Tax Laws Create Opportunity for Business Owners

Posted on September 20, 2011 by Bill Faiferlick

Revisions to our tax code in 2002 once again permitted business owners and other professionals to have meaningful tax deductions through the adoption of owner or professional benefit plans.

For those of you who are old enough in the mid-sixties there were similar, favorable tax treatments for inpiduals with high incomes, but a congressional review a decade later determined few benefits were percolating down to employees as Congress intended.

Consequently, Congress clarified their intention. What followed was the rollback of benefit plans for high income earners with new plans which favored the employee, known today as a 401(k) and profit sharing plans. This departure overnight changed the landscape and accumulation opportunities for successful inpiduals, professionals, and business owners.

Why the 2002 tax code change to a more favorable environment for successful inpiduals and business owners? It’s fairly simple. Congress is starting to realize successful inpiduals need to take on the personal financial responsibility of providing meaningful retirement dollars necessary to see them through their extended life expectancy.

Social programs, as we know them today, will not be available for the masses in future years in their past or current forms. Consequently, the greatest and most effective incentive Congress can offer is substantial tax reductions through the adoption of owner or professional benefit plans.

These plans are not employee based plans, such as the 401(k) and profit sharing. Rather they are intended specifically for successful inpiduals’, owners’ or professionals’ participation, leaving the employees in their existing plan but providing significant benefits for high income earners proportionate to their income. By excluding the owners from the employee base for calculating benefits(providing you have employees), a tax strategy can be designed to provide a meaningful tax savings with accelerated accumulations in only a few short years.

Example: After tax investing

Excess income of $100,000 available for investing after current lifestyle expenses. Assume you’re paying a combined tax at a 40% rate.

$100,000  gross income

-     $ 40,000   taxes owed

$60,000   net income to invest

The net income is invested with some annual return and fluctuates depending on market conditions.

Example: Pre-tax investing

$100,000  gross income

-          $ 0  deductible contribution

$100,000  to invest

The contribution is invested with some annual return and fluctuates depending on market conditions. However, the plan provides additional incentives: tax deferred growth.

With yearly after tax investment contribution amounts of $60,000 per year, in five years you’ve only invested $300,000 or $600,000 in ten years. In contrast with pre-tax investing in five years, you would have invested $500,000.00 or $1,000,000.00 in ten years. You’re taking advantage of the accumulated deferred tax savings..

Here’s the question?

What annual return using the after tax investment of $60,000, would be needed to achieve the same account balance of $100,000 applied in the pre-tax model?

You need a 67% after-tax annual return to compete with the pre-tax investing.

Providing a favorable plan can be designed based on your information, you can take advantage of the tax deduction Congress intentionally created. Certain contractual guarantees can be included eliminating traditional market volatility ensuring the account balances are completely available when needed. Without the hype of returns in either scenario the pre-tax principal balance monstrously dwarfs the after-tax opportunities.

Advisors traditionally promote returns to attract and retain clients. Designing tax favored environments to accumulate and grow wealth is exceedingly more valuable than taking the risks and attracting potential higher rates of return in after-tax environments. When even a modest rate of return is included, the accelerated creation of wealth is undeniable. Understanding how to leverage the tax system as it is legally intended, empowers you to create personal wealth.

What is so important about Productivity Profitability? 

Using the after-tax dollar scenario, how many lost productivity hours were you forced to give away to the government to pay your taxes? My intention is to radically reduce the months you work and capture those productivity hours and frankly put that money directly back into your pocket. Heaven knows businesses work extremely hard to maintain margins. Investors kill for a one or two percent long term higher return. Yet we’ve accepted the tax liability intrusive levels.

The tax system in the U.S. is an amazing tool with bountiful opportunity providing one knows how to appropriately use the system without going into questionable or gray areas.

If you sell a product or service and the bill or billing to a client is $1,000 what is your net profit or income? If your margin is 10% then it’s $100.

Let’s step it up to meaningful numbers. At $100,000 of services billed or products sold, using a 10% margin, your net profit or income is $10,000.

At $2,000,000 of services billed or products sold applying the 10% margin, your net profit or income is $200,000.

To understand how overpaying taxes affects your productivity profitability, how many weeks or months are necessary to work or bill $2,000,000.00 of gross income generating $200,000.00 of income?

Assuming this represents at least one month’s worth of your gross billing, implementing a strategy that will capture this tax liability and put it back into your retirement account, has saved you an entire month’s productivity by not paying it to Uncle Sam.

Most business owners can’t even take a month’s vacation per year. This strategy just increased your wealth by $200,000.00. Multiply this by 5 years and this is an additional  $1,000,000.00 savings. With a return on your investment, you now have in excess of $1,300,000.00. However, this is interpreted, this is a lot of unanticipated wealth at your disposal for your future needs and dreams.

Adopting strategies such as this, do not require altering your business or how you work. It does allow you to accumulate additional wealth effortlessly. It’s crucial today to not be passé about overpaying taxes and take back what you’re already legally entitled to; your hard earned income!