Nobody likes to pay taxes. We all feel that we work hard and give the government too much money. At the same time, owning a private business provides opportunities to save money on taxes by making expenses pre-tax versus after tax.

For example, if I spend a thousand dollars on medical care and I do it on an after tax basis and I’m in a 35% tax bracket, I’ll have to earn about $1,350. The reason for this is that I will need to pay about $350.00 in taxes to be left with $1,000 to pay for my medical costs.

On the other hand, if I can make that $1,000 a pre-tax cost, my actual cash cost for the medical expense is $650.00. This is true because I now have a tax deduction of $1,000.00. Again, if I’m in a 35% tax bracket, my tax savings will be $350.00 so the after tax cost of having my medical costs be pre-tax is $650.00.

The savings are significant when we make our life a pre-tax one.

The Challenge

With this sort of advantage it’s no wonder we try to find all the tax deductions we can while running our business. Sometimes advisors promise tax savings that are larger than we thought possible, sometimes too good to be true. The challenge is finding which tax strategies work and which don’t. We may hire professionals to help us on a regular basis, and these are the people we normally turn to for advice on whether a strategy makes sense or not.

We trust our regular advisors have our interests at heart. It’s also in their interest to make sure we stay on the right side of the law. They understand that if they bless a strategy and we get audited, we will blame them as well as the person who brought the strategy. For this reason, advisors may be hesitant to help you find tax deductions and strategies which are deemed to be aggressive.

New IRS Regimes

Luckily there are some new regulations from the IRS on whether something is a tax shelter. If the IRS has deemed a strategy likely to be a tax shelter there are now reporting requirements that you must use when sending in your tax information.*

These new regulations require that you notify the IRS if you are using a tax strategy which the IRS has said is a “listed strategy”. A listed strategy is a strategy that will limit the amount of taxes that the IRS wants to be aware of. Many of these strategies have been deemed fraudulent. If the IRS finds out you are using them without notifying them, you can incur significant fines and penalties.

Most of the people we deal with are not interested in having the IRS breathing down their neck. As a result, we’ve developed a few simple rules that you can follow to make sure you stay on the right side of the law.

• If you are asked to sign a confidentiality non- disclosure agreement for a tax strategy, it probably is not going to hold up.
• If your advisor can't find legal precedent, then the idea has not been tested and you and your advisor don't know if the idea will work.
• If the strategy has a huge fee attached to it, that might be a sign that the promoter will win, but you might not.

On the other hand, if your advisors say the idea is just not a good one, you will want them to explain in detail what’s wrong. If you still like the idea have the promoter and your advisors have a discussion. The promoter should be able to explain to your advisors why the idea works and what legal authority is behind the idea.

The goal in tax management is to take every legal deduction we can. There are ways of minimizing taxes by using structures in an appropriate way. We just want to make sure that those structures will stand an audit if and when one comes your way.

As part of the wealth management process for your business, you should review what tax saving strategies are available. At the same time, you want to be safe and have your long-term advisors agree. Just make sure those long-term advisors give a fair listen to those with the new ideas.

We at Stage 2 Planning are happy to assist you in evaluating any ideas that come your way. In fact, we would be glad to discuss with you and your advisors whether any ideas we see are good for you to consider. Who knows? There might be some significant tax savings in your future.

With warm regards,

Stage 2 Planning Partners

Josh Patrick © 2006

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