account for at least 5 years, and that it is only tax free if you don’t
take anything out until you are age 59 ½. But, here’s the rub, earnings
are the last thing that are taken from a Roth. The IRS bases this on
the fact that the first money that is withdrawn from the account and
the annual contributions that you made into that account. It is only
after you’ve taken your contributions and converted amounts from a
401k that the actual earnings are tapped in to.

So, for example, let’s say you converted $100k from a 401k account.
You could take it all out at the tax free rate, though you would pay a
penalty if you’re not over 59 ½. Traditional IRA accounts have
mandatory withdrawal rules, but not so with Roth IRA accounts. So,
literally, you can leave the money in a Roth IRA for as long as you’d
like to. And distributions from the Roth IRA are also tax free. These
accounts can be inherited too, making them one of the hottest
retirement accounts coming, and going.

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