Posted on: March 1st, 2020
When it comes to lowering your tax bill—something seemingly all entrepreneurs want to do—it’s crucial to make sure you’re avoiding taxes and not evading them. The difference:
Here’s another way to look at it:
Question: What’s the difference between tax avoidance and tax evasion?
Answer: About four inches.
Why four inches? That’s the width of a typical prison wall!
Why would you even want to take the chance?
 Disclosure: Tax laws are subject to change, which may affect how any given strategy may perform. Always consult with a tax advisor.
Here’s something most of us don’t fully appreciate: The government supports tax avoidance. They know it’s good for you and good for the country. The government has social goals and uses the tax code to foster them. That’s why the government intentionally creates ways for you to legally lower your tax bill!
Take, for example, the social goal of people having money to take care of themselves when they’re no longer working. The government wants its citizens to be financially secure, so it forgoes money presently. Thus, when you put money into a qualified retirement plan, you take a tax deduction.
Another example: charitable contributions. The government wants to promote philanthropy. It’s a social good. So when you make contributions to recognized charitable causes, you get a tax deduction. With the intent of fostering charitable giving, the government has created various tax benefits depending on the way you donate. For example, using a charitable trust to sell some of the equity in your business can enable you to get a tax deduction—as well as avoid capital gains taxes on that equity.
Most recently, the Tax Cuts and Jobs Act of 2017 created economic opportunity zones. The incentive for investors is tax benefits. The social goal is to increase investment in distressed communities and foster economic development and job creation in these areas.
When you’re using the types of tax avoidance strategies described here, you have two purposes. Arguably, the most important purpose is the social and personal goal. The second purpose is tax mitigation.
Take retirement plans. Having money later in life can be highly advantageous. So too can taking current tax deductions. The money in a qualified retirement plan grows tax free—and there’s the possibility that you’ll be in a lower tax bracket when you eventually withdraw the money from the plan.
There are different types of qualified retirement plans. While most entrepreneurs are familiar with defined contribution plans such as a 401(k), fewer are as aware of defined benefit plans. Business owners could potentially benefit significantly from understanding the pros and cons of the different types of qualified plans.
There are many ways to lower your income tax bill. Some strategies that entrepreneurs tend to consider and benefit most from include:
Money put into a qualified retirement plan is tax deductible and grows tax deferred. For various reasons, not all business owners set up qualified retirement plans. However, among those who do establish such plans, the tendency is to go with a defined contribution plan—such as the well-known and highly familiar 401(k) plan.
That could be shortsighted, however. Defined benefit plans—or DB plans—might do a much better job for business owners. One big reason: DB plans can allow business owners to put in a lot more money.
A captive insurance company (aka a “captive”) is a closely held insurance company set up to insure the risks of the parent company. The owner of the parent company wholly owns the captive insurance company. That means the business owner controls the captive insurance company’s operations—including underwriting, claims decisions and the investment strategy. The underlying reason to use a captive insurance company is risk management.
There are different types of captive insurance companies that are appropriate for different business scenarios. In all cases, however, entrepreneurs can use captives to reduce income taxes. Under the right conditions, the premiums paid into a captive insurance company can be tax deductible. A company is then able to get a current-year write-off, even though losses may never occur.
Pro tip: The services of a high-quality accountant can help you get the most from your possible deductions.
There’s also the issue of avoiding capital gains taxes. This is often a big goal when entrepreneurs sell their businesses. Too often, however, entrepreneurs wait until just before the sale to think about capital gains avoidance—at which point it’s generally too late. Instead, consider tax mitigation strategies well before the sale of a business or any appreciated asset.
If you gift some or all of the appreciated equity in your business to a charitable trust and the trust sells it, the capital gains taxes on the equity will be eliminated. A percentage of the money in the trust can also be used to provide you (or someone you designate) with an income stream. Also—and perhaps most important—a nonprofit of your choosing will end up getting funding.
The upshot: Charitable trusts are very powerful tools for entrepreneurs because they’re one of the few ways to eliminate capital gains when selling appreciated assets such as a business. They’re also a way for entrepreneurs to provide money to loved ones and charitable causes they care about.
Within the business world, disharmony among family members or unrelated business partners can also mean a higher tax bill if the owners are forced to divide assets among its members. Through the use of sophisticated partnership structures, entrepreneurs can structure a division of their companies, eliminating capital gains taxes at that time.
As a general rule, any asset can be contributed to a partnership and can be distributed from a partnership to a partner, tax free. There is no need for disgruntled partners to continue to work together—and they pay taxes only on the businesses they control.
Finally, there’s estate taxes. If you’re really successful, you might create enough personal wealth that you’ll owe estate taxes when you die. But with careful and thoughtful wealth planning, you may be able to significantly reduce—and maybe even eliminate—future estate taxes.
You can lock in the current value of your business for estate tax purposes. This means if your company increases in value between now and when you sell it, for instance, the appreciation over that time is not included in your estate—and therefore not subject to estate taxes.
All of these types of tax avoidance approaches are called “bright line transactions.” That means there’s no question about their legality, as they’re clearly specified in the tax code. Moreover, every knowledgeable and capable tax professional—lawyers, accountants, wealth managers and the like—should know about these and other ways to help you potentially legally avoid or reduce taxes.
The catch, however, is working with a knowledgeable and capable tax professional.
The tax professionals you want to work with will not only be very technically adept, but will also seek to truly understand you—your personal and professional objectives and dreams, concerns, and anxieties. Armed with an in-depth understanding of your world, a high-quality tax professional can work with you to design and implement solutions that are best suited to serve your particular situation in terms of tax mitigation.
Important: High-quality tax professionals all have access to the same legal tax mitigation strategies. Because of the formal government-created tax code, no strategies are secrets known only to a few. Indeed, if someone claims to have a proprietary tax strategy, it’s a potential red flag that he or she could be veering into tax evasion territory. At a minimum, you should probably get a second opinion on that strategy’s legitimacy.
Best advice: Avoid taxes as best you can, using the advice of smart tax pros—but stay on the right side of that wall by steering clear of all tax evasion strategies and the people who peddle them.
This report was prepared by, and is reprinted with permission from, VFO Inner Circle. AES Nation, LLC is the creator and publisher of VFO Inner Circle reports.
Disclosure: The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra IS or Kestra AS. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by Kestra IS or Kestra AS for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS.
Fusion Wealth Management is not affiliated with Kestra IS or Kestra AS. https://www.kestrafinancial.com/disclosures
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