Tammy Neal for National Oil & Lube News writes: Are you overpaying when it comes to taxes? You might be and not even know it, according to Mark MacDonald, co-author of the bestselling book “Breaking the Tax Code” and managing partner at Sage Financial Partners, who specializes in tax issues, business succession and retirement planning for businessowners. In this interview, Mark discusses why nine out of 10 businessowners are overpaying on their taxes — and how to re-capture money that’s going to Uncle Sam back into your own accounts.
Tammy: Mark, taxes are front-page news these days. Can you give us an idea of where we are and where you see taxes heading for businessowners?
Mark: Businessowners and high-wage earners have targets on their backs. If you earn more than $450,000, your tax rate is now 39.6 percent. Meanwhile, everyone is paying higher payroll taxes and more forMedicare. Capital gains rates have gone up, estate taxes have gone up and so have taxes on certain levels of investment income. There are also new limitations on exemptions and deductions.
Tammy: I remember when lower taxes were the goal of tax legislation.
Mark: After a period of historically low tax rates, the tide has turned. Higher taxes are here, and we expect a prolonged period of tax increases across the board.
Tammy: Why is that?
Mark: Take a look at where we are. Most states haven’t recovered from 2008. Some cities have declared bankruptcy. The federal government has run up a $13 trillion deficit and is borrowing at the rate of $800 billion per year. We have many billions in unfunded obligations. Oh, and the Fed is printing one trillion dollars per year. Who’s going to pay for all this? Many smart people we talk to feel higher taxes are unavoidable.
Tammy: Do higher taxes affect businessowners differently than W-2 employees?
Mark: It’s a triple whammy for businessowners. First, they will pay higher taxes on income. I don’t know if you caught the controversy earlier this year regarding Phil Mickelson, the professional golfer.
Tammy: What happened?
Mark: He went on a rant about high taxes. Not too many people think of it this way, but Phil Mickelson is a businessowner. He’s selling the Phil Mickelson brand. What he earns on the PGA Tour he gets paid as an independent contractor, and then of course he has many endorsement deals.
Tammy: Was he complaining that his tax rate is too high?
Mark: Yes, and I don’t blame him. The new tax changes pushed his cumulative tax rate to 62 percent, including 13.3 percent in California state income taxes. He made a comment saying, “I happen to be in that zone that has been targeted both federally and by the state, and it doesn’t work for me right now.” A couple of days later he apologized. He got hammered in the press for being insensitive to folks who don’t make as much money as he does. So he apologized for that, but I also think some of his sponsors probably weren’t too happy.
Tammy: Why is that?
Mark: Well, one of his sponsors is KPMG (a professional firm providing audit, advisory and tax services). They’re paying him millions of dollars a year, and here he is, announcing to the world that his tax experts can’t figure out how to keep him out of the 60-percent tax bracket.
Tammy: I see your point.
Mark: I feel bad for Phil. We’ve worked with professional athletes and have been able to help them reduceincome taxes on endorsement fees to 20 percent — not 60 percent. There’s also a way Phil could pay 0 percent on his retirement savings. I could give him a lesson on that, if he’d show me how to straighten out my driver, but we’re getting off track. Where were we?
Tammy: We were talking about the triple tax whammy for businessowners.
Mark: Right. So the first whammy is higher taxes on current income. The second whammy is higher taxes in retirement. One of the biggest lies we’re told by accountants is that we can expect to pay lower taxes during retirement. Most economists and forecasters agree that taxes are going to be higher in the future — not lower. That means the only way you’re going to be paying lower taxes is if you lower your standard of living. Most businessowners we work with want the same or better lifestyle in retirement than they have today, but the government might get in the way of that.
Tammy: How so?
Mark: Well, they’ve already fired the first shot across the bow of 401(k) plans. In President Obama’s proposed budget are regulations that would limit the size of your 401(k) plan. If that passes, it sets a precedent, and retirement accounts could come under attack. That’s one reason we don’t like 401(k)s for businessowners.
Tammy: What’s the third tax whammy?
Mark: You’ll likely pay higher taxes when you sell your business and on your legacy. For example, this year the gift- and estate-tax rate has jumped from 35 to 40 percent.
Tammy: What can lube shop owners do to protect themselves from these higher taxes?
Mark: Fortunately, businessowners have options available to them to limit and control their taxes. These options aren’t available to W-2 employees because employees have already paid their taxes. The government has been paid before the employee has been paid. These folks have lost control of their taxation because they’ve lost control of how they’re paid. On the other hand, businessowners have the ability to control the timing and amount of income that they receive. This is a big advantage. They also have retirement and fringe benefit options not available to regular employees.
Tammy: How much can these options help lower taxes?
Mark: Quite dramatically. In 2009, the IRS reported that the top 400 individual tax returns had an average gross income of $358 million each. The average amount of tax paid by these men and women came in at under 17 percent. The Urban Institute estimates that individuals who make more than $1 million pay 18 percent in personal income taxes.
Tammy: I remember last year when there was all that fuss about Warren Buffet paying a lower tax rate than his secretary.
Mark: The interesting thing about that was that with all the fussing and grandstanding Warren Buffet did, he never offered to write a bigger check or give money back, did he? He made a lot of speeches saying it wasn’t fair, but he continues to pay taxes at the lower rate, as far as I know.
Tammy: Throughout your career you’ve worked with and for some very high-profile and high-worth businessowners. How is it possible that Warren Buffet pays taxes at 18 percent, while his secretary pays 25 or 30 percent?
Mark: We meet new businessowners every week, and I’d say nine out of 10 are paying more in taxes than they need to — and more in taxes than the IRS expects. They’re paying 35 percent to 45 percent or more when they don’t have to. The biggest reason is that they don’t have the right advisers to show them how they can keep their money. Taxes are not a certainty. They’re a variable, and the amount of tax you pay is dependent largely on the quality of your tax advisers.
Tammy: So they need a better CPA?
Mark: No, most likely the accountant is probably fine. However, if you’d rather pay closer to the minimum amount of taxes rather than the maximum, you need another seat at the table.
Tammy: Another seat at the table?
Mark: Most successful businessowners have a brain trust or circle of advisors that they rely on to help make the big decisions. Usually an accountant, a banker, a lawyer, maybe a business partner, plus the top executives or partners — they all have a seat at the table.
Tammy: Right.
Mark: But there’s one difference. The high-net-worth entrepreneurs I worked with always had one extra seat at the table, and that was the person in charge of proactive tax strategies.
Tammy: Are you saying that their CPAs couldn’t figure out all the best tax reduction strategies?
Mark: Correct. Despite their CPA’s insistence that they were doing everything they could to reduce the client’s taxes. It’s a silly statement. It’s the biggest lie that’s ever been told about tax planning. It is simply not the truth. Too many CPA’s are merely historical record keepers. Their perspective is the rearview mirror — not future tax strategies. If you really want to lower your tax bill — significantly and permanently — you need the services of a competent and experienced tax attorney.
Tammy: So that’s the other seat at the table — a tax attorney.
Mark: Correct. That’s something I noticed and never forgot, and now it’s one of the secret weapons our firm uses to help our clients dramatically lower their taxes.
Tammy: What can a tax attorney do that a good CPA can’t?
Mark: One aspect is how your company is configured. Most companies outgrow the corporate structure they originally started with, but don’t realize it. Only an attorney can create or modify your corporate structure. Another area is fringe benefits and retirement planning. Oftentimes, certain language has to be written into your corporate documents and bylaws. Again, a CPA’s license allows him or her to do certain things and not others. They don’t have the training or the licensing to execute certain strategies. The best combination is a tax attorney who is also a CPA. They bring an additional layer of tax-planning tools to the table and additional tax savings become possible.
Tammy: Aren’t tax attorneys expensive?
Mark: They can be if hired independently. We bring our tax attorneys enough steady work that we’re able to negotiate reduced fees. The client always saves more in taxes than they pay in fees by a large margin.
Tammy: Still, I think many of our readers are going to believe that having a tax attorney is a luxury they can’t afford.
Mark: The key is to match the right tax attorney to the client’s needs. One of the tax attorneys we work with is the former tax manager at a Big Four accounting firm, responsible for the firm’s 100 wealthiest families. We’re not going to put him with a lube shop owner whose yearly revenues are $750,000. It doesn’t make sense, and it’s overkill, frankly. We try to be smart with the match-ups. Again, the goal is to save 10 times more than you spend. Otherwise, there’s no point.
Tammy: So what are we talking here, offshore tax shelters and secret Swiss bank accounts?
Mark: No, we’re talking about conservative IRS-approved strategies that have been implemented for more than 5,000 businesses across the country.
Tammy: Can you give me a real-life example?
Mark: Sure. The strategies vary by size of company and amount of taxes you’re currently paying, but one thing almost every business can do is take advantage of a retirement savings program that’s IRS-approved. It allows you to take the money that you’re currently paying to Uncle Sam and instead use it for tax-free retirement income or to pass the money on to your heirs tax-free. It’s called a Business Owner Private Plan (BOPP). If set up correctly in accordance with the tax code:
• The government will fund a portion of your retirement contribution
• Your money grows tax-free
• You pay zero taxes on retirement income
• You can pass wealth to your heirs tax-free
Tammy: Do these tax planning strategies work for anyone?
Mark: Well, the BOPP can work for anyone, but not every tax strategy does. There are three types of individuals who benefit most. First, you need to be a businessowner with control over the amount and timing of your income. Second, you need to have paid at least $75,000 or more in taxes last year. We serve clients who have paid a lot more, but from a benchmarking standpoint, when a person has paid about $75,000 or more a year in taxes, they reach a point where they need the next layer of tax defenses in place. The third type of client who can benefit is someone who has not actually paid that much in taxes before but expects to be growing their income — and their taxes — significantly, unless better defenses are put in place.
Tammy: They should talk to a tax attorney before the income is earned?
Mark: Correct. When a client is confident that their income is going to grow rapidly and wants to be proactive in getting defenses in place before the income is earned, it’s a great time to have a conversation. Because once income has been earned, its character and, therefore, its taxation has been determined.
Tammy: Do these strategies make you more likely to be audited?
Mark: Not as long as you follow black letter tax law and the IRS guidelines. Naturally you don’t want to use a rookie tax attorney for this — especially if he is not a CPA as well. I wouldn’t recommend that, but we have data showing that reducing your tax payments can actually lower your likelihood of being audited.
Tammy: What if the tax code changes?
Mark: The tax code will probably change, Tammy, and has changed over the decades. Regardless of all the changes over the last eight-plus decades, these strategies continue to be used successfully by businessowners. Arthur Godfrey once said, “I am proud to be paying taxes in the United States, but I could be just as proud for half the money.” That’s what we’re after: Helping businessowners hold onto more of their hard-earned income.
