The 50,000 foot view of risk
First — you can’t eliminate risk, you only can reduce it. The “safe” approach you were sold on might not actually be all that safe.
The question that always makes me bite my tongue is “Will this raise any red flags?”, as if the worst thing in the world is a tax audit. I disagree. I believe the worse thing is to abandon prudence and pay more in taxes than you should because you are afraid of an audit.
Here’s an example of “red flag” deductions we have been able to support and have had an IRS examiner sign off on:
- Jetskis for a personal services company as a legitimate business expense. Audited and accepted.
- Home office deduction of $15,000. Accepted.
- Able to prove cost of goods sold with no business records reducing a proposed tax bill of $120,000 to $18,000. Accepted.
This whole idea that we should take the “conservative approach,” and NOT claim a completely legitimate, but perhaps imaginative deduction because someone is not comfortable backing up their position with the IRS is complete nonsense.
If your books are in good order, if your positions are well-stated and researched, the IRS has a lot more to lose at an audit than you do. Why? Before every audit the IRS conducts a risk assessment. They consider the likelihood of a slam dunk were an additional assessment required. The risk the IRS runs is that they may waste an auditor or an audit teams time with no substantial change or litigation that buries them. Worse yet, they could get a tax court opinion that leads to what they consider bad law to be on the books. The IRS has half the field auditors it did in 2008, so the IRS wants easy audits. The IRS looks for:
- Baseless claims.
- Tax professionals who will fold.
- Books in disarray, when the taxpayer is unable to challenge income and expense determination adequately.
- International transactions and foreign assets where there is an substantial likelihood the IRS can assess large penalties for small technicalities.
Overpaying for security theater
Consider the two alternatives:
A. You overpaid $10,000 in taxes for the last 20 years to perhaps avoid an audit (but you could be audited being “conservative", anyway…right?).
B. Or, assume you are selected for an audit, but have paid $10,000 less the last 20 years. The IRS will audit 3 years at most (6 years is incredibly rare).
Do you see how Alternative B could be quite preferable? If you are afraid of failure, you can’t win.
2017 Tax reform. What to do about it.
We think it's best to hold off on some things that could be affected by tax reform. For instance, a huge benefit of setting up a Family Partnership Trust is avoiding gift and estate taxes. But, if tax reform is passed as proposed the gift and estate taxes with be repealed. For anyone considering moves to avoid gift and estate taxes, it's probably better off waiting until the smoke clears.
However, there is a litany of other items that make sense to undertake regardless if tax reform is passed or not. If tax reform passes you want to have your “ducks in a row”. This way you can take advantage of the best structure so that you can immediately:
- Enjoy a lower 20 or 25% pass-through rate, or 20% “C” Corporation rate
- And, take advantage of full and immediate expensing of capital expenditures.
This is how we segregate tax planning into three categories: Low hanging fruit, often overlooked or claimed “red flag” strategies, and then ‘shoot the moon’ strategies that could eliminate a tax bill, but have so many drawbacks very few people can take advantage of them.
- Claiming bonus depreciation where allowing
- Looking for year-end moves to avoid 3.8% surtax on net investment income tax (NIIT)
- Making the best use of stock market losses
- Converting Traditional IRS to Roth, recharacterization, reconversion strategies
- Increasing withholdings/estimate payments to save underpayment penalties.
- Determining an immediate guaranteed savings by analyzing if first time penalty abatement applies for any earlier years
- Making year-end gifts to family members to shift taxable gains to lower-bracket earners (including those not subject to 3.8% NIIT)
- Disposing of passive activities to free up suspended passive losses
- Using energy tax credits.
Overlooked "red flag" tax savings
These are the typical "red flag" deductions that many tax preparers are afraid of claiming because they are intimidated by the IRS. We find these can be very helpful to our clients:
- R&D Tax credits
- State tax credits
- Cost segregation for business owners
- 1031 like-kind exchange for under-performing assets
- Goodwill deductions for both self-created and purchased assets
- Structures for asset protection
"Shoot the moon"
Often, clients want to know how to avoid paying any tax. There are only two structures that make this possible, one better than the other to do so. The rules are incredibly complicated and it requires a degree of wealth and also a willingness to give up control. It is the latter part that disqualifies most high income earners from exploring this tax treatment. If this is something you want to discuss, we can certainly assist you.
If you're interested in seeing if we can add depth to your team, contact us to schedule your consultation
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