Secrets of the 1%: Wealth Building and Tax Strategies for Business Owners

That leads to our next big legal loophole or tax minimization strategy, which is owning a business. Yeah, this is the one that you hear about at the cocktail party. So people like to talk about real estate; that’s the one they get excited about. But when you think about owning a business—well, business owners, they get all the benefits. They’re able to write off everything. If you don’t believe us, take these people’s words for it. It’s a write-off for them. How is it a write-off? They just write it off. Write it off. What, Jerry? All these big companies, they write off everything. You don’t even know what a write-off is, do you? No, I don’t, but they do, and they’re the ones writing it off. How many conversations have you been in like that?

Well, I mean, I think because the genius of Seinfeld is that it realizes this is from the ’90s, right? Mhm, we didn’t have social media like we have now. But when I watch all the videos that tell you all this stuff that’s deductible, it’s kind of like what we started the show with at the top. If you own a business, everything’s deductible. I mean, and it’s the craziest thing. So we actually want to kind of separate the fact from the fiction. Here’s the reality of the situation. And the first thing we were going to cover was business structure.

Yeah, the way that you own your business can have an impact on the way you pay taxes. I mean, there are other impacts that come into it between liability protection and those sorts of things. But whether you are a sole proprietor, you’re an LLC, or an S corp, or you’re a CP, there are different implications to how you structure your business because they’re not all taxed and treated the same way. Yeah, I mean, if you think about the progression of a small business owner, they start off as a sole proprietor who’s just doing a Schedule C. And then after they decide they want some legal protection, they might become a single-member LLC still taxed on a Schedule C. But you know, P.E., they will progress, and you’ll see LLCs are taxed as partnerships. You’ll even see LLCs are taxed as S corps.

So what’s the difference between when you see people talk about an LLC versus an S corp? Here are some key things just to point out. Now look, this is oversimplified, but you’ll still get the point. A lot of your LLC income is going to be subject to self-employment tax. It’s going to be subject to the 15.3%, all of it is, up to a point up to the Social Security tax limit. And then you’re subject to the Medicare to infinity and beyond. So that’s one thing. Then some very creative people in states that accept S corporations have recognized that, hey, S corps have a unique advantage in the fact that you can have two different components with your ownership. You have your working in the business, meaning your wages, what you would have to pay somebody to do the job you do within your business. And then you have your income that is derived from you being the owner or the investor in the business. So that’s why you can quickly see this creates an opportunity that if you underpay yourself on the S corp side, you’re avoiding a lot of payroll taxes. But I tell you, be careful. Do not try to hoodwink the IRS to where, because I even, we were talking to somebody recently in the last week, Bo. This happens all the time where he told us, he said, “Yeah, so and so just told me I need to pay myself $40,000 a year and then I could take the rest as just distributions and only pay income tax, avoid the 15.3% self-employment tax.” I was like, “Yeah, that sounds like an audit waiting to happen because could you pay somebody 40 grand to do what you do in this business?” He’s like, “Of course not.” And I’m like, “Yeah, that’s exactly what it’s going to feel like when you sit across the table from the IRS. So go and figure out what you really would have to pay somebody. Don’t get cute with it. And then, yes, owning the business allows you to have a little different tax treatment on that component. But be very respectful to make sure you don’t run afoul of this rule. I love it.”

Another huge benefit when you own a business. We’ve talked about how retirement contributions can be fantastic from an employee standpoint. But as a business owner, retirement contributions can be fantastic from the employer standpoint. Because not only do you get to participate, specifically if we’re talking about 401(k)s as an employee, where you can do a $22,500 salary deferral, or if you’re over 50, you can do a $30,000 salary deferral, you can also do profit-sharing contributions. It would take your contributions all the way up to $66,000 or even higher if you’re doing the catch-up. Well, even once you graduate past that, there are other types of retirement plans you can bolt on, like a cash balance plan where perhaps you as the business owner can not only max out the salary deferrals and not only max out the profit-sharing, but you could also do six-figure contributions into a cash balance plan. When you look at the total cost of the plan, you say, “Okay, well, I’ve got to put this much in for my employees, and this is how much administration costs, and this is how much I have to pay for recordkeeping.” And I add up all those costs. Well, if I’m able to save this much money based on my income tax rate, I’m actually going to save more in taxes than the entire plan is going to cost me. It is a fantastic benefit for small business owners that have had some financial success and have a lot of discretionary cash flow to be able to fund these. It’s a huge way to legally decrease your tax bill in a given year. Since these cash balance plans are defined benefit plans, not defined contribution like your 401(k)s, so they have actuarial calculations. When these things, when I first heard about them, the only people offer them were usually associated with high-cost insurance products, investment. I’m happy to report now that there’s an entire industry out there. If you want index funds in your cash balance plan, you can have index funds in your cash balance plan because I feel like this industry has evolved to where it’s created a lot of opportunities. Now, the only catch is on these things. I always like to give you the asterisks. This is not something if you had just one good year, you kind of say, “Well, let’s go set up this plan, and we’ll be good to go.” No, this needs to be something that when you set it up, you know that going forward for the foreseeable future, at least 3 to 5 years in the future, you’re in a good stable place with this. And then, of course, there also, you’ll get a big education on how actuaries work, also how Pension Benefit Guarantee Corporation works. There’s lots of moving parts on this, but it can be very effective, even though it’s complicated. It could be something for high-income people to really take advantage of.

Another thing that you can do as a business owner, if you do operate a business that requires a physical location, whether it be an office or a warehouse or a storefront or whatever that may be, one of the things you as a business owner can do is you can actually buy the real estate itself. And then since you have the operating company that’s working out of the real estate, you can actually pay yourself rent. What a wonderful benefit. Instead of you paying rent every month and it going out to someone else, what if you as the business owner could then pay it to yourself? So it’s a great benefit, and it’s not uncommon for business owners to acquire a piece of real estate, operate their business out of it, and then one day, even in the future when they sell the business, they continue to own the real estate. And that becomes part of their retirement income, part of their cash flow in financial independence. It’s a huge benefit available for business owners that also need a real estate location to operate out of. Yeah, I don’t mind sharing. I’ve been in the game long enough that I’ve worked with a lot of business owners. That’s actually how I kind of felt like I got my way into this industry. If I could help a business owner save some taxes, they loved me. And I’ve now seen them go from starting companies to selling companies. And it’s not too surprising to find that a lot of these business owners will make more on the real estate of the building they bought for their business than even the liquidation of their business when they retire. So it is definitely something that’s very valuable, very effective, and even tax-favored. So don’t overlook the opportunity and benefits of paying rent to yourself.

Another big benefit that exists for business owners—again, this is similar to what we discussed in the real estate section—is that you do get a deduction for qualified business income inside of a business that meets specific and certain qualifications. Again, this changed with the Tax Cuts and Jobs Act of 2018 and is set to sunset to expire in 2025. But right now, assuming you have a business that qualifies for the qualified business income deduction, you get a 20% deduction on the net profit generated from the business. That can be a huge tax offset. So you just want to make sure that you understand the rules for qualifying businesses, and you want to make sure that you’re seeing that reflected on your tax return, at least for these next couple of years.

So we’ve gone through a lot of business things, but I want to just go through in rapid fashion a few honorable mentions because these were good things but not as good as some of the other things. I think it’s important you hear people talk about the deductibility of vehicles. Yes, there is potential, but it is gray. Remember, there are all kinds of restrictions. What is the weight of the vehicle? How much is it used? Because if it’s not used for 50% business purposes, and by the way, make sure you’re not counting those commuting miles in that process. It can get complicated, but it is worth noting. If you do your research, there’s potential that vehicles could be a good deductible expense for you. Also, meals. Now, look, during the pandemic, the government did something that was very unusual. They made meals 100% deductible. They were trying to really help out in the food industry. But it’s gone back to normal now that we’re in 2023, where it’s only 50% deductible. And then the last thing, you know, we’ve even reacted to some funny clips where people just basically say everything’s deductible as long as I slap my logo on it. That’s not exactly true. You can’t go buy, you know, a brilliant suit and just because you signed your name on the inside sleeve, it is the perfect thing. But it is true that you can go by promo wear, logo wear, and other things to give out to customers, to give to your team members, to even wear yourself as a uniform. Nothing wrong with that. So doing promo-type stuff like that is a very effective and actually a useful deduction for business owners. For more information, check out our free resources.