Reducing Your Lifetime Tax Bill is a Wealth Building Super Power

In this episode of the 'Retire Early Retire Now' podcast, host Hunter Kelly dives into advanced tax strategies for individuals and business owners, aimed at boosting wealth and financial stability. The episode covers an array of topics including the utilization of 401(k) plans, Health Savings Accounts (HSAs), and donor-advised funds, as well as strategies like tax loss harvesting and qualified charitable distributions for those over 75. Small business owners are advised on the benefits of electing S-corporation status and the Qualified Business Income (QBI) deduction, along with a focus on meticulous documentation and professional advice. The importance of long-term tax planning with the assistance of financial advisors is emphasized throughout. The episode wraps up with a teaser for next week's discussion on investments 

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Transcript

0:08

And welcome to the retire early retire now podcast. I'm your host hunter Kelly. And today is an extra episode this week. So. it is Thursday. We're releasing this, second episode this week about taxes. and on Tuesday, if you did not listen to the episode, go back. That is just the basics of some basic tax terminology. How the tax code works. not only your federal income tax, but FICA, social security, Medicare, things of that nature, and then some, different things that you should consider, whether you're employed versus self-employed things of that nature. Well, we'll talk about now. Is some ways, some strategies to reduce that income. not only in the short-term, but in the longterm. And so this is where I think Palm valley wealth management separates themselves. If you find a good financial advisor, or if you're just trying to do planning or your own, thinking about not only the short-term, but also the longterm implications of your lifetime. tax bill can help, be that super power to a wealth building. as you kind of move through life and want to reach your financial goals. And so I think, before we get started, go ahead and like, and, Before we get started. Go ahead and follow or share this podcast episode with a friend. leave a five star review. If you're enjoying this content, I know taxes can be, daunting, confusing, scary. but if you have someone on your side, whether that be, solid financial Pfizer, that does tax planning or CPA or enrolled agent tax prepare. it can, it can be a thing where you can kind of mitigate that and again, use it to your advantage to make this kind of a superpower. and wealth bedding and building, but. What I want to start it out today. It's just to talk about how I think about tax planning when working with clients. and how other financial advisors that do tax planning think about. Taxes with clients and things of that nature. And so the first thing I'll do is when I'm meeting with a perspective client or reviewing with a client, Is, I want to look at their tax return. I want to analyze it and say, okay, where's their income coming from as a W2, as a self-employment. what are some things that we're looking for? Right. one, what are some ways to reduce that income? If possible. So if you're a W2 employee, Are you taking advantage of certain areas like for one K's, uh, HSA health savings accounts, charitable contributions, things of that nature that we'll talk about here in just a little bit. and then, from there, what are your, Where's your income coming from, outside of just income. Do you have a significant amount of interest? that maybe we can mitigate through other types of investments, things of that nature. one, what can we do to help reduce now, but what is the impact of that later? Right. And so how can we kind of smooth out that tax rate or that tax bill over time versus maybe. declining it Maybe decreasing significantly or front, but then later on down the road, we have a much higher tax bracket or vice versa. Right? We're paying a lot more now, whereas now we can't recover as much and it takes us longer to kind of get those investments back. So find that happy medium of where should I tap our tax bill? Be. given our income and our situation, our goals that we want to try to achieve. Right. And so again, taxes are what they are, right. The only way to change your taxes is to vote. politician in that you think that will write a bill that will lower taxes, right? That's the only way to lower your taxes from that sense. Now, what we can do is we can. Use the tax code as it stands. And, find ways to avoid those taxes through some of the. loopholes or just, advantages that is in the tax code that we can use. Right. from here, This is where I want to look at, those four individuals. And then if they're businesses, we'll talk about that in a little bit. But, once I look at that tax return, I'll figure out. some ways that, Hey, can we mitigate it? And does it make sense? And so in the planning, I'll start putting in scenarios. Should we do Roth versus pretax versus, how much should we put in be putting into our health savings account? How much do they does this client or this household actually need to save to reach their retirement goals? and are we really just putting this extra. Into, their 401k from a tax benefit standpoint. And what does that impact their cashflow? And how does that impact their cashflow and things of that nature? Right. so some things that I'll look at if they're purely just an, a W2 employee, and that is one 401k's for three BS. that is one easy way. To reduce your income. you contributing the 23,000. to your 401k, or if you're above age 50, doing that ketchup as well. That will reduce your income. Now it won't reduce your, social security or Medicare base, but again, if you're making a hundred thousand dollars and you put 23 in, it'll make it look like on paper that you made 77,000. So if you're in the. The 24% tax bracket or higher. now you're saving at least 20. 24 cents on the dollar when you put it into that account, right? And so moving forward. the other thing that you would want to look at is the health savings account. And this one's awesome. And there's a lot of content on this. if you. Read or watch any sort of financial, type of education type videos and things of that nature. it is a triple. tax advantage account. Right? And so it, as long as you're using your payroll deductions to fund this HSA, You're actually going to get the deduction on your income, but also your social security and FICA as well. and then that money, if you invest, it will grow tax deferred and be tax-free. with any medical expenses that you would draw for. and then also if you make it to 65 and you have a fair amount in there that you want to use a retirement, you can do that as well. You would just pay income taxes on that money as you kind of pull that out. another great way to reduce your income, especially our front as a utilize that HSA. And if you're a family you can put up to.$8,500, moving into 2025. The next thing. that you'll want to look at, and there's a couple of ways you can do this, but charitable contributions. Most people are not itemizing now that we, like we talked about last episode and because the, standard deduction has gone up to, if you're filing jointly, it's a little bit over$29,000 right now, and it's moving up to$30,000. So finding, those deductions. for just a normal employee. That, is filing jointly pretty hard to find a$30,000 worth of deductions, but what I've seen clients do and what I've seen CPAs and. Enrolled agents advise is to lump some of these charitable. Charitable contributions together. Um, every other year, right? So if you know that you're going to give a significant amount. each year, what you can do is lump these contributions together, so that maybe you can reach, over that standard deduction. Um, every other year, maybe every odd year, every even year. So that you can deduct more from your income, then the standard deduction. Right. That's one strategy that you can utilize with charitable contributions. The other. strategy is that you could open up a donor advised fund. and this is a more complicated. Method or strategy. So make sure you do your research or, or get with a professional. And then, I'm willing to talk about high level in this one. we could do a whole podcast episode on that. So if you'd like to hear that, let me know. But you can open up a donor advised fund. And again, if you know that you have a plan to give a hundred thousand dollars or$200,000, to a particular charity or church. Whatever that may be. And in a given time period, you can go ahead and fund that donor advised fund in a given year in reduced shore income upfront, and then give those distributions or the. charitable contributions. Over time. Right? And so this can be a good way to reduce income, to maybe do some Roth conversions. Or if you know that you're going to have a high income year and want to save on taxes. And in that sense. So this is a great way to do that. Now there are a bunch of, rules and things of that nature. So again, do your research get with a professional. if you are considering this, but it's a great way to. Uh, take a large reduction of income in a given year. the next thing is, if you are. Uh, age or where you're taking your, required. your required minimum distributions then. You, and then you don't need them. You can make qualified charitable distributions. Right. And so if you're over the age of 75, I think it is now. and you're starting to take those. You can actually move those to a charity or, or send those. distributions to a charity from your IRA. Or your 401k, wherever you're taking those distributions. And then that will not count as income. And to you, right? So a couple of ways to reduce your income. If your individual, either filing jointly or single. The next thing you can do is if you have a fair amount in brokerage accounts and investments, things of that nature that are after tax dollars. A tax loss. Harvesting is one area where maybe you can offset some capital gains. we'll, we'll talk about this in great detail. When we go over investments again. this is a whole month about financial planning. We haven't even talked about investments yet. that'll come, either next week or the following week. But, you can utilize tax loss, harvesting. So if you have an investment, that's just had a really bad year. and you bought it for, let's say a hundred dollars and now it's at.$60. Well, you can sell that investment either. Keep it in cash or buy a different investment. Put that on paper, put that loss on paper. and then as your other investments grow. Things of that nature, you would be able to utilize that loss to Allstate offset, any gains moving forward. Let's say you have more losses than you do gains. You can actually carry forward. Those losses, moving forward. as you sell other positions later on down the road, 2, 3, 5 years down the road, you can use those losses that you captured in that, that particular year. to offset those gains as well. the other way to, potentially lower your income. This is more for state income. There are some states that have obviously state income tax utilizing a 5 29 plan for educational savings. it can be a good way to reduce your income on the state level. Obviously it's not going to do much for you on the federal level, but just something. to consider. the other thing you can do to reduce your tax bill. but not necessarily reduce your income. if you have children, you can use the, child text tax credit. There's other educational credits as well. like the lifetime learning credit and the American opportunity, credit things of that nature, which are all income based. So depending on your income, you may be excluded from that or. you may have an opportunity to use it right. So these are all things to reduce your income immediately. Now, what. makes. tax prep and tax planning different. Is that when you're doing these strategies, you want to consider. what is this going to do to my tax liability longterm? Right. And one of the key decisions you have to make is, well, should I be doing Roth or should I be doing pre-taxed right. while it may feel good to do pre-tax now. and you reduce your tax bill and you save a couple thousand dollars or$10,000, whatever it ends up being. does it make sense to do that now versus doing that later? So what you have to ask yourself is one, what is my income now? Right. And what do I foresee my income being later because of my income is going to significantly increase over time. It may make more sense to go ahead and pay those taxes. Now. And utilize a Roth IRA or Roth. 401k option. and go ahead and do that and let that start growing, because I know I'm going to want to deduct a higher income or a higher tax rate later because my income is going to increase significantly. So if you're a resonant, And a local hospital or whatever. if you're a resident. working to become an attending physician. Obviously your income is going to increase significantly. So utilizing your Roth IRA and potentially a Roth portion of your four, three B or whatever retirement plan you have at the hospital that you're working on, would make much more sense than deferring that. right now, at least from a tax standpoint, now, some of the things you would have to consider as like student loans and things of that nature, but, just from a pure tax standpoint, using the Roth in that situation would make more sense. Now, if you feel that you are your peak earning potential and. And your tax rate is very high relative. What it will be in the future then utilizing that pre-tax. money. Or contribution would make more sense. For the now and then what you could plan on doing is Roth conversions later. And I've done a couple episodes on Roth conversions, but essentially what you want to the goal of the Roth conversions is to defer. At a, at a higher tax rate now. So let's say your effective tax rate is at 25%. And so you're putting into your pre-tax accounts, 401ks. IRAs things of that nature. And you're reducing that at a 25% clip. But when you go. Later on down the road, maybe you, you retire or you take a part-time job and you want to slow down. You can go ahead and start converting some of that money. So that pre-tax dollar to that Roth dollar, at maybe a lower rate, maybe at that point, you're at a 22% rate or a 18% effective tax rate, whatever the case may be. and you're, you're kind of making that spread. now you're paying less taxes on that dollar. You're putting that money into Roth where it's gonna be able to grow tax deferred and be tax-free or non-taxable later on down the road. Right. that's another thing that you would want to consider long-term right. So are we. Are we trying to save taxes now? Or are we trying to save taxes over? Over time. Right? And so sometimes it hurts to pay those taxes upfront, but if you have a long-term vision and mine. The planning piece can be again, a superpower to help him building your wealth. Right. So. Now let's transition over to business owners, and this will be quick because again, owning a business and the tax code gets a lot more complicated. I just want to kind of, uh, just outline a couple of things that you should be considering. as a small business owner, right? So if you own a business, One. A couple of misconceptions that I see business owners all the time is that they feel they need to, especially toward the end of the year, like this time of year. they feel like they need to make business expenses to lower their tax bill. Right. so they need to go out and buy machinery or buy these new tools or software or equipment. What it, whatever it may be. And so I just want to remind you business owners, if you're a business owner, And you're making, you're wanting these deductions. Make sure that you actually need these pieces of equipment or whatever. You're expanding that business money on, to reduce your time. Make sure you actually need it because essentially. Let's say you needed a truck for your business, right? And this is a$50,000 truck. Well, you're paying someone$50,000 to get potentially a$10,000 decrease in your taxes. So that would be like me giving the IRS$50,000 so that they can give me back$10,000. Right. So. Make sure that when you're doing these business expenses, you actually need, some of these things that you're buying and you're not just doing it for taxes, right. so obviously business owners get a lot more flexibility in what they can deduct and things of that nature. So if it's pertinent to the business, they can do that, but also know that you're actually spending that money. out of the business. as well, when you buy. Different pieces of equipment and things of that nature. Right. And so the next thing. that most business owners, especially if they're doing well, have to decide at some point is, well, I've been just a sole proprietor. for a long time and now we're starting to make money and I'm filling the self-employment tax. It's a big expense every year. what's a ways to reduce that. And so one of the things that you'll have to decide as well, should I go and file as an S-corp? Right. you see it, especially if you have not done that and you're kind of teetering on this decision. You should start getting ready to start doing that analysis here soon because as the new new years rolls around and you have to make that election. I think by March 15th or the, in the March. in any case you have to elect and say, Hey, I'm going to be an S-corp, for the following tax year. So. What, what electing as an escort does, and allows you to pay yourself a reasonable salary. So let's say your profit is$200,000 a year. well, if you are sole proprietor, you're going to pay income tax and a self-employment tax on that full. 200,000, obviously with social security. you'll, you'll max out at like 168,000. so you'll, you'll reduce that a little bit as well, but. for the, the simplicity of the example, you're going to pay taxes on that 200 and$200,000 of profit. Right? If you say, Hey, I'm going to file as an escort. And you elect, you have a reasonable salary of let's say,$80,000. Well, you're going to pay. going to pay. Your income taxes on the$80,000, along with your self-employment tax. And then everything above that, the other$120,000. Would be. called distribution. So you'll avoid some of that self-employment tax, right. the things that you have to worry about with that. Is one, how do you show evidence of what a, a reasonable salary is? Right. And it's not a lot of things I see on the internet are kind of like a ratio, like a 40, 60 ratio of salary to. Salary to distributions things of that nature. Right. but really what you want to do is you want to look at, what your responsibilities are in the business and how many hours you're working in the business, things of that nature. And come up with a formula and there's a lot of softwares out there. A good CPAs and EAs. We'll we'll have, softwares to do this as well. And they'll come up with a reasonable salary so that if you ever get audited, you can say, Hey, this is how I came up with this number. I'm doing CEO role this many hours a week. Admin this many hours a week. Business development this many hours a week, so on and so forth. Right. And this is how it came up with the$80,000. Of income or of salary and then the 120 of distributions. Right. And again, this is a great way. To help save on some of that self-employment tax. That's why we would do it. Right. We would do that. To help save on that. Self-employment. The next thing you want to look at, that often gets missed, especially for business owners that are trying to file their taxes. Their own is QBI. And so what is QBI section 1 99, a deduction small business owners may qualify for a 20% qualified business income deduction. So, this is just a way, a friend of mine said this and it made a lot sense. This is just a way. For small businesses to kind of get close to what that corporate rate is because of your member, when the tax. laws changed in 2017, 18. the corporate tax went from, I think 39%, a 21%. so what the federal government is trying to help out with is if you were a high income earner, would they want to give you a income deduction on this qualified business income? So again, if you have that S-corp or you have that sole proprietor income. they want to give you a deduction to help you get a tax rate down because, Because with self-employment and income tax, it would end up. It would likely end up being higher than that corporate tax rate. So it's just a way to kind of help with that. and there's ways to. kind of maximize this. and then there are some things that you want to look out for. There are certain industries. like professional service industries that, will phase out of this deduction. So you just have to be careful about that. but it is a good way to, again, help reduce your income. moving forward. So make sure that if you are a business owner, you're getting with the professional tepee, maximize that as well. So those are some common tax savings strategies that are utilized very often. Am I planning with clients? But also, just in general with CPAs and things of that nature. And really what I want you to get out of this as one, hopefully you take a good strategy that you can utilize for your situation and take it back to the professionals that you work with. if this is confusing, obviously reach out. To me through, my website, Palm valley, awm.com I would be happy to help you with your situation. But what I really want you to think about here and kind of understand is not only. thinking about the short term and how I can help myself in the short term and taxes, but how does this affect me longterm? Because if you can reduce that lifetime tax bill. Likely you're going to save yourself, potentially tens to hundreds, to potentially millions of dollars, depending on your situation. and, and that will grow. Your, network much quicker. Than, some of the other strategies like China, Figure out what the perfect investment is and things of that nature. Right. taxes are well within your control. you can. Figure out ways to use the tax code, to avoid, paying more than you should and things of that nature. You can't always pick the perfect investment. That's going to get you 12% every year. So just thinking about that, this is one thing within financial planning, that's within your control and you can see a finite dollars that you are. saving each year to help you reach your financial goals. So do you need help with tax planning? That is one of the things that I do. each year. his review, my client's tax return to help them maximize or minimize their tax bill over time. And, maximize their net worth. So go ahead and reach out through Palm LA wm.com. and. Next week. So next week we'll be talking about investments and that's the topic that everybody loves. So we'll get nitty gritty. On how to maximize those as well. and some things that you should think about with that. So look forward to next week's episode and glad we got to do an actual one this week. So go ahead. Leave a five-star review and share this with a friend. And as always, This podcast is not meant to be financial advice or financial planning, advice, or tax advice. It is for educational purposes only. Do not make decisions solely based on this podcast. Please reach out to attacks. Financial legal or insurance professional. When kids centering your own situation, please keep Palm valley wealth management in mind when making those considerations.