Dear Accountant, originally a book featuring career insights and advice from 21 professionals across 11 finance and accounting disciplines, has transformed into a podcast, blog, and platform for young professionals to gain mentorship, advice, and resources from. Today, we hope to shed some light on the best tax strategies to reduce taxes and build wealth that everyone can make use of, pulling from the excellent advice of James Rainwater from Rainwater CPA.
Have your numbers together
Whether you are a member of a large organization, a sole W2 employee, or starting your own company, James advises you to be on top of producing good financial statements with tracked expenses. Not filing taxes can have some dire consequences down the line, and the best approaches to tax planning are based on the company’s numbers. First and foremost, ensure that you are acting in compliance. Compliance, however, is merely the first step (and usually the step that most CPAs exclusively focus on), and serves as the building block for your future investments.
Side Hustles Save Money
For w2 employees, creating a side hustle through incorporation can lead to a considerable increase in tax savings. A side hustle can be any form of incorporated business entity, such as consulting, writing, or editing. With a side hustle, James explains, business expenses can be deducted from IRS filings. For example, your entire garage, computers in the home, security systems, and more - if you use a home office - may classify as business expenses. The IRS even allows de minimus expenses; if a cell phone’s primary use is for this side hustle, it’s 100% deductible.
Offsetting Capital Gains
James explains that although advice is always context-specific, offsetting capital gains that exceed $500,000 can be key to saving money and maximizing wealth. There is an opportunity to engage in tax-loss harvesting throughout a diversified portfolio, as well as installment sales, which can be set up directly with the purchaser as deferred income, or structured through trusts.
Hiring your Children and Spouse
Hiring a child to work directly with a parent (not with an S-corp or C-corp) can save you money on payroll taxes. Moreover, children are not subject to social security or medicare taxes, or even labor laws if they are under 18, meaning there is no need for a work permit. Finally, the income tax for children is at 0% for up to $12,000 of income generated. Moving money around from your paycheck to your child’s can therefore serve as an effective tax strategy to include in a diverse approach.
When hiring a spouse, the goal is to reimburse medical expenses through the business. Because 2% or more of S-Corp shareholders cannot reimburse themselves for medical expenses, the spouse can be brought in for this reimbursement through a salary and 401K.
Optimizing Legal Entity Structure
Sole propertiers, or LLCs, serve as effective structures until they generate around 50 to 75 thousand in net income, which James refers to as the LLC’s breakpoint. SP’s taxes are quite large, and he recommends moving to a corporate structure in order to ensure that profits are not subject to self-employment, payroll, or investment taxes while you are active in the business. Analytically, analyzing whether the LLC should become a C-corp or S-corp will be the next step.
C-corps can be valuable, given exclusions on capital gains and qualified small business stocks. Moreover, C-Corps can be helpful when most of the profits are staying in the business - transferring to product development, research and design, etc - and the goal is to continue to build a product that will be sold as a valuable entity in a small amount of time.
S-corps, on the other hand, are helpful when profits are being used to pay for bills, investments, and personal use. Because the cash flow is leaving the business, associated taxes will pass through to the shareholders.
Investing in Real Estate
Firstly, becoming certified as a real estate professional can allow one to create losses that offset income from real estate, leading to lower taxes. James advises that each individual approach real estate based on their desired outcome and level of commitment to the projects, given the diversity of opportunities to become involved in real estate. Some ideas of investments include flipping single family homes, flipping commercial properties, renting homes you purchase, or buying investment funds that work within real estate. Investment funds are useful as they serve as a combination of leverage and depreciation. In other words, although you only need to put down a fraction of the price into the fund (dependent upon your credit, bank, and other factors), the entire building space will be depreciated, creating a tax advantaged cash flow. Individuals can also purchase wholesale and distress properties, and sell the contracts.
Remember the 1031 exchange for rental properties, which defers capital gains and recaptures depreciation when you sell. These days, James shares that it is quite popular to combine a Delaware Structure Trust with 1031. When these tactics are combined, the real estate is sold to a partnership, which renders the income tax free (for you, not your heirs).
Tax now, Tax Later, or Tax Never? The Power of Zero
James explains that because of the US’ rapidly increasing debt, it’s unlikely that taxes will be lower than they are right now in the foreseeable future. As such, he recommends engaging in tax planning to ensure that you can create cash flow and redeploy it wisely into avenues such as wealth management, investments, and real estate. Inflation means that the money sitting in your bank account loses value every year; redeploying the capital towards other opportunities can create significant tax advantages.
James also discusses an undoubtedly powerful tool in tax planning: the use of Life Insurance. Most people don’t realize that they can structure their life insurance so that the death benefit is low, but the cash investment is high. By doing so, individuals can earn money tax-free and take out the cash on their own schedule. Thus, Life Insurance can work like a ROTH, even for clients who are phased out of the ROTH savings account model.
🎧 To learn more about the best strategies to use in your approach to tax planning, James’ personal career, and his advice to budding entrepreneurs, listen to our podcast episode with James here. For more mentorship advice from Cece Leung, listen to all of the episodes of the Dear Accountant podcast here.
🎙 The “Dear Accountant” podcast is a uniquely insightful and entertaining podcast for aspiring young business professionals. Each episode is packed with actionable advice to help young finance professionals get ready for whatever challenge they may face next. Aside from all of the many cool things in accounting (technical topics and trends), we bring in industry experts and influential leaders to share their journey, insights, and perspectives. We will also cover topics that were not taught in school - life essential skills such as personal finance, emotional intelligence, mentorship, networking, body language, and human behaviours, and so much more!
💬 About our guest, James Rainwater: James received his degree in accounting from the University of Maryland before obtaining his MBA in Finance & Leveraged Information Systems from University of Baltimore. James worked within the corporate landscape for decades, serving as the CFO of Acadia Companies, Director of Finance & IT for Unitec Electronics, and Tax Director of EvolveCFO. James has taught as an Adjunct Professor at the University of Maryland’s University College in Business and Corporate Taxation, and continues to serve in his role as an Expert Instructor at Corvee, while running his own CPA company, Rainwater CPA.
📖 Get amazing advice from the 20 mentors in “Dear Accountant” Book: The book offers a unique immersion into the lives and careers of 20 inspiring leaders in finance from different disciplines - their backstories, pivotal moments, career trajectories, and hiccups along the way.
🎧 Listen to Cece’s interviews about her passion and mission in writing this book and paying it forward to help young professionals to find meaning and fulfillment in their life and career: