If the post-pandemic recovery has taught us anything about business, it’s that no one has a monopoly on good ideas anymore.
If you’re like most business owners you have an appreciation for strategy, but are likely severely limited on time to research, understand, process, and implement strategies that bring you the highest value possible. So if you’re like most, you outsource. For tax and accounting issues we seek the trusted Certified Public Accountant or CPA to compile our mountain of receipts, misplaced invoices, haphazardly photographed lunch receipts, and a hundred other records of our financial behavior that seems to get more difficult to manage as your success grows. The 2022 tax law updates are just a representation of the change and constant growth to be expected as the Federal Reserve continues to pour money into the economy and the IRS gets one step further behind each and every day.
CPAs and their profession are a cornerstone to our society and if I could fill my neighborhood with only one professional to live next door to, it would be them. They’re analytical, they keep to themselves, rarely talk unless necessary, follow their own detailed understanding of laws and rules, and otherwise make for a pretty reliable person to get some sugar from in a pinch. The challenge with this dynamic is the same things that make them great, are the same things that keep them stuck in the past and resting on the laurels of some model they thought of a decade ago and haven’t optimized. It’s great for them and their business model because they can just copy and paste their strategies. We see this from niche focused accountants and CPAs, those who claim to focus specifically on helping a certain business model (physicians, dentists, attorneys, ecommerce, etc) all the way to organizations like the Big 4 (PwC, KPMG, Deloitte, EY). It’s just how business works and we’re all just people doing our best to make it to the next checkpoint in our lives.
This sounds reasonable, and is quite understandable but the missing component in this equation is that all of those things come at the expense of the business owner, you.
What I’m about to tell you is going to upset you, it might even enrage you..but you need to know the truth about accountants and CPAs…
They’re humans too.
This means they can become lazy, complacent, stuck on auto-pilot, distracted, and any of the other attributes that make humans so lovable. This also means you can be stuck in a tax planning strategy that is costing you a lot of money, and in fact – if you have over $1,000,000 of business revenue on an annual basis I’d almost guarantee that you’re overpaying in tax and are charting a course to do so for the rest of your life unless you do something about it now.
01. The Hidden Opportunity within the Tax Cuts & Jobs Act of 2017
In 2017, the Tax Cuts and Jobs Act changed business as we knew it, except no one had any clue. Having a greater mind for finance than tax & accounting I couldn’t help but wonder what landmines and roadblocks were on the journey to realizing any benefit from the provisions within the Act. The more our collaborative team of accountants, CPAs, attorneys, consultants, advisors, exit planners and investment managers dug into the legislation, the more lightbulbs started to come on.
The reality we’ve discovered is that there is a huge opportunity within this legislation and we’ve been decanting it for over 4 years to truly understand it more. Since we learned of it, we’ve implemented it hundreds of times with clients and continually optimize every aspect of it.
Here’s the fundamental premise: A C-Corporation strategy pays a fixed 21.00% federal tax for any and all revenue, period.
But wait, aren’t all CPAs and tax news outlets discussing how this provides no benefit? That the crippling nature of the dually-taxed income makes putting money into a corporation you ever intend to take out of it a losing proposition?
The answer to that question is two-fold:
- Yes most CPAs and tax news outlets are saying this.
- The reason for this is everything I mentioned at the start of the article, and it’s the problem at hand.
Let me explain:
The Tax Adviser, a prominent tax publication opined in 2018 that utilizing this strategy made no sense because upon realizing the flat 21.00% tax on C-Corporation strategy income, they would just pay another 19.00% or 20.00% on the inevitable dividend distribution.
Nerd Wallet takes a nose-dive on their informational accuracy in 2020 by addressing double taxation of profits. To address a negative feature of an entity design in a vacuum and without context is just bad information.
Even The Tax Foundation misrepresents its characterization of C-Corporation strategy as they relate to real world applicability and use for business owners.
Why? Because the same folks who write these articles and give the opinions they do learned about C-Corporation strategy one time, in college. They heard a lot of bad things about them, so they went and built their cookie-cutter business models around S-Corporations and never looked back. It doesn’t make a single one of these people or organizations bad however, it just makes them like everyone else. I mean, think about it. An industry that is filled with people who do nothing but follow the rules to the letter every day and are essentially penalized and admonished by the government for being innovative. In the end, adjusting to 2022 tax law updates will be just as difficult in 2023, 2024, 2025, and so on unless you design a multi-entity c-corporation strategy to stay agile indefinitely.
So, of course no one has done anything about it (except for us, who have saved clients over $5,000,000 in tax overpayments since this all began but that’s a topic for another day). What you need to know now is why is this strategy a benefit to you and what do you need to do now to get your money back before Uncle Sam gobbles it all up.
02. Recipe: How to Design, Structure, & Implement Your Mega Entity
Now that we know enough about the recent changes to be open minded around entity design and structure – let’s discuss the four ingredients you need to create this successfully and without excess audit risk:
- Passthrough Operating Entity (OPCO)(S-CORP/LLC)
- Management Service Organization (MSO) (C-CORP)
- Management Services Agreement (MSA)
- Management Fee Analysis (MFA)
- Executive Benefit Plan
Using these four ingredients, we’ll perform a simple calculation to determine the styling of our entity design:
- A – How much gross income do you earn?
- B – How much of that do you need to fund lifestyle every month?
- A – B = C (Excess Income)
- C = Target Management Fee
For example, if you earn $600,000 a year annually from your business and only need $250,000 to fund your lifestyle. The targeted amount to steward into your C-Corporation strategy is $350,000. I say target, because you cannot just put money into a C-Corporation strategy without documentation governing how it goes in. Through performing a proper management fee analysis, that will determine the amount available to move. Once this is completed, you just saved up to 19.00% on taxes for that $350,000 which is close to $70,000.
Disclosure: This C-Corporation strategy cannot be effectively implemented by an individual, many try to but fail. While it is great for our business revenue to meet those who have tried the DIY approach before – I can assure you that fixing any mistakes you’ve made will cost 3x as much and it’s unlikely it would be in true optimal form and require specialty upkeep indefinitely. This is a huge waste of your time and money and can produce outcomes you didn’t intend to:
03. Executive Benefits: The Hidden Passage
When discussing ‘Executive Benefits’ I’m talking about Non-Qualified Deferred Compensation (NQDC) rules that stipulate opportunities to utilize various financial products as means of compensation for employees and executives. These work very well inside C-corporation strategy and designs.
If you’ve ever wondered how mega corporations like McDonald’s, Bank of America, JP MorganChase, P&G, J&J, etc are able to take substantial tax benefits from compensating their executives – this is mainly how, the 2022 tax law updates have really created this opportunity for small and medium sized businesses. The C-Corporation strategy combined with executive benefits provides an ability to take your income today, and specify it for a purpose in the future therefore foregoing the taxation of it today. To many people these are well known as ‘deferral strategies’, which are concepts around moving the realization of income taxes to a future date, where the societally-driven auto-pilot thinking have promised us our taxes will be lower. They won’t, but again that’s a topic for another day.
Executive benefits are not deferral strategies. When you handle these types of plans properly you’re not deferring the tax, you’re neutralizing it. This means that once your dollar is taxed at the federal 21.00% rate (plus SALT), it won’t ever have to be taxed again. This strategy is also closely linked to why you would put a C-Corporation strategy in your ecosystem in the first place.
You wear a lot of hats in your business. From accounting, to HR, to sales, to marketing, to operations you’ve got your hand in almost everything. Most business owners just opt to account for their money (taxable) income, rather than account for their time (activities). The problem with accounting for income after the fact is that you’re still stuck with the tax bill, often only with mediocre deferral strategies to provide relief. Accounting for your time allows you to decide how you receive income, instead of the U.S. Government. By accounting for your time properly, you’ll realize that business owner is only one hat. All of the other hats, you could provide compensation for and even provide benefits to in another organization that say, provided management services. You could even become an employee in both organizations, add/remove family members from them mix for maximum benefits and more.
04. Getting help to navigate 2022 and tax law updates
Now obviously I’m biased in this statement, but you ought to absolutely seek help in performing this strategic shift to greener pastures. If slapping a few documents together we’re all this took, we wouldn’t have much of a business and making sure you get things right is the easy part. Making sure you don’t get things wrong when left to your own devices and thought bubbles is where our rubber meets the road.
- It’s possible to accidentally trigger dividend distributions in a C-Corporation strategy
- It’s possible to accidentally revert your tax rate from 21.00% back to 37.00%+
- It’s possible to build up retained earnings with no business purpose that add surprise tax bills
- It’s possible to incorrectly convert entities and cause massive phantom retained earnings tax to distribute unexpectedly
- It’s possible to misuse your executive benefit plan to the extent distributions become treated like income rather than tax-free
- It’s possible to incorrectly design your governing documents and turn your entity into a Passive Investment Company rather than a functioning management organization driven by C-corporation strategy and design
Your curiosity might beg the question as to how I know these things. Unfortunately these have all been excruciatingly painful life lessons we’ve learned about from people who find us to help them get it right-sized and back on its journey. However, if you’re willing to accept there may be some things you didn’t know you didn’t know – there’s hope yet.
We’ve dedicated our lives to helping business owners get ahead, reclaim time in their lives, and focus on what matters most through all-in-one consulting solutions designed to do just that.
