The Mark Perlberg CPA Podcast
The Mark Perlberg CPA Podcast
EP 110 - Why You Should (or should not) Defer Taxes
Tax deferrals can be a powerful tax strategy when implemented properly and at strategic times, as demonstrated by a client who missed an opportunity that will cost them approximately $100,000 in taxes. We explain why timing your tax deferrals between high and low-income years creates massive tax savings despite common objections.
• Common objections to tax-deferred accounts include eventual taxation, liquidity concerns, and ordinary income tax rates on distributions
• Retirement accounts offer more liquidity than people realize, with loan options for Solo 401(k)s and principal withdrawal flexibility from Roth accounts
• Strategic timing of contributions and distributions between high and low tax bracket years creates substantial tax arbitrage
• Contributions to SEP IRAs and Solo 401(k)s can be made until October 15th of the following tax year
• Self-directed retirement accounts can invest in real estate and other alternative assets without needing real estate professional status
• Advanced strategies include timing Roth conversions during temporary valuation dips, potentially reducing conversion taxes by 30-40%
• Beyond retirement accounts, consider 1031 exchanges, installment sales, and charitable planning for additional tax deferral opportunities
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Before we go into this episode, I want to share with you an example of a client who made a mistake that will likely cost them around $100,000 in taxes, maybe more. So we have a client who we've shared so many ideas with and they keep on shutting us down and shutting us down and saying, oh, but I don't like the structure of this. Ah, this is risky, this doesn't align with what I like to do with my cash. One of those opportunities was to put some money into a solo 401k and SEP IRA, and they didn't want to do it because their reason, which we will debunk in a little bit well, the taxes are going to go up in the future and I don't trust what the tax rate's going to be. We don't want to defer. So the client owed about I believe it was around $430,000 in federal taxes and they were obviously in a very high bracket. Now this year we're projecting they're in a far lower bracket and because of that and the volatility in their businesses, this is a huge, huge missed opportunity here, and so what I'm going to share with you today is the objections that we see to wanting to defer your taxes with retirement accounts. And also, when does it not make sense, and when does it make sense? And at the end of this podcast or YouTube video, you're going to understand the value in deferring taxes, some of the setbacks and a little more about why this might make sense with you, and hopefully you'll have the right tax team to help you execute on some of these concepts and start creating real wealth.
Speaker 1:So let's just first talk about why folks are against deferring their taxes. Well, they don't know that you're eventually going to be paying taxes on these tax deferred vehicles like your IRAs and your 401ks, so it's only a matter of time before you pay taxes on that income. And then all the investment income is tax deferred as well, and eventually that's taxed. So a lot of folks are like why am I going to defer taxes when I'm eventually going to pay it? This is not that exciting. And then another reason why is when you put them into these retirement accounts, you have less control over what you can do with your cash. So for those of you who are cash strapped or need liquidity or liquidity is your greatest concern with tax planning this may be a real challenge for you and it may deter you from a lot of these tax deferral vehicles. Another thing you may want to think about here is the way that you're not only when we're talking about liquidity, but when you look at your return on investment for these vehicles. So you put them in these tax-deferred vehicles and you can invest passively, put them into stocks or get passive interest in other companies, et cetera, et cetera commodities, whatever it is, whatever bonds or whatever it is you may find or think that the return of investment of putting the money back into your company is going to have greater value than putting it away in a retirement account.
Speaker 1:And then another concern and here's a legitimate concern is that when the money comes out, it is taxed at your ordinary income rate. Concern is that when the money comes out, it is taxed at your ordinary income rate. So you may actually find a net increase in your taxes on certain activities with this, because think about this If you take your savings and put it into a brokerage account and later down the road you recognize a long-term cap gain, well, that long-term cap gain is taxed favorably. The highest it'll ever be taxed on the federal side is 23.8%, and it may be taxed at as little as 0% if you're making under $90,000. But when you pull the money out of the 401k or IRA, it's going to be taxed at your federal marginal rate, which is always going to be higher than that cap gains rate. And also there's all these really exciting and unique cap gains tax strategies that are not going to apply when those cap gains are within your retirement accounts.
Speaker 1:So let's talk about why it still is going to make sense for a lot of you to consider deferring your taxes here. Well, one is you can borrow. It's not a lot, but you can borrow from some of your 401k money. So if you have money in a solo 401k or a self-directed 401k, you can borrow the lesser of $50,000 or 50% of the balance. Now you and your spouse can each do that to your retirement account, so we can borrow up to $100,000. Another idea here, when we address the liquidity concerns, is if you decide to roll this into a Roth, obviously you will pay taxes at that time, but you can take the principal out of your Roth without paying any penalties or taxes or fees, just the principal. So there are ways to actually have liquidity here.
Speaker 1:Some other things that you may want to think about here is there may be some additional tax savings when you do this when you structure it right in the sense that if you were to compensate yourself more or we'll talk about later of incorporating your spouse into your group of employees, paying your spouse and then deferring their taxes, you may actually find an increase, under certain circumstances, to your QBI deduction a 20% tax deduction. So you may find that the tax reduction is a little more than you actually thought. Tax reduction is a little more than you actually thought. You may find that you are reducing your taxes by more than just your marginal rate for the incremental increases in your tax-deferred contributions. Now to explain the nuances of there, that would really be a deep conversation, really reserved for tax advisors listening, and I don't want to overwhelm you guys with tax jargon. But just keep this in mind that if you're working with a skilled and experienced strategist, qbi deduction may factor into this with some other variables as well, but that's going to be a whole other can of worms that I don't want to open. So we're going to move forward on that topic.
Speaker 1:Some other things I want you to think about here as well is well, let's just get into it on why this is still going to make a lot of sense for you, and one of the key reasons why I think a lot of you are going to like deferring your taxes and this is going to make sense is the timing mechanism. So the idea here is you stash your money in a way, you contribute money into these tax deferred retirement accounts and you are reducing your taxes at whatever bracket you're in, and eventually you're going to recognize the income. But you're going to be able to recognize your income at a lower tax bracket. And some may argue well, I don't know what tax bracket I'm going to be in in the future. Well, when you retire, there's a good chance a portion of your social security is untaxed and you're likely going to not be in your highest tax bracket.
Speaker 1:And another thing to think about here is when you retire. Or let's say, you have volatile income, so your income can go up and down for a variety of reasons. Or let's say you have a. You know you're going to get real estate professional tax status in the future. You have some tax planning opportunities. It's last second. You know there are ways to mitigate taxes in the future, but right now you need something to do. There are also. This is a way by which we can defer the taxes now and then later on where we have more tax advantage situations, like I said, maybe a rep status in the future, maybe you have short-term rentals in the future, maybe you have some expensive assets in the future. That's when you can kind of time, when the money gets converted into the Roth or you take a distribution.
Speaker 1:Another thing you can think about here is not only timing of when you put the money in and when you roll it into the Roth and convert it and you do it, you really can smoothen out the tax brackets. So let's say we know we're going to drop in a lower bracket and we recognize the income in those lower bracket years. Obviously the spread between those two brackets are going to drop in a lower bracket and we recognize the income in those lower bracket years. Obviously the spread between those two brackets are going to create an overall tax savings. But some other things that I think you should think about here and this will motivate you to at least set up the account you don't even have to put money in is that you do not have to always put in the money into these tax deferred vehicles by the end of the year.
Speaker 1:So let's say we don't know how next year is going to shape out. Yet we don't really know what our profits are. We have some key transactions we're waiting to figure out and we don't really know. Let's say, our books still need to be cleaned up, et cetera, et cetera. And we're getting a bunch of K-1s and we don't know what the K-1s are going to say. What we can do is we can wait until the dust settles to determine how much we're going to put into some of these retirement accounts, which is really cool. So it could be after the end of the year where we may be able to decide how much of our employer contributions, which is 25% of the net self-employment taxes when you have a solo 401k and that is maxed out at.
Speaker 1:I'm going to have to put that in the show notes. I don't remember how much for 2025. But I think it's around $75,000. Don't quote me on that. I'll put it in the show notes. But we have the opportunity for the employer contribution amount and even if you're a single member and S-Corp or sole prop, this is possible. Here you can wait until October 15th of the following year. You can see to yourself well, do we want the deduction more in the prior year or this year and you can make that game time decision as you file the taxes. Not only do we have a chance to really think things through and see how the dust settles for the prior year's books and the current year activity, we also have access to the cash a little longer and can maintain a little more liquidity before making these decisions and getting the tax deduction for the prior year. Now for the SEP, we have a maximum contribution of 25% of the employer contribution, and we can do that up until October 15th as well. So there is just another way where we can be flexible in making these decisions. That may make you want to do this.
Speaker 1:Some other things I want you to think about here is not only timing of when we put the money in and when we put the money out, but there are also other things we can consider in our strategies. So some of the things we can think about is, like we talked about earlier, hiring the spouse, hiring the kids even if the kids are over 18 and they're paying FICA and looking at the whole family here. So I had a really good conversation that I'll probably put in the show notes as well here with a financial planner talking about when he does planning for his clients and he's thinking about how much is going to go in these retirement accounts, he's not just looking at his accounts and his profits and his income. He's looking at the income of the client and the client's children and the heirs and all the other people, because your heirs are going to inherit these accounts. So that could just be one of the. When you consider the fact that your heirs could inherit a tax deferred vehicle and they may be in a lower tax bracket, that's another way where we're timing of it and we're going to take the tax deduction and our heirs inherit it and eventually the money will grow in a tax advantage manner and be recognized at a lower bracket or they can more favorably roll it into the Roth. When we talk about timing in the year, we can also time expense events. So when are we going to have this major event? When are we going to time maybe certain renovations or the sale of other assets and really having control of all of these moving pieces so that when we eventually pay taxes on these deferred vehicles, we can make sure that we are minimizing the impact of them?
Speaker 1:Now a really, really cool and fun and advanced strategy that I've seen some folks use and some of our clients use is with self-directed IRAs and 401ks you can invest into real estate and you can also invest into oil and gas. Those are the two most common and when you properly time the conversion into the Roth, there are ways by which we can reevaluate the fair market value of the assets in these investments. And the value of the assets, if you do it at the right time, has diminished. So you buy a rental property. Let's say the rental property has been demolished and you put all this money in and you haven't really seen the benefit of the improvement. So if you time it properly and you do your conversion, we've seen this offset anywhere from 30% to 60% of the potential taxes on the conversion of moving that investment into the Roth. Now, 60% is high, by the way, and I'm not sure if the folks and we didn't recommend this strategy to our client, but they did it. I'm not sure how legitimate those valuations are, but I would say 30 to 40% we can mitigate right away.
Speaker 1:Some other ways that we can think about this here is timing life events as well. So if you're going to get married and jump into when you're married, filing joint tax status is going to be a little more favorable for recognizing the income. And then I also want us to consider the fact that a lot of our clients don't realize that the age of 59 and a half is really not that far away. And if you're worried that, oh, I got to wait until I'm 59 and a half is really not that far away. And if you're worried that, oh, I got to wait until I'm 59 and a half to touch the money, hold on a second. That day is going to come a lot faster than you think.
Speaker 1:And if you think that you're just going to put the money away and have it, do stuff that you're not interested in and grow in index funds, think again. You can do a lot with self-directed accounts. You can do hard money lending that can give you really strong returns of investments. You can self-direct and invest in real estate with your tax-deferred vehicles. For some of you who don't have real estate, professional tax status or short-term rentals and you want to find a way to reduce your taxes to invest in real estate, you can simply find a way to put more tax deferred money in the 401k and IRA and there you're, reducing your taxes and using the funds to invest into the real estate and you can partner other people's deals through the retirement accounts. There's so many unique and interesting ways by which we can do this.
Speaker 1:So when we think about deferrals, there are obviously there's a whole world of ideas out there and variables to consider, and you know we're also going to need to consider changes in your situation, family situation, tax law changes, what strategies you're using now versus later. So many things to consider but at the end of the day, this is just one of the many pieces of the puzzle here for tax planning. Another thing I want you to know about tax deferrals is that retirement accounts aren't the only ways to defer your taxes. So you may want to also consider and I think 1031s are a great way to defer because you eventually get that step up basis in the asset, so eventually your heirs inherit it as a step up basis, so you may never pay the cap gain on a 1031. Installment sales and breaking out the cap gain over a number of years so we can keep ourselves away from that highest 23.8% Fed tax bracket.
Speaker 1:Another thing I want you to look at here is there are some advanced charitable strategies that may involve some tax deferrals, which we can dive into in another conversation. So obviously there's a lot of innovative strategies out there and there are so many creative resources that we have and experts and ideas out there when it comes to tax deferrals. And one other idea I just want to give you if you're planning to invest your money for a long period of time and let's say it doesn't make to defer you can still put the money and defer and then just roll it right into the Roth. Now, there are some regulations you have to follow here, but you can still roll the money into the Roth and grow it tax free. So why not? I mean, if you have the opportunity to do it, why not?
Speaker 1:And another thing I thought I'd add while I'm riffing on this topic is when you want to be careful. If you have multiple employees, that's going to impact your decision making as well maybe exclude folks from being overcompensated in the form of benefits. Most of these policies or many of these policies, when you have multiple employees in your companies, do have to apply to your staff as well. So things get a little more complicated. Now some of you may be thinking, oh, I'll create an entity here that does this for me here. Well, there's all these attribution rules that you have to follow. So if you're going to create off a spin-off entity that just maybe rents out equipment to your own company and that's it, the IRS is likely to see this as a workaround to just give you benefits. I've seen a lot of folks do some sneaky things that really wouldn't pass the smell test here. That really wouldn't pass the smell test here. So I hope that what you took away from this is that tax deferral vehicles such as retirement accounts can be very powerful and when you have a holistic tax plan in place and you're considering all these features, it may actually wind up making a lot of sense and it may save you a fortune in taxes.
Speaker 1:Back to the example earlier. The client will likely be dropping from like a 37.5% tax bracket all the way down to maybe a blended 15 to 20% tax bracket. So we could have just contributed in the prior return and then rolled into the Roth this year as the income went down, or a portion of it. But that opportunity has come and gone. We recommended it. They could have even just created the accounts and we'd still have an opportunity to do it.
Speaker 1:So listen to your advisors, your advisors Tax deferrals. While it may not sound so sexy because you're eventually going to pay taxes, and you're going to pay taxes on that amount that has grown and accumulated there's a reason why people across the country are doing this and saving billions of dollars and you can too. So talk to your tax advisor. Hopefully you have a good team to help you consider this factor. It's part of your holistic tax plan and if you need someone who can help think about these concepts at a high level, as we're doing your overall tax planning, you know where to go Prosperalcpacom, prosper with an L cpacom slash apply. And if you want to just start being introduced to some of these planning concepts and seeing what may apply to you, go to taxplanningchecklistcom for our mini course. Have a great day.