Tax planning strategies for self-employed professionals

Tax planning for self-employed professionals.

Transcript

SPEAKER_01 1:10

Whether you're just starting your financial journey or you've been around the block. Welcome to money, finance, and investment with Mr. Will.

SPEAKER_00 1:34

Hey, welcome to today's episode of Money, Finance, and Investments with Mr. Will. So if you tune in to last week's episode, you know that I talked a great deal and focused that episode on retirement. And this week I gave you a little bit of a preview in that I am going to be talking about self-employed professionals. And particularly, this episode is dedicated to self-employed professionals and the ability to implement tax planning strategies. So we're going to focus on tax planning strategies for the self-employed. And so I actually several years ago I started doing a seminar, and this was the title of the seminar. And what I discovered as a self-employed professional is that the self-employed community is really an underserved community. There aren't as much resources available for self-employed professionals. Not that there aren't any available, there are certainly some available, and some areas do better than others. But in general, there's not a great deal of support for the self-employed professional in terms of really providing them with the necessary information, tools, and resources to help them be successful. Outside of obviously, you know, information here, information there, but there's a lot that goes into being successful as a self-employed person. And one of the things that I learned is that there are three common problems that self-employed professionals have. Now, there's not only three, but these are three that I found to be very common. One of those issues is taxes. Self-employed people often have more tax issues than non-self-employed people. Now, this is evident because if you do a research and a study on who IRS audits the most, what you will find is that self-employed people get audited way, way, way, way, way, way, way, way, way, way, way, way more than people who are not self-employed. So that means that taxes are a problem with self-employed professionals. One of those problems is a lot of self-employed people don't pay quarterly taxes like they should. So as a result, they are oftentimes paying an additional penalty when they pay their taxes because they don't do quarterly taxes. And a lot of tax preparers don't provide that information. How do I know? Because in my seminars, I communicate this often, and a lot of the questions that I would get is how come my CPA didn't tell me that? So I can't answer that question because I don't know why their CPA wouldn't tell them that. But it's a common problem, and uh I thought it was important to uh address that in this particular episode. Another one of those problems is validating income. Self-employed people who are strictly self-employed, they don't have another W-2 job, or they have a spouse that's got a W-2 job. If they're just strictly self-employed, when it time when it's time to get financing or get loans or uh to get access to capital to expand their business or just to do things like the buy a car or buy a house, they oftentimes have more challenges in obtaining those particular uh resources and paying higher costs than people who are not self-employed because they don't do a good job of validating their income. Uh, so that's a common problem. And then the third one, which may be the biggest problem because of the impact that it has long term, is planning for retirement. Self-employed people don't do well in planning for retirement, they they are so consumed with doing their business. I'm not even going to say running their business, because uh one of the problems that self-employed people have is they don't actually, many of them don't understand the difference between running a business and being the business. And many self-employed people are the business, and if something happens to them, the business dies. So, to an extent, that's not really the definition of a business, that's a self-employed hustle. But for practical, you know, uh uh purposes, we're gonna go ahead and refer to it as a business. But those three issues taxes, validating income, and retirement savings are common problems to self-employed uh professionals. Now, I'm not trying to address all three of those problems in this episode, just would take too much time. So uh I'm just going to focus on the tax planning part of it. And the first thing that I want to do is talk about the difference between tax planning and tax preparation. Tax preparation is what most people do, and that's something that happens at the end of the tax year, meaning you've gone through the whole year and now you have to prepare your taxes to submit to the IRS so that they don't do you like they did Wesley Snipes, okay? Come after you because you didn't take care of your tax responsibility. The reason why I want to emphasize this difference is because you can't save money doing tax preparation. You can only save money doing tax planning. Tax preparation happens after you've already done everything for the year. So there is really no way for you to save money because you've already done the things that you know are encompassed in that previous year, and that year is gone, so you can't go back in the past. Tax planning, however, is what you do at the beginning of the year, and some people start prior to the year being over in terms of going into the next year, but tax planning is something that you do at the beginning of the year, and in some cases, and in many cases, throughout the course of the year, to help mitigate or to reduce your tax liability as you go throughout the year. Now, why is that important? Because oftentimes you can save yourself, depending on how much revenue you bring in, thousands and thousands of dollars in tax payments that you don't have to give to the IRS, that you are able to keep for yourself and reinvest that money towards your future financial security. So that's important, especially when you compound that over years and years and even decades of time, right? So tax planning is what I do and recommend. Uh, I don't focus on or nor do I do tax preparation, right? Leave that to the tax professionals. All right, I'm a financial professional, a licensed financial planner, licensed financial advisor. So I do what I do on my end, and I let the tax professionals do what they do on their end. But obviously, it's something that I address because I provide a service to my clients that's ultimately designed to help them be in the best situation that they can be in. Right? So that brings me to the difference between a CPA or a tax professional versus a financial planner or a financial advisor who does financial planning. Okay, CPAs get bombarded at the end of the year with their clients to rescue them from a tax uh uh catastrophe. And so oftentimes they are working with a very, very limited amount of time and deadlines because obviously, depending on what your situation is, whether you have a business or whether you're individual, there are different tax deadlines. But for the most part, by April 31st, I mean April 15th, that tax professional has got to get everybody's taxes done. And, you know, of course, there's extensions filed and what have you, but those individuals may not drop their taxes off until March 18th. And then they have people coming all throughout the uh tax filing season, and most people and most tax professors that I've talked to, what they tell me is that most of the tax returns that they do, and most of the people who come to them, come to them between um March, the 1st of March, and April 15th. So that means the first two months of the tax filing season, they're not as busy. Well, that's two months worth of time that they don't have anymore because the deadline is the deadline. And again, I realize that there's uh an extension being filed and you got another date, but now you're actually adding to your cost. If you file an extension, no, you don't necessarily have the penalty, but if you owe, you still have interest accumulated from the tax deadline until the time when your taxes are submitted. So it's costing you money. So either way, you look at it, tax preparation is intended to help you, or tax planning is intended to help save you money, whereas tax preparation is just a reaction or reactive to what's already been done. And so that CPA does not necessarily have the time if you approach them during that window to provide planning. And to be honest with you, that's not even the way that they think. You talk to a tax planning or a tax professional who does not do uh financial planning or do planning in general, that's not really how they're wired. And so kind of isn't appropriate to expect that from them because that's just not a normal part of their wheelhouse. So working with a professional that does planning is more advantageous, i.e., an advisor or a financial planner. It's more advantageous in terms of addressing your future tax scenario as opposed to a CPA. Again, I use CPAs, I'm not diminishing their value, um, but again, in most cases, now there are exceptions, there are uh financial planners who also do tax, uh do taxes, and that's great. That's for you. So if you have a person that does both, then you have the best of both worlds. But if you don't, and you only rely on the CPA, then you're missing out on the opportunity many times to improve your financial scenario as it relates to your taxes. Okay, so I recommend uh utilizing both a tax professional and a financial professional who does planning to again put you in the best scenario possible. Um now, why is that? Well, it's pretty simple. First of all, people regard CPAs differently than they do financial professionals, financial advisors and financial planners. CPAs are actually regarded in a higher light than people who are financial advisors. Now, the reason why, in my opinion, is because financial advisors are considered salespeople. And CPAs aren't. And people have a different mentality towards salespeople. Like, lawyers aren't considered salespeople, but they sell you their services, they sell estate planning, they sell uh injury law, right? They got commercials that's telling you, hey, if you've had this happen, you've taken this kind of medication, what are they doing? They're trying to sell you on their services, but people don't look at it that way, and so there's a different mentality. So I'm bringing this up because for those of you who have CPAs that you talk to and you ask them all of the questions about finances and investments and all that kind of stuff, that's not really the best source for you to get that information. Again, unless that person is a licensed financial advisor and they have, of course, access to all of those resources and that information. But if they don't, then a CPA that that's not they're not that's not what they're trained to do, that's not what they study, that's not where they spend their time. So you would be well advised to have a financial professional that you are able to refer to when it comes to those particular scenarios. All right. So now what's the best way to reduce your tax liability? Well, the first thing that you should do is understand your situation. What do I mean by that? Are you married? Do you have children? Obviously, your geographic area uh you know plays a big part in that. But uh, you know, do you have a um business? Do you have a side hustle? Right? All of these things you want to understand about your situation as you consider doing tax planning because they all provide different scenarios to help address your situation, right? So that's the first thing. The second thing that you want to do is you want to get with a tax professional who understands business taxes, don't just go to your cousin who does taxes, they use the HR block or the tax turbo tax software program, but they don't actually study and research the tax laws and the changes in the tax code and even understand how those things correlate. Okay. I've known people that prepare taxes and they do a great job for those situations for those people who have very basic situations. But if you are a business professional, and depending on the complexity of what your situation is, that particular person probably doesn't have as good a command on the tax laws and the tax codes as a person who is licensed and trained for that. So do yourself a favor and consult with a tax professional who understands business taxes and, of course, who's familiar with the tax codes and the current tax laws because it absolutely makes a difference in what the end results are. Right? And then the next thing that you want to do is after you understand your situation and consult with a professional, because that professional is going to provide you the information that you need to know as it relates to um what you can duct, what you can deduct, uh how much uh you know percentage you conduct of this, and you know which scenarios are gonna make the most sense. Then you want to take time to maximize your business deductions. Whatever things you can deduct as it relates to your business, you should deduct, whether you have a home office or whether you have an office outside of the home. Um, you know, if you if you use a security system uh and there's monitoring involved, that's a business expense. If you obviously pens and paper and supplies and and those types of things and internet, uh all of those basic standard things, basic and standard things that people use for their business, you want to maximize those things. So in the planning process, you want to go about it in a way where you plan to spend money on things that you know you can deduct at the end of the year. So that way you are utilizing your resources in a more effective way. But equipment and supplies, you want to, you know, software, uh, computers, laptops, um tablets, um what other kind of things. Um, you know, I use um lockboxes. I use lockboxes for one of my business uh that that involves real estate. So, you know, things like that. Um digital uh doorknobs, right? So again, and and I made the decision to use to purchase those things because I knew that they were deductions from my uh business uh uh expenses as in terms of my tax liability. So the planning process allows you to exercise forethought in how you're gonna spend money throughout the year. So you want to, of course, like I said, maximize your business deductions. Uh you want to deduct things like uh health care, right? So if you are a self-employed professional and you have health insurance, you can deduct the premiums paid for your medical, your dental, and even qualifying long-term care insurance for yourself if you have it and your spouse. If you don't have it, this is a good time to think about hey, I might need long-term care at some point in time in the future. I did not realize that I can deduct the premiums for me and my spouse if I'm self-employed. It's reducing the tax liability, right? Your CPA may or may not have shared that with you. So if you're listening to me and you are a self-employed person and your CPA has never told that to you, that's the evidence of why I say it. You should also have a financial professional available to you to share that kind of information with you. All right. Um, what else? Um Qualified Business Income Deduc, right? Depending on how you are structured. As a business, LLC versus sole proprietor versus S Corp versus C Corp, you may be missing out on the qualified business income deduction, and that may be advantageous for you. Sitting down and talking with your professionals can help you to figure this out. Because if you qualify for the the QBI deduction, that means you can deduct 20% of your business income right off the top to reduce your tax liability. So if your business income is $100,000 and you qualify for the QBI deduction, you're now actually only being taxed on $80,000 instead of the $100,000. This is if you have no other deductions whatsoever, you right off the top reduce your tax liability by 20%. Now, you can only do that if you're structured a certain way. So you um, well let me not say that. That's a deduction that you can take advantage of. But another uh option or another advantage that you may have is if you were to set yourself up as a S corporation. Because as an S corporation, you have the option to take some of your earnings as owner's draw or dividends. I like to use the term dividends because um that's how I learned it, but as dividends, and dividends are taxed differently, and only an S corporation can utilize that strategy. And I'm not going to get off into deep detail about it, I'll address that on another episode, but using you know the right kind of structure can help make a significant difference in reducing your tax liability. Um, because the self-employment tax that we pay, everybody pays uh who's self-employed pays it. The self-employment tax that you pay is reduced when you utilize an S corporation and you pay a portion of your earnings in dividends versus um versus um wages, W-2 wages or salary. Right. So what do we got? We got um business uh duct deductions, we got uh QBI qualified business income, we got um your your business structure and set up. Um we talk about health care. So let me now turn my attention to the item that I think is the most beneficial, and that is utilizing qualified deductions. Most people don't who are self-employed don't take full advantage of this, okay. Qualified deductions are basically taking money that you earn and putting that money into a qualified uh uh instrument. The one that I recommend the most is the individual K, right? Also called the Solo K. It is a 401k plan for self-employed individuals. How does it work? It works just like a regular 401k, except the rules are structured for people who are self-employed. So, what does that mean? If you have a wife, you can actually set up an account for your wife. So if your wife helps you with anything regarding your business, you can set up an account for you and your wife. And if you earn a significant amount of money and your wife doesn't work, then you can even take greater advantage of this than someone who has a spouse who works at a company and who has a 401k at that company. Now, I was talking to my own tax professional, and we were talking about this for a number of clients that she works with, and what she said is well, this particular client, that wife, their wife, has a 401k with their job, so they can't contribute to another 401k. And I said, That's not true. I said the rules don't restrict you from the amount of 401ks that you can have, the rules restrict you from the amount you can contribute to 401ks. So if you have a 401 where you are maxing out with your employer, and you have a spouse who is self-employed, and that spouse has an individual 401k, you can contribute, rather, you can have contributions to that 401 made by the spouse from the employer side because with the individual 401k, you get to make contributions from the employee side and the employer side. She said, Really? Now, this is my tax professional who's pretty good. She said, Really? Well, I didn't know you could do that. So again, I'm giving you more evidence to support the rationale for not just having a CPA, but also having a uh licensed professional who does tax planning or does planning as well. But to go along with this, the individual 401k has the same contribution limits as the regular 401k. So for this year, I believe it's up to 32,000 if you are eligible for the uh catch up, which means 50 and older. But let me keep it simple. With the individual 401k, you can maximize the employee contribution amount. So whatever that amount is, if it's 26.5, right, or if you are eligible for the catch up for an additional uh $6,000, right? You can maximize or $6,500, I think, uh, for this year. You can maximize the contribution as the employee, but then on the employer side, you can contribute up to 25% of your earnings. So now let's say you earn $200,000. You can do up to $50,000, up to the maximum amount, uh obviously that you can contribute into the plan, but you can do up to $50,000 on the employer side. So now you got the employee side and the employer side. Well, what if you have a spouse? And what if that spouse is maxing out on her $401k at her job, but that spouse works with you? She does your social media, she you know uh does other administrative stuff for you, and you pay her a salary, right? That salary that you pay her, once you figure out what the numbers are, you can have that uh full amount 25% of that full amount contributed into the individual 401k side for her account. So that gives you options to do things to reduce your tax liability. And by far, contributing to an individual 401k, the non-qualified plan, is going to give you the most uh the highest option to reduce your tax liability. So now, if you got more questions about these, you can certainly reach out to me, reach out to your tax professional, reach out to your uh uh financial professional, you can get more information. But I just thought this would be a good episode to talk about uh things that the self-employed person can do to reduce their tax liability. So hopefully you got something out of this, and I'll see you next time on money, finance, and investments with Mr. Will.

SPEAKER_01 31:09

This has been another episode of Money, Finance and Investments with Mr. Will. For more information, check out his book, Money Ain't the Problem. What we do with it is so that you can learn how to live your best financial life. In the meantime, be sure to check out our next episode of Money, Finance, and Investment with Mr. Will.