Qualified small business stock (QSBS) overview

This week’s Wealth Formula Podcast features an interview with a tax attorney. While I’m not a tax professional myself, I want to drill down on something we touched on briefly that is incredibly relevant to many of you: the so-called short-term rental loophole.

If I were a high-earning W-2 wage earner, this would be at the top of my list to implement—and I know many of you are already doing it. The short-term rental loophole is one of those quirks in the tax code that most people don’t even know exists, but once you do, it can be a total game-changer.

Here’s why. Normally, when you buy a rental property, depreciation losses can’t offset your W-2 income. They’re considered passive, and they stay stuck in that bucket.

But short-term rentals—Airbnb, VRBO, whatever—work differently. If the average stay is seven days or less and you materially participate, the IRS doesn’t classify it as passive. It becomes an active business. 

That means the paper losses you generate can offset your ordinary income, even from your day job. Normally, you’d need a real estate professional status to get that benefit. This is the one situation where you don’t.

So let’s walk through how it works. When you buy a residential property, the IRS requires you to depreciate the structure—the walls, roof, foundation—over 27½ years. On a million-dollar property, that’s about $36,000 a year. It’s a slow drip.

A cost segregation study changes that. Instead of treating the property as one block of concrete and wood, it carves out the parts that don’t last 27 years. Furniture, carpet, appliances, cabinets, and even ceiling fans—those are considered 5-year property. In other words, you can depreciate them much faster.

Now add bonus depreciation. Instead of spreading those 5-year assets out over five years, the current rules let you write off most of them all at once in year one.

Here’s the example. You buy a $1,000,000 short-term rental and finance it at 70 percent loan-to-value. That means you put in $300,000 cash and borrow $700,000. A cost seg often shows about 30 percent of the property—roughly $300,000—is 5-year personal property. Thanks to bonus depreciation, you deduct that entire $300,000 immediately.

So you put in $300,000 cash, and you got a $300,000 paper loss in the same year. In practical terms, you just deducted your entire down payment against your taxable income. This is what real estate professionals do all the time and why they often end up with no tax liability at all.

In this case, it works for you as a W2 wage earner. And for that reason, I think its one of the most powerful tools out there for high paid professionals that is grossly underutilized.

Remember, the biggest expense for most people is the amount of tax they pay—especially W2 wage earners. This strategy lets you use money you would otherwise pay the IRS to build a cash-flowing asset for yourself. 

Listen to this week’s Wealth Formula Podcast to learn other ways to legally pay less tax!

Transcript

Disclaimer: This transcript was generated by AI and may not be 100% accurate. If you notice any errors or corrections, please email us at phil@wealthformula.com.

 In general, W2 income is hard to defer and you can do things when you’re self-employed or when you have a company or when you have stock gains or investment gains, real estate, those kinds of things. But I think wages, I think you’re pretty much stuck with.

Welcome everybody. This is Buck Joffrey with the Wealth Formula Podcast coming to you from Montecito, California today. Before we begin, I wanna remind you that there is a website associated with this podcast called wealth formula.com. Go check it out. And, uh, one of the things on there that I wanna draw your attention to is the, uh, accredited investor club, otherwise just known as.

Investor club. Uh, this is where if you qualify as an accredit investor, basically that is not something you apply for, but you either are or you are not. If you make $300,000 per year or more filing, uh, jointly, or you have a million dollars of net worth outside of your personal residence, you are an accredited investor, you just didn’t know it, and, uh, who doesn’t want to join a club.

So go to wealth formula.com, join investor club. Now today’s, uh, podcast is going to be a conversation with a tax attorney. And, uh, while I’m not a tax professional myself, I do want to drill down on something that we touched on in this conversation briefly, but probably should go into a little bit more because I think it’s so relevant for this audience.

And it’s called the short term rental loophole. You may have heard me talking about this before, but you know, if I were a hiring W2 wage earner. This would be really at the top of my list to implement, and I know many of you are already using it. I’ve, I’ve talked to some of you who have used it after, during me talk about, which are good for you.

Um, the short term rental loophole is, it’s really one of those quirks in the tax code that most people don’t even know exists. Uh, but once you do, uh, it can be a pretty significant game changer for you and here’s why. Okay. So if you’re a W2 wage earner, usually when you buy a rental property, all that good tax benefit, a lot of it depreciation, uh, depreciation losses in particular, they can’t be offset by your W2 income.

They’re considered passive and they get stuck in that bucket. But short-term rentals, we’re talking, you know, the Airbnbs VRBO, whatever. They work differently if, if the average stay is seven days or less, and you can, uh, show that you material materially participate. The IRS doesn’t classify it as passive.

It becomes an active business, and that means the paper losses you generate can offset your ordinary income even from your day job. Now, normally you would need real estate professional status to get that benefit. This is one of those situations where you don’t, so let’s walk through how it works. And by the way, you know, I keep calling a loophole.

This is, this is black and white tax law. This is, you know, they call it the loophole. I don’t even know why people call it the loophole, but the reality is that it’s not it. You follow this law. It is black and white in the code, but here’s how it works. Okay? You buy a residential property. Usually, you know, uh, you get depreciation, right?

The IRS requires you to depreciate the structure on paper, the wall, the roof, the foundation, and typically that’s over 27 and a half years. So on a million dollar property, that’s about $36,000 a year. It’s, uh, you know, it’s, it’s, it’s real money. It’s a, but it’s a little bit of a slow drip and. You know, normally on investment property, you can’t use that as a W2 wage earner anyway.

Now let’s get back to that 27 and a half years in a million, uh, dollar thing. So there’s something called a cost segregation study that we’ve talked about again on this show that changes that. And so instead of treating the property as one block of concrete and wood, a cost segregation study basically carves out the parts that don’t last.

For 27 years. And namely, those are things like furniture, carpet, appliances, cabinets, even ceiling fans. Those are considered personal property and are depreciated typically over five years. In other words, you can depreciate them much faster. Now that’s where bonus depreciation comes in. The, you know, the Trump uh, uh, laws now are allowed that five year.

Uh, the stuff that’s depreciated over the five years to be taken all at once in the first year. So here’s the example. I think maybe that’ll help to put all this together. So you buy a million dollar short-term rental, and typically, of course, you’re gonna finance that. And let’s say it’s a 70% loan to value type situation.

So you’re putting down 30%, you’re putting down $300,000 cash, you borrow $700,000. Now a cost segregation study. My experience, having done it many, many times shows approximately 30% of the property, roughly $300,000 in this case as personal property. Okay? That’s not gonna be the same every time, but I, it seems to come out to about that amount frequently.

So thanks to bonus depreciation, that $300,000 that you put down is a down payment. You deduct that entire $300,000 immediately from your taxable income. Again, let’s repeat that a little bit so it’s very clear. You put down 30% to acquire this million dollar property. The cost segregation comes out in such a way that you basically get $300,000 of depreciation.

So effectively you’re writing it all off. I mean, it’s, it’s magical. Okay? $300,000 cash, you get $300,000 pay per loss in the same year. So in practical terms, again, you just deducted your entire down payment against your taxable income, and this is what real estate professionals do all the time and why you often hear that they end up having almost zero tax liability at all.

In this case though, with this so-called loophole. It works for you as a W2 wage earner. And for that reason, I think it’s one of the most powerful tools out there for high paid professionals. And I will say, I think it’s grossly underutilized. I think a lot of people don’t even know about it. Now, remember, the biggest expense for most people in the is the amount of tax they pay, you know, and that is definitely the case for apec, you know, for W2 wage earners, it may not be for for real estate professionals, but it is for W2 wage earners.

What this strategy is allowing you to do is to use money that you’d otherwise pay the IRS to build a cash flowing asset for yourself. Anyway, I wanted to drill down on that because I think it’s really a really powerful tool. I think people should consider it. Now, for today’s show, we’re gonna talk to a tax attorney who is going to give us a.

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Visit Wealth formula banking.com. Again, that’s wealth formula banking.com. Welcome back to Show Everyone Today. My guest on Wealth Formula podcast is Robert Wood. He’s a managing partner at Wood, LLP in San Francisco, one of the nation’s leading tax attorneys. He’s widely known for his expertise in legal settlements.

MA tax planning, capital gains Strategy and qualified Small business stock. He’s the author of the Standard Text on the Taxation of Damage Awards and Settlements, and his commentary is regularly featured in orbs and other national outlets. Robert, welcome to the program. Thank you. Nice to, nice to be here.

Well, let’s just start right off the bat. You know, this, uh, audience has an unusual number of high income W2 wage earners. That, uh, of course W2 earners feel like it’s an immovable wall. So let’s just start with some things here. What are some overlooked but fully legal strategies they can use today to meaningfully reduce, uh, tax burden?

I would say I’m, I’m more effective typically at, and I, and I think in general with Wade Earners, um. There’s not a lot, at least in my opinion, that you, you can do legitimately. I mean, obviously wages are taxed as wages withholding is, is taken out. Um, if you live in California as I do, um, the, the, uh, state, uh, income tax burden.

On top of the federal is, is high. So I would say it’s, it’s not the answer that your audience wants to hear, but I would say in general, um, W2 income is, you know, is hard to defer and, you know, you can, you can do things when you’re self-employed or when you have a company or when you have, uh, stock gains or investment gains, real estate, those kinds of things.

But I think wages, I think you’re pretty much stuck with, in my view. Yeah, I mean, one of the things that comes to mind for me, um, in this space and would love to get your thoughts on, is the, uh, short-term rentals. Um, people who are, um, you know, buying short-term rentals, as long as they’re, they’re W2 wage earners, they can often get the, uh, they can do the cost segregation analysis, take bonus depreciation, and as long as they’re, you know, actively participating in that short-term rental, they can.

Offset that, uh, potentially against, uh, that, that income, can’t they? I think finding a, uh, you know, rather than somebody like me, a tax lawyer, I think finding a good accountant who is, uh, savvy and well-versed in, you know, in those rules, uh, I think is important. I mean, I do see, or I have seen historically.

People who don’t do it right, you know, who claim whether it’s short term or you know, longer, more traditional, uh, rental real estate activities, you know, who end up in, in trouble, uh, or, you know, auditing, audited, and having, uh, deductions denied. But I mean, you’re right. That’s a fertile ground for I think for people to, you know, to have something.

Against which, um, you know, to offset some of their, their income. And it’s, you know, the idea of course with real estate is, which I, I know is something you’re, uh, experienced in, is, yeah, we, the value grows over time, depreciation, deductions, those kinds of things. It’s how Donald Trump became wealthy, I believe.

Sure, sure, sure. So, um, you know, the o the other OP option is to, you know, essentially. Structure income through businesses and you know, for someone who doesn’t own a business today, again, say it’s a doctor, you probably get a lot of tech executives who make a bunch of money. What are some of the ways that they could potentially legitimately structure, you know, structure businesses, um, structure things in their, you know, to create businesses that they don’t even know there’s an opportunity potentially.

Yeah, I mean, it’s sort of tough to talk in a generic way about those issues. I mean, and maybe it’s the, you know, the luxury of having, um, at least for, for me, um, a sort of a busy practice where people tend to bring me specific things, uh, specific. Well, maybe you could give us an example that you’ve seen. I mean that just as a, just as an idea.

Oh, sure. An example of things that I’ve seen people bringing something to me. Um, yeah. Yeah. Well, I mean, the most, and I guess you, you, uh, sort of said it in the introduction. The thing I see, you know, every day of the week, uh, really probably half of my work, I would suppose on a percentage basis, um, would be people who are settling some kind of a dispute.

Uh, they’re either paying money or receiving money, um, in the, you know, tax characterization questions is what, you know, what are they receiving. How can that money be optimized from a tax viewpoint? So, I mean, that’s not everyone, certainly who’s a listener, because hopefully you don’t have any disputes.

But, um, you know, in today’s world, people have employment disputes. They have accident disputes. They have disputes. I, I see a lot of founder disputes. Um, uh, you know, where people are exiting a company or in a dispute over, you know, who’s entitled to what share of the profits in a business. Those kinds of things.

And they’re invariably tax opportunities, uh, there and, you know, a lot of, a lot of pitfalls. Um, but I mean, as to things like I wanna start a business, I mean, there are always choice of entity questions. Uh, should it be a disregarded entity, A, a single member LLC, which typically is taxed directly to the owner.

An S corp, a C corp, uh, you know, you think about qualified small business, stock rules, all of those sorts of things are good to think about. Yeah. At the, you know, from the get go and, and later on as well. So let’s talk about that. ’cause I know that’s a big part of what you write about is qualified small business stock.

Um. A lot of people probably have not heard of this concept at all. Can you break down what it actually is and, and you know, who might qualify for this kind of thing outta business owners? Uh, sure. The rules are highly technical, so it’s a little difficult to summarize, but I guess the, the headline, which will be alluring to people, I think the headline is really for the past couple of decades, and I, I suppose you could say this is.

You know, in large part, uh, Silicon Valley has been the beneficiary, but, uh, Silicon Valley is sort of all over the country now, in a sense. Um, if you have a, a stock that’s qualified small business stock, which is a defined term, it’s gotta be a C corporation. So shares in an S corporation or an LLC don’t qualify.

Uh, and a C corporation is a regular old, um, you know, traditional. Corporation that, uh, you know, doesn’t file any tax elections and pays its tax and then distributes money to shareholders. Uh, but essentially if you sell your stock and you’ve met the various tests, including generally a five year holding period for the stock, you can exclude up to $10 million of your gain.

So that means, I mean, you, if you sell stock in Amazon and you’re lucky enough to have a $10 million gain. You can, you know, you pay tax, of course you pay tax at capital gain rates, but you still pay tax. Uh, in contrast, if it’s, uh, stock in a company that’s qualified as a small business, um, then up to $10 million is tax free, I guess notably, and it’s in the news in the last few months, notably that $10 million was just raised.

By the big tax bill, the so-called beautiful tax bill, um, to 15 million. Again, you gotta meet some tests and I mean, there are various articles online, including by me that sort of run through the tests, but getting a tax-free chunk of money, you know, is, is, is uh, you know, can be a, an enormous benefit, which is why people try to qualify.

So can, can we drill down on that a little bit? Uh, in terms of like, what, okay, so this is a small business and is it investments into a small business or could it also be your own small business that you are essentially converting into stock ownership? How, how does that work? There’s a list of things that no matter what you do, do not qualify.

Those are generally service businesses, um, such as, you know, being a doctor, a lawyer, a dentist, uh, an accountant. Things of that sort. Service businesses don’t qualify. Again, it’s gotta be Es uh, C Corp stock. It’s gotta be original issuance. So if you start a company, a buck and I buy shares from you, and then I, you know, build it up, let’s say, and it sell it for a lot of money, that doesn’t qualify because I bought the stock from you.

It has to be issued by the company. Um. So, but I mean, it, it could be a company, you could be a company founder and start, uh, and, and start the company and essentially build it up and be selling, uh, either entirely or in large part your own, you know, your own stock in your own company and that, you know, what’s small, I guess means different, uh, different things to different people.

Um, the traditionally for, again, for many years, decades. The rule was the company had to be worth $50 million or less. That doesn’t sound very small. Uh, but in today’s world, or even a couple of decades ago, uh, it was easy with, um, you know, with venture funding and that sort of thing, to have a company be worth a lot more than $50 million, uh, in assets.

Um, and, and that’s not when you later sell, that’s when the stock was issued. So now along with that. Increase from 10 to 15 million. Now that, uh, that 50 million number went up to 75. So, I mean, the main thing is if you’re starting a business or you are operating a business and you’re looking at selling, it’s good to talk to a tax person about, you know, in starting, what should you do?

What are your plans? What’s the sort of likely off ramp? Is it gonna be generational and build up in your family for decades? Or are you trying to build it up and take it public, sell it off to a bigger competitor? Those kinds of things are all relevant. I guess one question I would have on that is, um, if you, if somebody already has a business and it’s a, you know, qualifies otherwise, but they didn’t start it, uh, thinking that, uh, you know, they were gonna use a qualified small business stock and it’s come to the point where they’re thinking about selling.

Is it there, is there a way to convert it? Uh, to C corp and, and then utilize this kind of thing, or not so much? It, it depends. It depends on, you know, what you’ve got and, um, sort of how long the off-ramp might be. And also, um, you know, what you own. For example, uh, one that, that would work, this is maybe the easiest example would be if you have a single member LLC, which you know for, and these are very common in my experience, so it’s your entity.

Sometimes people are confused about how that’s taxed. Typically, it’s simply passes through and is taxed on your own individual tax return. But, but you, you know, you own all of it or you own your spouse. And then you say, well wait a minute. I wanna incorporate and I might be, you know, selling in five years, even though you own the business now and have already built it up, uh, you can form a corporation, essentially trade your LLC membership interest in for stock and still qualify for a qualified small business.

So, I mean, once again, if for someone who’s got on a business they’re starting, or a business that’s underway. They may want to sell. Um, it’s good to get some, some tax advice about what’s possible. Yeah. Let’s talk about capital gains, um, something you’ve written quite a bit about. So average investor selling stocks or real estate, what are the most effective ways to really minimize capital gains exposure?

I mean, without stepping into IRS Gray Zones, again, there is renewed talk of opportunity zones. Those were, those came back. It’s essentially, you know, taking your, um, it’s oversimplified, but essentially, you know, taking your proceeds and putting it into something that wa is a tax advantaged investment as a way of, of, uh, avoiding, uh, paying a capital gain tax.

You, you probably, or listeners may not like this, um, this approach, but I, as a tax lawyer in California, I’ve seen an awful lot of people who are most bothered by California taxes. And if they have a big gain, let’s say. Um, they are about to sell, um, you know, their cash of a large amount of, of crypto, uh, that’s highly appreciated, for example.

Or they’re about to settle a, you know, a, a career sort of lawsuit and get a bunch of proceeds, or they’re about, you know, they’ve been lucky enough and they have huge amounts of stock, which, which by the way could be. Fully taxable sales or could be qualified small business stock. So they might be escap escaping federal tax on the ladder, but not California.

California at one time had a qualified small business rule for, uh, capital gain on, on stocks, but, uh, that’s been, that was repealed, um, a long time ago. So I, I do see people fairly regularly who are. Before they trigger a big gain, want to look at moving out of California? Yeah. Or, or gift, uh, potentially gifting to, uh, uh, like a non guarantor trust.

Yep. Oh, you know, a non guarantor trust outside of, of California, like a Nevada trust or something like that. Right. Y yeah, that, I mean, courtesy of the, the governor, um, uh, and, and state legislature in California. Um, that is, it was about a year ago. I, as I remember, um, the sort of the non-California trusts, um, is sort of a no-fly area now.

That is it. It did work for years. Aggressive people would put something in a, um, uh, in a non-California trust of a, of a certain type. Basically that gain would not be subject to California tax. Um, but as I say, that’s, I think that loophole has been closed. And I would also say, I mean, I’m certainly not, uh, you know, saying that moving is an easy step for a, at least in my experience, for someone who is young, doesn’t have a lot of assets, you know, may not own a home in California.

Maybe, you know, more mobile than somebody like my age is, um, I mean, it can be a fairly easy thing to do. In contrast for somebody who has a lot of assets in California, has family. Um, it’s, it’s a, it’s a much bigger task and you know, you don’t wanna be unrealistic about it and then end up in trouble with the franchise tax board.

Sure, sure. Um, you did mention legal settlements and windfalls. Um, just, just kind of going in on that, let’s say somebody’s got a settlement and, you know, for half million dollars or something like that, what are the things they need to be thinking about in, in that situation? Everyone is, is different. I, I guess it’s, it’s a very repetitive area for me, and yet I’m always.

Are continually, um, surprised at the variations in, in legal disputes. And so it’s important to sort of first and foremost ask sort of what the, what the dispute is about. Um, but there’s a lot of press, uh, the last, I don’t know, five, five years, or actually seven years since 2018. About the tax treatment of legal fees.

So I think, and, and many, not all, but most probably people who are, uh, in some kind of a legal dispute and they’re the plaintiff, uh, trying to receive money from somebody else. Most people on that context are using a contingent fee lawyer. So probably the first tax consideration with legal settlement is, is the plaintiff gonna pay tax on the legal fees?

And that’s a, I guess for, even for sophisticated people, it’s a little hard, I think, to comprehend this rule. But there’s a US Supreme Court tax case that basically says, uh, if you use a contention, fee lawyer, doesn’t matter how you divvy up the payments or how the, uh, lawyer is paid, even if the lawyer is paid directly by the adverse party of the defense.

You as the plaintiff will be treated as receiving the money and then paying your lawyer. So just to use a, you know, simple example. If it’s a a million and a half dollar settlement, uh, $500,000 a third goes to the lawyer. So the client usually in that circumstance, ends up seeing the million dollars, you know, and it doesn’t see the other 500,000.

But for tax purposes, it’s, it’s pretty clear. Uh, the, the clients in that example will usually get a 10 99 for the million five. And so, you know, the question is, can the client always deduct the 500,000? Always would be overstated, but the answer is usually yes. There’s not a problem. There’s a bunch of kinds of cases, employment being the best example, where it’s unequivocal the client, you know, deducts it.

But I’d say, and if you, you know, if you gross those numbers up by a big amount, um. You know, and say it’s a $20 million case or something, uh, and the legal fees are correspondingly higher. I mean, that’s, I’d say always a big concern. Probably the first concern that people have. Yeah. Interesting. Um, just moving away a little bit with, uh, charitable planning, um, what structures, um, have you seen.

That you think are legitimate? Like, you know, you hear about donor advised funds, charitable lead trusts. Um, maybe tell us a little bit about those and you know, what your thoughts are. Yeah, I mean, and number one, the, the two that you just mentioned are perfectly legitimate. Um, I mean, I think, I think some people may have the impression, uh, that sort of a charitable donation doesn’t involve.

Uh, actually benefiting charity and that it’s, you know, some kind of a tax write off without a cost. That of course isn’t true. I mean, the things like the donor advised fund and charitable lead trusts and other things, creating your own private foundation, um, I mean, these are all, uh, involve tax write offs, uh, a tax deduction, but you’re still, you know, you’re still spending money, you’re giving money to, to somebody else.

So, um, but I mean all, all of these. Things. I think when you look at the amount of someone’s income, their age, their family, I mean, some people, um, you know, older or wealthier people, um, may, uh, you know, may want to be. Helping their kids with sort of a, kind of a full employment to be running a charitable organization.

Uh, and there are rules about related parties and, you know, what’s arms length, but there’s, you know, there’s nothing illegal about doing that. And it can be, you know, doing, uh, doing good works at the, at the same time. But I’d say, you know, with, in the tax world in general, if something is. Totally free and the government pays for it and it doesn’t cost you anything.

I’d, I’d, I’d be weary of those things. Uh, because, you know, sometimes people end up with, uh, with tax problems because they got lured into something by a, by a promoter. Yeah. What types of things are you seeing out there that are making you weary? I’m just curious. People probably. You know, clients probably run things by you all the time.

Yeah, I mean, uh, I, I, I don’t, I don’t see as many, um, I guess fortunately as I used to, but, but you’re right. I, I mean, I do see, uh, things that are being, um, you know, essentially products that are being promoted. I’m sure you, you’re aware, I mean, there, there have been various, I guess you could call them tax shelter eras where.

Um, essentially very sophisticated, sometimes intentionally, complex structures were put in place, frequently involving partnerships where you’d be investing in something and just to use a kind of crazy numbers, um, from that era. And you, you know, you put in a hundred dollars, but you’ve got, uh, you know, you’ve got a thousand dollars worth of tax deduction right away.

Mm-hmm. Like conservation easements, for example. Yeah. And actually, yeah, I mean, so it’s, it’s not that you, that everything you know of that sort you should run the other direction from, but you definitely, you know, before you sign on the dotted the line or write a check, you definitely should get some independent advice from somebody who’s not, you know, basically selling or marketing it.

Um, I probably nine out of 10 of those kinds of things that I look at, um, I I end up saying, look, I wouldn’t do it and here’s why. Uh, but that doesn’t mean everyone you know, is, uh, gonna be conservative or gonna, you know, is gonna follow that advice. You mentioned conservation easements, and that’s a, that’s a great topic.

Um, I mean, the IRS is, it’s not that you, you know, that this tax, um. Deduction is, you know, is illegal. The idea is that you, you know, the basic idea is that you have an investment as a, as an owner or part owner of, of, uh, of land. And you essentially are, you know, not building a building on it, but you’re agreeing.

You’re not gonna build a building on it, or it’s gonna stay open space or something. Um, I mean, there’s been a lot of tax law on those subjects for, for many decades. Uh, and I, you know, I’ve seen them and, and done them, um, successfully. However, there’s a big industry of syndicated ones that are, uh, highly aggressive.

The IRS has made it really clear they don’t like them, so I think, I think it’s more important these days for people to be sort of careful buyers if they’re gonna go down that road. Another area that, um, I’ve seen and makes a lot of sense in many ways, but has become very much scrutinized by the irs is the area where business owners, self insurers, the, the so-called captive insurance, uh, type, uh, situations.

Tell us a little bit about that. Where I haven’t heard, uh, and I think captives were also always on the IS dirty dozen list or whatever, but yeah. There, there’s legitimate tax law there, uh, um, that people are trying to take advantage of. What are the things that make a captive much more likely to be, um, legitimate than not legitimate?

Yeah, I’d say I’m, I, and I mean, I’m certainly familiar with, um, you know, the topic and you’re, you know, you’re quite right that the IRS has not liked, you know, uh, a captive insurance. Um. Structures or products for, you know, for years, um, decades even. Um, you mentioned the IRS Dirty Dozen list. I mean, that’s a good thing to mention in the sense that, you know, if you are in conservation easements is, is on it as well.

If you are doing something that’s on this dirty so-called dirty dozen list, I mean the, the name of that list should tell, um, your audience right away. It’s something the IRS. You know, has identified in kind of a systemic way as a problem. It doesn’t mean you can’t go down that road, but it should tell you that you, you know, you may be buying yourself a dispute and do you wanna do that or is there something else that you can do that might be on the dirty dozen list five years from now?

But it isn’t now. Um, but I mean, the, the captive insurance idea, just, um. In essence is you’re a business owner. You know, you’re paying, let’s say a hundred thousand dollars a year to, um, uh, you know, Lloyd’s of London or more Allstate or somebody for insurance of, of, of various types. And what if you took that a hundred thousand dollars and essentially self-insured and plug, you know, plowed that money every year into your own kind of insurance company?

Um. And then the idea is hopefully if you don’t have claims that money is building up on a tax deferred basis. ’cause you know you’re deducting the a hundred thousand dollars, you’d pay to a third party insurance company every year on your taxes and you can deduct the payment you’re essentially making to your own insurance company.

Again, I’m oversimplifying, but that’s the basic, basic idea. And the IRS was seeing, um, a lot of people who end up with quite a large stash of money and, you know, which is why they target it and try to make sure that people are complying with the rules. Got it. Um, you know, if, if you’re, I mean, just, I wanna make sure we have some just takeaways you’re.

When you’re talking to, um, say a, you know, high paid physician or lawyer and, you know, you talked about service industries, which makes it di difficult, and they are W2, and they come to you and say, well, okay, maybe I don’t have, maybe I don’t have a lot of things I can do now, but if you or me, what are some of the things that you would think about in the future in order for me to not only, you know.

To save taxes legitimately. What sort of framework would you give somebody to think about? Yeah, I mean, I think, uh, again, I um, I may not be the best person to, uh, given what I’ve, what I’ve said to uh, talk about things you can do as a wage earner. ’cause it’s really, um. You know, I, I obviously, you know, ev everyone knows, I suppose from, from, uh, you know, the news that you, um, some years ago, and there were all the stories about the, you know, CEOs who were taking $1 of pay, and of course that’s because they want equity instead.

That’s clearly a better deal. Um, so that the big pay packages that Elon Musk, uh, were, you know, on a much smaller scale, equity, getting equity is, is always better than regular pay, but most of us don’t have those, those choices. So, but I think you hit it. Uh, hit the nail on the head when you asked about real estate, you asked about, you know, other businesses, retirement funds.

Of course, if you’re a W2 earner. You have whatever it is that the company provides, typically, whether that’s 401k or or something else. Uh, but you, you know, you don’t have earnings from something else. It’s really, you know, is there a side business? Is there a real estate activity? Um, those kinds of things would be.

A way to build up wealth more than, uh, you know, wealth with lower taxes more than W2 earnings would be, you know, when we’re talking about retirement accounts, people, you, you read, uh, I read about, uh, people talking about backdoor rots or mega backdoor Roths. Can you explain what that is and, and how they work?

Uh, I, I, I’m not, I’m not, I’m not sure that I can, I mean, uh, there was a lot of press over, uh, I think it was Peter Thiel. Um, about, you know, having a, a Roth, uh, IRA that was worth, I don’t know, hundreds of millions, or may, maybe it was billions. I don’t remember. Um, I mean, most, a, a Roth, um, IRA is essentially where, you know, taxes has been paid.

So unlike, you know, when, when the money goes in. So unlike a regular IRA, uh, which is more like a traditional retirement account, or 401k money goes in. It’s a tax deduction or non-taxable when it goes in, but then when it comes out, it’s taxed. So I think, I mean, there are strategies, um, it’s sort of not my area of practice, but there are strategies about, um, you know, when to convert, uh, you know, how to optimize, uh, the size.

I, I think after the Peter Teal press, if I recall correctly, there was an effort made to limit the size of. Roth IRAs, I don’t think that passed. Um, mm-hmm. So, but I mean, it, it’s another area, um, where, you know, someone with investments could look at, um, you know, building up wealth, any tax laws that you think may change and fundamentally, you know, that people should have a radar out right now.

That, that could, um, that they should be thinking about and potentially planning for. I mean, I’m not an estate planner, um, uh, but there’s always discussion about, um, you know, about, uh, the estate tax laws and, and, and ways, again, for people of, of, uh, large wealth, um, how to, you know, pass assets to their kids without, you know, without a gift or estate tax.

Um, you know, the idea of in real estate is, uh, another prime example there, the idea of trying to, you know, pass things to, uh, the kids when the value is low and it’s expected to appreciate, I mean, I’ve seen this done with crypto too. The idea is, um, rather than using up, uh, a big chunk of your unified credit.

Against gift and estate taxes. Um, if you can use a small piece of it and have the asset grow in value. Um, I mean, I think, I think that’s the kind of thing that, that, um, you know, families think about. But, but as they say, what I tend to see, um, uh, which is why I am on some of these topics, uh, you know, I, I rarely see them, but what I tend to see is somewhat targeted tax questions like.

I have this building and here, you know, here are my choices about selling what, you know, what, what, what’s the best? Or, I’m starting this company, or I started this company five years ago. Here’s the size. Now what are my choices? Uh, if I, if I were to sell, uh, or. Again, the, the, the lawsuit, um, you know, over, over my interest in a company that I co-founded.

You know, how do I, how do I optimize that? How do I, how do I solve? Or what’s the least amount of tax I can legitimately pay on a sexual harassment or some other kind of, um, you know, employee discrimination case or a case with large punitive damages. Punitive damages, no matter what kind of case, are always taxable.

So I, I see a lot of those, which I know are somewhat unique. Um, yeah. But there are a lot of lawsuits out there, so I guess I see a lot. Yeah, sure, sure. Well, if someone has an issue like that, uh, how, how do they get ahold of you, Robert? Uh, yeah, I mean, my, my website is, uh, wood lp.com and my. Email address isWood@woodllp.com, and my phone number is on my website and it’s, uh, 4 1 5 8 3 4 0 1 1 3.

I’m old fashioned. I still answer my own phone, but, um, but yeah, I’m pretty easy to reach, um, for anybody who has questions or whom I might be able to help. Great. Thanks so much for being on the show today. Thank you. Nice, nice meeting you. You make a lot of money but are still worried about retirement.

Maybe you didn’t start earning until your thirties. Now you’re trying to catch up. Meanwhile, you’ve got a mortgage, a private school to pay for, and you feel like you’re getting further and further behind. A good news. If you need to catch up on retirement, check out a program put off by some of the oldest and most prestigious life insurance companies in the world.

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Check it out for yourself by going to wealth formula banking.com. Welcome back to the show. Hope you enjoyed it. Uh, of course some of this stuff was maybe not relevant to all of you, but I do wanna bring you back. If you get one thing from the show and one thing only, let’s talk about that, uh, short-term rental loophole.

Again, talk to your CPA about it. Look it up, you know, put it into chat, GPT or something like that. You know, get all the codes, bring it to your CPA. There’s no reason why they should say this won’t work. Now, there is certain qualifications. That you have, you have to make sure that you’re materially involved with that short term rental and such.

But listen, uh, there’s a lot of people doing it here, and, uh, there’s no reason you can’t. So anyway, that’s it for me. This week on Wealth Formula Podcast. This is Buck Joffrey signing off.