Radical Personal Finance with Joshua Sheats – Part 2

Interesting. Where do you go as a layperson to try to figure this stuff out and learn about it?

I guess you could go to the tax code. I go to seminars throughout the country a number of times a year.  They’re typically hosted by a CPA that does training for other CPAs. Where a lay-person would go, I would say–I guess they search the internet and hope they get it right.  It’s kind of like— you could go to the store and buy a bone saw, but would you want to amputate your leg?

Not so much. So tell me some other stories. Whatever, some other interesting ones that you look at that, people love to hear about when it comes to the world of tax deductions?

They love the medical expense reimbursement plan. They love the self rental. OK? Let’s see, you’re real estate. If people that own real estate, there is something called cost segregation, which basically, is almost like an accelerated depreciation. So, I had a client that has five rental properties. And he’s the appreciating these properties over 27 1/2 years and now he’s going to sell one of them. These are going to have a big gain. And we talked to him about doing a–what’s called a cost segregation study.  And basically, you accelerate some of that depreciation. So instead of writing everything off over 27 1/2 years, you get to write some things over five years, seven years, 10 years and 15 years. So in the early years, you pick up more depreciation. In the later years, you pick up less depreciation. You do a cost segregation study, fill out a certain form, 3115,  for the years and you pick up all that missed depreciation over the last five or seven years in one year and you get to offset some of the costs of the gain.

So my understanding of this cost segregation strategy, the reason this works is because instead of having the entire value of the home counted as real estate, which would be depreciated over that 27 1/2 year period, you’re recognizing that there’s a certain value of plant and equipment, or appliances, things like that, and some of those are able to be used more quickly. And to the US, if you go ahead and figure out that you have this million dollars of value in these properties, $50,000 of value is a plant and equipment that can be depreciated more quickly. That’s why you get that depreciation. Is that accurate?

Yes, it is.

So this is definitely useful because I’ve spoken with a number of real estate investors here in my local area. And especially, I mean, Craig, my impression is if you have larger commercial property, this is probably very much something you should pursue. If you haven’t–I don’t have the impression that it’s so applicable if just somebody has one or two rentals–am I wrong in that impression on me? Tell me more. How does it apply in an individual residential property?

Depending on how much you pay for that property, how much you allocate towards the land and how much you allocate towards the building. It can make a difference of $20,000 a year in depreciation.

That’s well worth investigating. So you do this thing, you do this tax planning thing for a living, and I’d love for you just to talk about–let’s pretend I or one of my listeners walks into your office. Now, obviously you can’t teach somebody everything that you do in the course of a short podcast interview, but where do you start? What do you actually–when you’re looking at a client situation–where do you start and what do look for to try to figure out where they can save money in tax?

First thing we look at, did they pay any tax? Because if they didn’t pay any tax, there’s probably nothing we can help them with.

What do you mean by any tax?

Any income tax or any self-employment tax. Then we look at the entity structure. A lot of times people set up their business and they basically go to the attorney and they say, “I want to start a business.” And he says, “OK, set up an LLC or set up a corporation.” Whatever he’s typically more familiar with. There’s no planning that goes into that. So, we look at that and a lot of times just changing the structure of your entity can save you a lot of money.

So explain why the different entities and the different advantages and disadvantages for each type of taxation.

So what we’ll compare an LLC and an S Corp.  LLC first. Your net income is taxed as income and also taxed for self-employment tax. So that means basically on the first hundred and $20,000 of profit you’re paying 15% self-employment tax plus regular income tax. Whereas if you were set up as a corporation, in this case, the S Corporation and you took a reasonable salary, you might be able to cut your self-employment tax in half.

Can you not do that just simply by electing to be taxed as an S Corp while maintaining your LLC?

Yes, but that’s rare that I come across that.

Why is it right? I mean, yes, I imagine it’s probably rare, but is there any technical advantage from a taxation perspective to my choosing to maintain an S Corporation instead of an LLC taxed as an S Corporation?

No, and like I said, we rarely see somebody come into us that isn’t LLC and their tax on the business as a corporation or an S Corp. Lot of times that’s one of the things that we will recommend if they are an LLC–will recommend that, you don’t need to change your entity. Probably from a legal perspective, it’s better to be. So now we could take advantage of the tax code and elect to be taxed as an S Corporation.

Do most people with LLCs come in, they’re being taxed as a C Corp or they’re being taxed as a sole proprietorship?

Most LLC, we see are either taxed as a sole proprietorship or they are taxed as a partnership. I don’t believe I’ve ever had somebody come into my office that was an LLC being taxed as a corporation or an S Corporation.

Interesting. Sorry, I meant to say partnership. What else, do you look for?

So we will start there. We’ll start to look at their compensation to see if their compensation is reasonable. A lot of times we’ll see regular C Corporation where the owner is taking all his compensation out in wages. That could be a trigger for the IRS and we’ll figure out ways to deal with that.

How do you define reasonable?

I know this is a big question, that people say you need to have reasonable compensation. How do you figure out what is defined as reasonable? You can hire a company to do a compensation study for you and for less than a thousand dollars, they’ll do a compensation study and they’ll tell you what reasonable compensation should be based on what you’re doing.  So you want to separate out. Separate out what your job functions are. How much of it is management, how much of it is employee type work? You can go online and you could go to the IRS website, download Schedule C information for that type of business. See how many Schedule Cs there are and what the average compensation is. There’s a lot of different things you could do, but depending on what the dollar amount is, you may want to go and get a real compensation study.

What else? What other ideas do you have and how else would you approach a planning situation?

You know, here’s another one home office.  We always hear home office.  It’s a red flag. It’s not an IRS red flag. You just have to make sure that the space inside of your office–you accurately documented it’s only used for business purposes. And then you get to write off a portion of your real estate taxes, your mortgage interests, your maintenance utilities. And then some people will say to me, well, why should I write off my real estate taxes and my whole interest on my home office? I get to list them on Schedule A. Well part of the reason is depending on how much money you’re making, if you’re subject to alternative minimum tax in the northeast, or east, our real estate taxes are generally high. So they get edited back. And you lose the deduction basically for that. Whereas, if you’re taking it as part of your home office deduction, you’re going to lose that deduction. Another thing you’re allowed to do is if you have a home office, is you’re allowed to have a deductible home athletic facility for the employees that work in your home office. So if you have a home office and maybe you have a gym in your basement or pool,  you can make a lot of those expenses deductible if they’re for your employees. (DUE TO THE RECENTLY PASSED TAX BILL THE ON PREMISES ATHLETIC FACILITY IS NO LONGER DEDUCTIBLE POST DECEMBER 31, 2017)

Yes. Interesting.

Yeah.

When I’ve looked into this in the past, when I looked into the athletic facilities, in the end, the opportunity’s there. I found that one had a lot of hurdles and I came to the understanding myself that it wasn’t worth pursuing. So I’m interested in your– and I–it wasn’t worth pursuing because it had so many hurdles, Before we get to like a home office, is it possible to do something where doing things like gym memberships or athletic club memberships, is there any way to deduct those expenses?

No, they’re not.

So the home offices, the home gym, are there rules on its accessibility and availability to other members of the family or is it able to be available to them and it’s just got to be in the home for the employees? (DUE TO THE RECENTLY PASSED TAX BILL THE ON PREMISES ATHLETIC FACILITY IS NO LONGER DEDUCTIBLE POST DECEMBER 31, 2017)

Correct. Correct. So if it’s for the employees and their families.

Interesting. I could see that being effective for somebody who wants to set up something like–have a pool or, or an exercise pool or something like that for physical therapy—as you get into bigger expenses, probably would be well worth looking into.(DUE TO THE RECENTLY PASSED TAX BILL THE ON PREMISES ATHLETIC FACILITY IS NO LONGER DEDUCTIBLE POST DECEMBER 31, 2017)

Yeah, I mean listen, they all add up.

Yeah. That’s the challenge with tax planning, you look for one big thing and it always seems to be many, many little things. I’d love for you to talk a little bit about your perspective and how you advise people when it comes to vehicles and the various deductions for vehicles, and then the various ways that somebody can own and operate vehicles. Share with us a little bit about your advice on business vehicle deductions.

Typically, I would say that you’re going to get a bigger deduction from a vehicle lease than you are going to be get when you purchase a vehicle. And let’s not talk about big trucks where they get to write off the whole truck in the year they purchased it. But let’s just talk about your standard car that you use maybe eighty percent of the time for business. So if you have a lease and you right off eighty percent of the leasee, ok? Um, let’s just say you’re driving a BMW for $500 a month, so you get to write off 80 percent of the payment, which is four hundred a month, at least now the IRS uses an inclusion table. Basically an amount that you have to head back to income and that number is such a tiny number. It’s almost ridiculous to even have it. But most clients will get a bigger bang on a vehicle lease, assuming they’re not doing 30,000 miles a year and stuff like that.

The reason I ask is this is you hear all kinds of pieces of advice on this. So why would–why would I get a bigger bang for my buck, bigger deduction, leasing a car versus buying?

Because when you purchase a vehicle, just like any other asset you have to depreciate it. Typically vehicles, unless they’re over 6,000 pounds, you can’t take a Section 179 deduction, which means you write it off in the year that you purchase it. So you have to depreciate it over time. And I believe the first year’s depreciation on a vehicle, if you’re using it a hundred percent, is about $2,600. So if you’re using it eighty percent, that’s–let’s just say it’s $2,000 versus the lease that’s costing you $500 a month and you’re using eighty percent; you’re getting about $4,000-$5,000 deduction for. So you’re doubling that action.

Assuming however, that I’m using an actual cost expense reporting methodology rather than a mileage expense reporting methodology, and that’s assuming that the actual cost is less than then the mileage. Is that right?

Exactly, exactly right. Because when–I’ve always driven cheap cars in my businesses and always been able to use cars to create a–I guess I don’t know what the right term for it is. I call it a phantom tax loss, meaning that the vehicle probably costs me because the car is so cheap. I can’t remember when I’ve calculated, but let’s just say it costs me thirty or forty cents a mile to run. And the actual expense allowance that the IRS permits is fifty seven cents, something like that now, so I wind up for every mile I drive–I wind up picking up, let’s just say a 30 to forty cents per mile tax loss. And that’s always been something that’s beneficial to me, but it assumes, however, that I’m driving an older, inexpensive to operate vehicle.

Yes, most definitely. I mean, you really have to look at all the different instances and figuring out what works best for you. But typically what we get is, we get the client that’s saying, “Listen, I’m going to buy a new car, should I buy it or should I lease it?” They’re not interested in driving the 1980 Chevy Citation. They’re ready to buy a new car. They don’t want to deal with the headaches of operating an older vehicle. So it really comes down to preference. And then once you know what your preferences are, then we figure out what’s the best way to go.

You see a lot of people talk about the 6,000 pound heavy vehicle thing. Do you see people buying big SUVs, et cetera? Can I buy a Range Rover and get extra tax benefits because I chose to buy a Range Rover instead of a BMW sedan?

Yes, basically you can, assuming it meets the qualifications for section 179, which a Ranger would. But it’s kind of like, are you buying it because you want the range rover or are you buying it for the tax deduction? If you’re buying it for the tax deduction, you’re going down the wrong path.

You still have to spend the money. Generally, I find that when people want to spend lots of money, they say I’m doing it because I get a tax deduction. When in reality they spend more money on it than they save on taxes. I usually find that the tax deductions are a good excuse for people buying fancy stuff for them and paying more money in.

Exactly. Because let’s just say you’re in the 30% tax bracket, 25% bracket you’re only getting twenty five cents, thirty cents on a dollar. So you still have to pay for that vehicle, right?

Right. And you get the same problem that you’re going to get the biggest tax deduction if you buy the newest vehicle, but the newest vehicle is where you have the highest appreciation and see how the biggest expense. So sometimes you can come out better if you choose to buy something different, something older, as you said.  You’ve got to decide what you’re trying to do and what you’re trying to accomplish.

I would never advise somebody to go out and buy a vehicle or lease a vehicle so they can get a tax deduction. It’s typically, “Listen, this is what I’m looking to do. We need to buy a new vehicle for the business. Okay, which way?” We go, “Ok”. And we do the analysis and that’s what we come up with. It’s never the other way around.

Do you have any other ideas for the kinds of things that people can deduct that the–again, the sexy stuff–the toys and things like that. Let’s see. You know, what about stuff like boats and airplanes?

Well, we don’t get too many people coming to us. There are rules with airplanes. So I believe that you get accelerated depreciation. I’ve honestly never had somebody come to me that they were going to buy an airplane. But there are special rules for airplanes that we do a little bit of research for.. There’s different types of defined benefit plans, how much free cash flow you have. There’s a lot of things that go into it other than just say I wanted deduction. Ok, can you afford the deduction? Can you put all this money away for your retirement? You know, can I use this money to do something else?

But typically the sexy ones, all your self-rental, your medical expense reimbursement plan, your typical forum on depreciating the vehicles. All right?

Making sure the taking–if they’re using a home office–they are taking advantage of all the home office deductions they can, those go into it. And the right entity. The right entity classification. We had one client that we saved. The wrong entity classification was costing them $450,000 a year. It was a pretty simple fix.

A good question, and I and my Listeners know that this one’s an area of special interest for me, you live in Massachusetts, is that right? No, New York. You live in New York. Have you ever thought about moving and do you just recommend that your clients move to save on state income taxes?

It’s a discussion we have with the client, depending on what–it depends on their business, where their business is located or are they consulting. How are they working? Work anywhere they want, I mean luckily today it’s very easy to work remotely, but if you’re a brick and mortar you can’t really do that. So it’s a discussion we have depending on what type of business the person is in. Yes, but you could move from New York to Texas or Florida that has no state income tax and save a lot of money.

I’ve in New Hampshire if you want to stay in the northeast and I think New Hampshire taxes dividends on an investment income, but they don’t tax earned income. I think that’s right. Have you ever considered moving yourself?

No. In New York, grown and raised and I’m not going. I love–I’m 15 miles, 20 miles to midtown Manhattan. I love it here. I’m not going anywhere.

That’s right for all the money; it’s the cost of doing business. It is always interesting to me because when I run the calculations and you go through and you figure out how much can I save on my tax return by setting up a home gym in a home office. And these are for many people. These are hundreds or perhaps up to a couple of thousand dollars of actual tax savings where, in the meantime, you have a state income tax bill of five, 10, 15, 20 grand even in just comfortable middle income. A six-figure salary people, let alone the uber wealthy, and how big those bills wind up being. Greg, tell us about your business. Tell us about your tax practice and let us know any action step that you would like my audience to take to follow up with you after this interview if they’d like to work with you.

Well they could reach us at craigcodyandcompany.com/dentists. And if they go to that website forward slash an ours in radical piece and personal finance, they could request a free copy of our book, right? Our office number is 516-869-4051. We do a free analysis of your tax returns. And our typical savings is close to $20,000 a year.

Across the country.

We have clients from Oregon, to south Florida, to obviously New York. We have a team of eight CPAs here. We specialize in tax planning. That’s where we start, and we’ll go from there to your typical tax and accounting work. We have a little niche in international clients that come to New York to do business. They’re doing business in Europe. They want to do business in the US with coke and then we have the outsource CFO business, whereas you’re a little bit bigger company and maybe you have a CFO, and he’s doing low level to high level work and maybe it’s not working out. He’s not satisfied because he doesn’t want to do low level work and they’ll hire us and we’ll have a bookkeeper and a CPA assigned to you. And then I’ll do the top-down heavy lifting and we have a nice diverse client group.

With that, I’ll put those links and the blog posts for today’s show. Craig thanks for coming on.

Thank you very much for having me. And I will look forward to listening to the episode.

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