Part One — How the Tax Law Can Be Your Best Friend
Chapter 1 — Taxes Are Stealing Your Money, Your Time, and Your Future
People with lots of money have lots of time. They don’t have to trade their time for money. They trade money for time instead. The average person in a developed country spends 25 to 35 percent of their life working to pay taxes. That’s more than two hours of every workday. Over a lifetime, it adds up to twenty years. That’s a prison sentence.
Yet millions of people legally pay little or no tax. They don’t know secret loopholes. They just understand how the tax law works. The tax law isn’t only a way to raise money. It’s a tool the government uses to shape the economy.
So build tax planning into your wealth plan from the start. It’s not what you make that matters. It’s what you keep. Every tax is based on your facts, meaning what you actually do. If you want to change your tax, change your facts. And be wary of tax preparers who only push your taxes off to a later year. Real tax planning is permanent.
Too many people compare investments before tax, and it steers them wrong. Say you put $100,000 into stocks that return 10 percent. Or you put that $100,000 down on a rental, with the bank covering the rest, and it returns 7 percent. The stocks look better. But capital gains tax turns the $10,000 stock gain into about $8,000. The $7,000 from the rental is tax-free, thanks to depreciation. And the depreciation is bigger than the rent, so the extra lowers the tax on your paycheck by about $6,000. The rental really earns you $13,000. That’s $5,000 more than the stocks.
Chapter 2 — Taxes Are Fun, Easy, and Understandable
Taxes can kill your hopes and dreams. That surprise family vacation? Gone, thanks to Uncle Sam. Around the world, the average person pays 30 to 50 percent or more of their hard-earned income in income, sales, payroll, estate, and property taxes. Almost a third to half of the world’s wealth gets handed to governments.
The basics of changing that aren’t hard. Here’s one: invest where you travel. If you have a favorite place to visit, think about buying an investment there. It gives you a reason to keep going back, and it turns trips you’d take anyway into deductions. The IRS rule is simple. Spend more time on business than on fun, and the hotel, airfare, and meals all count.
Chapter 3 — The Two Most Important Rules
Two rules matter more than any others. Rule one: it’s your money, not the government’s. Many people are trained to believe they owe the government their money. It’s just not true. Rule two: the tax law is written primarily to reduce your taxes. Nearly all of it, about 99.5 percent, exists to save you money. All the complexity people complain about is aimed at lowering taxes, not raising them.
The limited liability company, or LLC, shows how much room that gives you. The LLC has become the top choice for protecting your assets from lawsuits. But for taxes, your LLC can be whatever it wants to be: a sole proprietorship, a partnership, or a corporation. When you’re starting out and not making much, you can have it taxed simply as a sole proprietorship. Later, when you’re ready to cut your employment taxes as an S corporation, you check a box on a form and send it to the IRS.
Chapter 4 — Put Money Back in Your Pocket — Now
The fastest way to put cash in your pocket is to lower your taxes. You can even start with the past. In the United States and many other countries, you can amend your returns from up to three years back if you paid too much, and get a refund now.
Then look at what you spend. What if you could get a 20 to 30 percent discount on everything you buy? That’s what happens when a personal expense becomes a business deduction.
To count, an expense has to pass three tests. First, it needs a business purpose. A meal counts if you talk business with the person you’re eating with. Second, it has to be ordinary, meaning “customary and usual” for your industry. Third, it has to be necessary, meaning it’s meant to make your business more money. Lunch with a friend where you happen to talk shop doesn’t count.
Say your business partner is your spouse. You’re always talking about the business, so nearly every quiet dinner out turns into a business meal. Just don’t get extravagant. As the saying goes, “Pigs get fat and hogs get slaughtered.” Still, one of the most common mistakes is couples who talk business every time they eat out but never pay with the business credit card.
Chapter 5 — Entrepreneurs and Investors Get All the Breaks
Robert Kiyosaki’s Cashflow Quadrant sorts people by how they earn money. On the left side are employees and the self-employed. On the right side are big business owners and investors. People on the left pay much higher taxes than people on the right. And that’s exactly what Congress and Parliament wanted.
Governments want jobs, and entrepreneurs create jobs. So entrepreneurs get tax breaks for hiring. Governments want affordable housing, so real estate investors get breaks for building it. Those breaks cost far less than government programs, and the market does the job better. But don’t start a business just for the breaks. It has to be real and meant to make a profit.
One of the best moves is to make your business a family business. You can shift income from your higher tax bracket to your kids’ lower one. One longtime client put his nine-year-old daughter to work doing the bookkeeping for his rental properties. She earns a fair wage, maybe $4,000 a year. Her parents deduct it, and since she has no other income, she owes no tax. In their 40 percent bracket, that saves them $1,600. You get the tax savings, your kids get a real education, and you have someone ready to take over when you retire.
Chapter 6 — You Can Deduct Almost Anything
Business expenses are the best kind of deductions. Real estate expenses are next. Energy expenses are often good too. Stock market expenses are the weakest, because stocks aren’t an active investment.
So your first step to more deductions is to become an entrepreneur or an investor. Until you do, the tax laws will be stacked against you. And you have to be an active investor who invests for passive income, the kind that comes from dividends, rents, and businesses. It’s taxed at a much lower rate than your paycheck. You don’t have to quit your job to start. Just start small, and keep good records. Remember, if you pretend to document a deduction, you get a pretend deduction.
Chapter 7 — Depreciation: The King of All Deductions
When you buy something that produces income, you can deduct part of its cost every year you own it. For buildings and equipment, that’s called depreciation. Depreciation doesn’t cost you any cash that year. Better still, you get it on the whole building, not just the part you paid for. You get a deduction for the bank’s money too, even if you borrowed every dollar.
Take Pierre, who owns a restaurant called Chez Pierre. He buys a building for $780,000. In the United States, commercial buildings are depreciated over 39 years. But Pierre didn’t just buy walls and a roof. He also bought the floor coverings, window coverings, and cabinets. Say $100,000 of the price is for those things. They can be deducted much faster, at 20 percent a year. Together, Pierre deducts about $37,500 a year. That’s $37,500 of restaurant income he doesn’t pay tax on.
The sooner you get your deductions, the more money you have to put back to work. The trick is to document the value of each item in a cost segregation study, ideally done by a tax professional or engineer. The IRS specifically approves it.
Chapter 8 — Earn Better Income
The more money you make, the more you should care where it comes from. Go back to Pierre. Say his restaurant earns $200,000 this year. Instead of taking it all out and paying regular rates, he puts $100,000 back in, as new equipment and marketing that will earn more later. All of that is deductible. Now only $100,000 is taxed.
Picture your income going into one of five buckets. The first is earned income, from working. That bucket has big holes, and your money leaks out through high income and employment taxes. The second is ordinary income, like money from a pension or 401(k). It skips employment taxes but is still taxed at the highest rates. The third is investment income, like capital gains, interest, and dividends, which is usually taxed at lower rates. The fourth is gifts and inheritance, which usually aren’t taxed at all. And in the United States, the fifth is passive income, from a business or real estate you don’t personally manage.
Passive losses can only offset passive income. That sounds like a limit, but it’s really a gift. Most accountants are scared of passive activity losses, or PALs. Don’t be. The best way to use them is with passive income generators, or PIGs. Say your real estate gives you $10,000 in passive losses a year. Your friend Paul has a growing business, so you invest in it for a 5 percent share. When Paul’s company earns $100,000, your $5,000 share is covered by your losses, and the rest carry over to next year. That’s what happens when you combine PIGs with your PALs: tax-free money.
Chapter 9 — Take Advantage of Your Tax Brackets
Take George and his wife, Martha. They had six children, all still in school and without much income of their own. By splitting ownership of his business among the family, George could spread the profit across their lower tax brackets. Set up the right way, the business could earn $387,000 and have every dollar taxed at 12 percent or less.
George didn’t give up control. He managed the company, and he was the trustee of the trusts that held his children’s shares. And, of course, he had parental control, which is often the best control of all. It’s not how much you own that matters. It’s how much you control.
You can use your parents’ brackets too. Give them part of your partnership, S corporation, or LLC, and their share of the income is taxed at their rates.
Corporations have their own bracket too. In the United States, a corporation’s income is taxed at a flat 21 percent. So do what big companies do and hand work to other companies. A separate corporation of your own can handle your marketing, bookkeeping, or billing. A great one is human resources, a separate company that runs all the payroll and employee benefits. Just make sure each company has a real business purpose beyond saving tax, and document every payment between them.
Chapter 10 — Credits: The Cream of the Tax-Saving Crop
A tax credit is the cream of the crop because it cuts your taxes dollar for dollar. A deduction only lowers the income you’re taxed on. A credit comes straight off your tax bill. A $1,000 credit saves you $1,000, whatever your bracket. There are credits for the working poor, for giving to charity, and for business owners who build low-income housing, buy equipment, or do research.
But watch out for promoters who want to “sell” you tax credits. If the credit is your only reason to invest, you probably won’t get to use it. Look at the profit first.
Look hard at education savings plans too, like the 529 plan in the United States. They grow tax-free, but they often limit what you can invest in and how you can spend the money. Back in chapter five, you saw how to pay your kids to work in your business. Now have them put those wages into an LLC or partnership that owns a business or investments. Like a 529 plan, you get a deduction when you pay them, and with good planning, nothing gets taxed. But unlike a 529 plan, you keep full control, and you can take the money out any time with no penalties. Stop using government plans and make your own.
Chapter 11 — Conquer Your Employment Tax Troll
Some of your biggest tax costs are employment taxes, the money that goes to Social Security and Medicare. Wheelwright doesn’t mind the government rewarding him for running a business or investing. He loves that. What he hates is being told he has to pay into Social Security and Medicare, especially since he’ll probably never use them.
The way to lower employment taxes is to change how you’re paid. Take Michael, who sees patients in his own practice. He used to be self-employed. Now his company is an S corporation, and he’s both its owner and its employee. His salary gets hit with employment taxes. His share of the profit doesn’t. So the goal is to keep his salary low and his profit share high.
The tax collectors know this too. They want the salary to be reasonable for the work. Pay yourself too little, and they may tax all of your company’s income. So don’t pay yourself too much or too little. A reasonable salary can save you over $4,500 a year and lower your chances of an audit.
Chapter 12 — Your Property, Sales, and Value-Added Taxes
Most business owners focus only on income tax. Yet the dollars are huge, and there are as many breaks in the sales and property tax rules as there are in income tax law.
With sales tax, the bigger risk for most companies is the tax on what they sell, not what they buy. If you don’t collect sales tax and the state audits you later, the bill moves from your customers to you. So always collect it unless you have clear proof none is due.
Property tax is hard to swallow in tough times. You owe it whether you make a profit or not. Since it’s based on value, the way to lower it is to challenge that value. Show that your property is worth less than the assessor says, or that it’s valued higher than similar properties nearby.
Chapter 13 — Estate Planning Is Good Tax Planning
Estate planning makes things painless for your heirs and leaves your assets with the people you love instead of the government. It comes down to three steps: put your assets in trusts, write a will, and avoid the estate tax.
Trusts keep your family out of probate, the court process of moving what you owned into your heirs’ names. Probate is expensive and public. The way out is easy. Put your major assets in a trust. You control it while you’re alive, and it spells out what happens when you die, with no family fights and no court case. Then use a will to name a guardian for your kids.
The estate tax is the hard part. The obvious move would be to give everything away before you die. But you want to keep control while you’re alive, and every country with an estate tax also has a gift tax. So give away value without giving away control. Wheelwright only cares about controlling his business and real estate, not whether he technically owns them. A limited partnership does this well. You give shares to your children, and as the general partner, you stay in charge.
Giving away pieces also earns you a discount. Say your business is worth $500,000 and you give 20 percent to your kids. You’d think that’s worth $100,000. But 20 percent gives no say in how the business is run, so it could be worth as little as $60,000. That’s like getting an extra $40,000 you can pass on tax-free. In most cases, you can wipe out the estate tax completely.
If you want to leave something to charity, a charitable trust lets you give and take. You can give your assets to a charity now and still keep the income from them for the rest of your life. You get a deduction the year you set it up, and those assets avoid estate tax.
Chapter 14 — Reducing Your Taxes in Other Locations
You’ll be taxed where you have property, an office, or employees. But every place has different rules, and paying tax in several places can mean paying less in total than you would in one.
States tax you partly based on your sales there, and a sale belongs to the state the product ships to. So say your main office is in Arizona and your warehouse is in Nevada, and you have no offices or employees anywhere else. On your Arizona return, you only report sales shipped to Arizona. Nevada has no income tax, so all your other sales become “nowhere” sales. You’re taxed on only a small part of your income in Arizona, and nowhere else.
Across borders, most countries give you a credit for tax you paid to another country. But to get it, the same person or company that paid the foreign tax has to report the income at home.
Part Two — Your Tax Strategy for Tax-Free Wealth
Chapter 15 — Plan to Take Control of Your Taxes: Entities
Taxes matter, but not nearly as much as your personal and business goals. So make sure your tax plan never gets in their way. The first step in a solid plan is choosing your entities, the legal forms you own things through. You might use an LLC for your rental properties, a corporation for your business, and a limited partnership for assets you want to pass to your kids.
One of Wheelwright’s favorite moves is to combine them. Say you and a friend open a business selling widgets. You’d like the employment tax savings of an S corporation, but you also like the freedom of a partnership. Why not both? Own the business as a partnership, and have each of you own your share through your own S corporation. In one example, two partners who did this cut their taxes by about $70,000 between them. That’s the magic of a good tax strategy.
Chapter 16 — Protect Your Wealth from Pirates, Predators, and Other Plaintiffs
Wheelwright loves Robert Kiyosaki’s definition of an asset: something that puts money in your pocket. Anything that takes money out is a liability. By that measure, your home isn’t an asset. But your business and investments can be, and those are what you need to protect. You have three goals: prevent a lawsuit, stay under the radar, and win any lawsuit you can’t avoid.
Your entity matters here too. General partnerships are awful. You’re responsible for everything you do, everything your partner does, and everything your employees do. Corporations protect you from lawsuits aimed at the company, so all you can lose is what you put in. LLCs can be the very best choice. They protect you like a corporation, and even better if you’re sued personally. Have both a lawyer and a CPA help you set things up.
Chapter 17 — Plan to Retire Rich, Not Poor
Government retirement plans are built on a lie. They assume you’ll be in a lower tax bracket when you retire. That’s only true if your goal is to retire poor. If you plan to retire on the same income you have now, you’ll be in a higher bracket.
While you work, you get lots of tax breaks. You get breaks for your kids, but by retirement they’re no longer depending on you, if you’re lucky. Your mortgage is hopefully paid off, so that deduction’s gone. So are your work deductions. Maybe you’ll need less income, if you plan to sit at home and watch TV. But most people put off life’s pleasures so they can enjoy them later, like more golf, more travel, or a house on the beach. Plus, you’ll probably have cute grandchildren who need spoiling.
Plans like a 401(k) cost you in four ways. First, they raise your tax rate. Stock gains that would get the lower capital gains rate come out taxed as ordinary income. Second, your money sits in someone else’s hands. Third, they limit leverage, meaning borrowed money, which is the difference between building massive wealth and barely getting by. Fourth, you lose control over what you do with your money and when.
And never put a tax shelter inside another tax shelter. A rental property held in an IRA loses its tax savings, because the depreciation gets trapped inside the plan. Some plans do work, though. With a Roth IRA, you don’t get a deduction when you put money in, but you don’t pay tax when you take it out. Things like stock trading and hard money loans work well there. Rental real estate doesn’t.
Chapter 18 — Business Can Be Your Best Tax Shelter
Businesses get tax breaks because they create jobs. You deduct the wages you pay. Many governments add credits for hiring people who’ve been out of work a long time. Timing helps too. Your business year can end in March while your personal year ends in December. So your company can pay you a bonus in March and deduct it right away, while you don’t report it until the end of the year.
Then think about the kind of income your business gives you. Remember the buckets from chapter eight. The reason Warren Buffett pays only 17 percent on his income is that most of it is investment income. Passive income is even better, because real estate losses can cancel it out. So turn part of your business into a passive investment. Give a share of it to a family member who doesn’t work there, so their share of the profit is passive income. Then give them part of a property with passive losses. The losses cancel out the income. It’s simple in concept, but don’t try it without your tax advisor.
Chapter 19 — The Magic of Real Estate
Real estate is such a good tax shelter that a serious investor should never have to pay tax on their cash flow or on the gain when they sell. The key is to keep buying more.
Here’s why. Every year of depreciation lowers your tax basis, the number your gain is measured from when you sell. Once it hits zero, the depreciation stops. So keep buying, and roll your gains into new properties through what’s called a like-kind exchange. Buy another property for the same price or more, and you owe no tax on the sale. Like-kind exchanges plus depreciation equal zero taxes.
Picture how that plays out. You start with a few single-family homes. After a few years you trade them for a couple of apartment buildings. But apartments are still a lot of work. So you look for a building that needs no work at all, and you find a Walgreens. Walgreens usually sells its stores to investors and leases them back for 30 years. It covers all the upkeep. All you do is pay the mortgage.
Here’s the magic. Say your depreciation on all those properties adds up to $4 million. You paid $5 million for the Walgreens, so your basis is now $1 million. If you sold it for its $6 million value the day before you died, you’d owe tax on a $5 million gain. But if you hold it until you die, your basis steps up to its value that day. Your kids can sell it and owe nothing. You got all that depreciation, and nobody ever pays tax on it.
So don’t sell. If you need cash, borrow against the property. Loans aren’t taxable, so a refinance puts money in your pocket tax-free. Even your home can help. In the United States, there’s no tax on selling your home if you’ve lived in it two of the last five years. One couple lives in each house until it’s fully fixed up. Then they sell and do it again.
Chapter 20 — Stocks Can Lower Your Taxes Too
People who make a lot of money in stocks study the market. They don’t use the strategy Wheelwright used on his first stocks: buy, hold, and pray.
Be careful with mutual funds. Say you buy into a fund in January. Fifteen years ago, the fund bought a stock at $10 a share, and now it’s worth $50. The day after you join, the fund sells it. Who pays the tax on that $40 gain? You do, along with everyone else in the fund that day, even though you just got there. It gets worse. By December the market dips and your shares are worth less than you paid. You still owe tax on that gain. Mutual funds are one of the few places you can lose money and still owe tax.
If trading is a major part of your time and income, you may qualify as a trader and deduct your expenses like a business. Or trade inside an IRA. Frequent trades are taxed at your highest rates anyway, so the IRA costs you nothing and puts off the tax. Better still, trade in a self-directed Roth IRA, where none of the gains are ever taxed. Just remember it’s retirement money, so you can’t freely take it out before age fifty-nine and a half.
Chapter 21 — Commodities Can Be Your Tax Friend
In the United States, oil and gas is one of the truly great tax shelters. Buying oil company stock gets you nothing special. Investing in drilling does. Most drilling costs are things like labor, surveys, fuel, and repairs. Congress lets you deduct them, along with the equipment, in the year you spend the money. On top of that, you deduct 15 percent of the well’s income every year, even after everything else is used up. That’s called depletion.
Governments also reward renewable energy, like wind turbines, solar panels, and electric cars, with credits. Farms can deduct feed, seed, and labor as soon as they spend the money, and they get estate tax help so families don’t have to sell the farm to pay taxes. Gold and silver are the opposite. The United States taxes their gains at a higher rate than other long-term gains.
Chapter 22 — Don’t Fear the Audit
One of people’s biggest fears is being audited. There’s nothing to fear if you’re prepared. Keep your books organized, keep receipts for every deduction for seven years, and keep your contracts and company records ready.
What you call a deduction matters too. Instead of listing a seminar as a seminar, call it continuing education, or a marketing expense if you went mainly to network. You’re still telling the truth. You’re just not raising a red flag. And when you estimate a cash expense, don’t pick a round number. A more exact number looks less like a guess.
Chapter 23 — Choose the Right Tax Advisor and Preparer
Finding a great tax advisor is one of the most important things you’ll ever do. Look for someone who’s passionate about lowering your taxes. And look at how they see the law. Are they afraid of it, or do they see it as an opportunity?
You have all the answers. Your advisor should have all the questions. If you have to ask the questions, you have the wrong advisor. A good one knows the law, gets creative for you, and is willing to teach you the rules.
Chapter 24 — What Are You Going to Do with All Your Extra Money?
The best part of saving on taxes is using that money to build wealth. All great wealth rests on three ideas: compound interest, leverage, and velocity. Compound interest matters, but on its own it’s a pretty slow way to get rich.
Leverage is earning money on someone else’s money. It’s what a bank does when it borrows your savings and lends them out at a higher rate. You can do the same. Say you borrow $100,000 for your business at 8 percent and buy equipment that earns $12,000 a year. You pay the bank $8,000 and keep $4,000. Compare that to the $500 you might earn leaving $10,000 in a bank CD. That’s the magic of leverage.
Velocity speeds leverage up. Say you put in $10,000 of your own along with the loan. At 12 percent, you earn just over $5,000 after paying the bank, and you leave it in the business. Banks like that. If the bank lent you $100,000 for your $10,000, it should lend you another $50,000 for your new $5,000. Now more money is working for you, and the next year you keep almost $8,000. That’s $3,000 more than the first year.
It’s all about momentum. The more you use leverage and the faster you put your money back to work, the faster you build your wealth.
Taxes can eat twenty years of your working life. But the tax law isn’t your enemy. It’s a map of what the government wants you to do, with a reward for doing it. Change your facts, keep more of what you make, and put every saved dollar back to work. Do that, and you’ll stop trading your time for money and start trading money for time.