As a CPA, anything’s deductible, you just have to have good business purpose. You just need to go through life thinking about how [you can] make this a business deduction.”
Prosper Show is an independently run conference that occurs annually for FBA businesses to meet and confer with professionals in management and accounting. This year, Bob Kemble (CEO) and Jennifer Deroin (COO) from Amazon Accountants (not affiliated with Amazon) hosted a particularly interesting presentation regarding advanced tax strategies for high income earners.
This article takes a closer look at some of the topics they covered. A recording of their presentation can be found here. Before getting into the details of advanced tax strategies, they began with a number of disclaimers...
The first disclaimer was that all the scenarios they would discuss were to be based on 2018 tax rates. To speak of tax rates as they were in any year before would be a non-issue, as they do not accurately reflect the current position of FBA sellers.
The second disclaimer stated the relativity of the term ‘high income earner’. What is a high income for you may be a rounding error for another. As much as possible, Kemble and Deroin spoke in exact monetary values to avoid confusion in this area. However, just because the numbers do not reflect exactly what your business is making, this does not preclude you from the high income bracket. Circumstances vary between products, states, tax brackets etc.
The third and final disclaimer addressed the issue of professional help. While the strategies discussed could potentially work for your business, it is best to discuss it with an experienced accountant before making any decisions.
“As long as the purpose of the expense is to produce more income, it can be deductible.”
Throughout the hour long discussion, these Amazon Accountants took us through three stages of a business and discussed tax opportunities and decisions to consider at each milestone.
Establishing and Growing a Business: Initial Decisions
What we must understand when establishing and growing a fledgling business is the concept of goals. Initially, the two focuses of your new business will be to invest in new products and expand your marketing influence. A majority of your earnings from the business will most likely be reinvested for growth, so advanced tax strategies are not recommended at this stage. In order to employ advanced tax strategies, you must first have the cash to invest in said strategies.
That being said, there are important decisions to make from the outset that will put your business in the best possible position to thrive. The first of which is whether to register your business as an S corporation (S corp) or a C corporation (C corp) under tax law.
The Difference between S Corp and C Corp
“S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.”
The major difference between registering as an S corp or a C corp is that being an S corp can carry some tax advantages in certain scenarios. If you are an S corp, you save on self employment tax (in your personal tax return), and are only taxed based on the money that you take in wages, not what is also put back into the company.
However, there are a number of costs associated with being an S corp that must be considered. In order to register your organisation under this legal structure, you must have an active payroll. Because of this, there are more costs involved with admin, including additional legal fees for forming the company and costs associated with early preparation of tax returns.
Ultimately, whether or not you decide to register your business as a C corp or an S corp will depend on how much money you stand to save from being registered as an S corp, compared to the administration cost of doing so.
There is another important reason why you would want your business classed as a C corp, despite the tax disadvantages. This is an advanced strategy that looks towards the future of your business and the potential avenues it could take. This will be discussed in more detail in a moment…
Opening a 401(k) Account
“The beauty of using a 401(k) is that you can invest that into many many things. You could do the standard security route, you could do real estate, you could even do Bitcoin.”
Source (21:20 mins)
A 401(k) account is a retirement savings plan that helps employees to build an investment portfolio. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account. Using a 401(k) account is an excellent beginning strategy for a growing business. This type of account can save on tax by securing some of your income in there, so it will not be taxed. This can happen in two ways.
Firstly you can put away your money as a profit sharing saving. This has a limit of either 25% of your total wage OR $55,000, whichever is the lesser. Secondly, you can invest in what is called elective participation (also known as elective deferrals), where you can put away up to $18,500 of your total annual income. These dollars are not included in your regular income, thus saving you a fair amount of tax dollars.
This does not necessarily mean that you will always put the maximum amount of income possible into your 401(k) account. As mentioned earlier, a fledgling business mostly focuses on developing/stocking new products and expanding their marketing reach. In this case, most of the income is being put back into the business. Whilst a 401(k) account can be helpful for tax savings, any profits should be used in a way that makes sense with your business goals.
Taking Advantage of an Established Business: Personal Tax Strategies
The next stage that Deroin and Kemble take us through is when your business has moved beyond the initial establishment stages. As such, the goals are now different.
When businesses get to this point, it is common for them to begin focussing on things to do with inventory management such as forecasting and cashflow. The strategies discussed in the previous section are sufficient to get you through this period. However, there are also some personal tax strategies that can be taken advantage of at this juncture.
In particular, family can be a big advantage when it comes to saving on tax. If you are married and have a mortgage and children, then it is worth getting professional advice on how to maximize your deductions as these are all things associated with tax breaks.
In addition to this, you can use your business to maximise these advantages. For example, you can pay your children up to $12,000 a year in wages for helping out with the business. This can be anything from modelling in stock photos to assisting with admin and stock handling.
Deroin emphasizes that you can get very creative with what is considered ‘work’, but you must be careful to document each and every bit of labour you are paying them for - as you will need proof if you are ever audited. The biggest advantage of this is that you can funnel money directly through your family without it being included in your income tax calculations.
Kemble suggests that the most effective strategy for this money would be to have your child open a simple Roth IRA account. This account can store up to $55,000 in earned income and continue to grow tax free. However, it must be established at least 5 years before the child enters college.
A High Income, Thriving Business: What Now?
Deroin and Kemble move on here, and discuss a hypothetical business that has been running for over five years, has a handful of employees, providing $14 million in revenue and owns several warehouses. At this point, Derion and Kemble express that this is the time to take advantage of the more advanced tax strategies. There are a number of options available to you if you get to this stage of success, and the Amazon Accountants break them down into four strategies.
A Defined Benefit Plan
“If you’ve got defined benefit plan for yourself, personally, then you can really put away a lot of dollars.”
Source (39:26 mins)
A defined benefit plan is essentially a pension plan for the employees of a business. It allows you to contribute up to $220,000 a year that is tax deferred. This is a tax strategy recommended only to those businesses earning upward of $5 million in revenue because there is a significant cost involved in administering such plans, depending on the amount of employees you have.
Deroin supports this choice because of its flexibility. You can adjust how much you put into this plan year by year, as your business experiences rises and dips in the market. The main thing you would be balancing by choosing this plan would be the benefits you receive by partaking in the plan yourself, versus the cost of making in available to your employees.
“Anything that is an asset that has a fifteen year life or less, you can basically write off and take as a deduction in the year that you place that business into service.”
Source (38:40 mins)
This tax strategy is not particularly advanced nor exclusive to high income earners, but it is extremely relevant at this stage. Due to the fact that assets go down in value as they age, you can claim this in your tax return.
Large businesses make many investments into machinery, warehouses, carparks etc. If any of these assets have a 15 year life or less, you can depreciate them at a flat rate of 25%. This may save you a significant amount in tax dollars.
“1202 is just a beautiful thing if you are able to grow the business, hold it for five years, and then sell.”
Source (50:10 mins)
The best tax option to consider when selling your business is to take advantage of the 1202 capital gains exclusion. When structured correctly, this strategy allows you to sell your business with zero tax. This is obviously ideal, but there are some prerequisites:
Must be originally issued stock.
Must have held the business for five years or more.
Must be a C corporation.
Must not be a banking, real estate or financing company.
Without meeting these prerequisites, the tax on the sale of a business is 23.8%. Therefore, it is important to check with a professional before deciding that selling the business is the right thing to do.
“It’s an insurance company, at the end of the day. So you're setting up an insurance company to insure the risks in your business.”
Source (56:10 mins)
Captive insurance is one of the most complex tax strategies discussed, and Keroin & Kemble emphasized that this should never be attempted without first consulting a professional on the right way to implement it.
In a nutshell, it is an insurance company that is set up by the parent company to underwrite the insurance needs of the other subsidiaries that provides some tax benefits to the parent business. The main benefits of a captive insurance company are as follows:
Tax deduction for the parent company.
Opportunity to accumulate wealth in a tax favoured vehicle.
Asset protection from the claims of business and personal creditors.
Insuring risks that are otherwise uninsurable.
As you can imagine, creating another company has some major costs involved - so this is only recommended to those businesses that earn over $8 million in revenue.
Am I ready to Put These Strategies into Effect?
The short answer is no. Referring back to one of the three disclaimers at the start of Deroin and Kemble’s discussion, you should always consult a professional before attempting advanced tax strategies for your business.
Tax laws in the USA are in a constant state of flux. What is effective and legal today may not be so tomorrow or in a few months time. This is why it is imperative to keep up to date with changes in tax law.
The strategies outlined in this talk are some potential options for you to consider, not gospel. If you do not implement these strategies it doesn’t necessarily mean that you are not getting the most out of your business. You should be making tax decisions based on your company’s unique situation and doing what is best for you.
Disclaimer: this information is provided for educational purposes only, and should not be taken as tax advice. Every situation is different - therefore, we highly recommend seeking professional advice before implementing any of the strategies listed above.