In this episode of Tax Tuesday, Anderson advisors Barley Bowler, CPA, and Eliot Thomas, Esq., address listener questions on tax topics ranging from basic bookkeeping to advanced ESOP strategies. They cover essential bookkeeping practices for first-time rental property owners and the tax implications of transferring a fully depreciated truck from an S corporation to personal use. Barley and Eliot explain how to catch up on missed depreciation from prior years, the tax benefits of inheriting property versus receiving it as a gift, and how independent contractors should handle federal income and employment taxes. Other topics include choosing the best filing structure for single-member LLCs, tax reduction strategies for Schedule C solopreneurs earning over $100K, deferring traditional IRA distributions using Qualified Longevity Annuity Contracts (QLACs), and the little-known 1042 fund strategy for deferring taxes on ESOP distributions. Tune in for practical tax advice and strategies to keep more of what you earn!
Submit your tax question to taxtuesday@andersonadvisors.com
Highlights/Topics:
- “What’s the most efficient way to get my books ready for filing taxes? I’m filing taxes for my first-time rental business. I just acquired them this year. I’m a first-time landlord without bookkeeping experience.” A: Use bookkeeping software and categorize expenses properly throughout the year.
- “My S corporation owns a fully depreciated truck. Can I transfer the truck to my personal name and start taking mileage reimbursement instead? What are the tax implications?” A: Yes, but you’ll recognize income equal to fair market value.
- “For the eight years now, my prior taxpayer never took depreciation for any of my rental properties or my property assets for the building, along with the components like the water heater. What do I do now?” A: File Form 3115 for a change in accounting method.
- “I’m considering moving into my parents’ home while they’re still living there. I’m curious about the best way to either transfer the house into my name or should I stay there and wait until they pass because they intend to leave the house to me anyway.” A: Wait for inheritance to receive stepped-up basis and avoid gift taxes.
- “How do I pay federal income and employment taxes working as an independent contractor receiving a 1099?” A: Pay quarterly estimated taxes using Form 1040-ES throughout the year.
- “What tax filing structure do you recommend for a single-owner LLC wanting to not be a disregarded entity? Why? Pros and cons of the options.” A: Consider S corporation for self-employment tax savings if income supports it.
- “I’m a Schedule C solopreneur looking for ways to avoid being overtaxed. I made over $100K this year and I’m the only breadwinner in my family of four with two kids under 18. We’re in Florida. What do you recommend for ways to lower my taxable income?” A: Establish S corp, maximize retirement contributions, and utilize business deductions.
- “Is there any way to defer for tax reporting a distribution from my traditional IRA? I recently heard someone talking about this and was not sure if they were referring to a Qualified Longevity Annuity Contract (QLAC).” A: Yes, QLACs allow deferring up to $200K until age 85.
- “How does a 1042 fund work? I’ve never heard of that.” A: It defers ESOP distribution taxes by reinvesting in qualified replacement stock.
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Full Episode Transcript:
Barley: Hey guys. Welcome back to another episode of Tax Tuesdays. My name’s Barley Bowler, CPA here at Anderson Advisors. One of your hosts today, joined by Mr. Eliot Thomas.
Eliot: Hello.
Barley: Tell him what we’re doing today, Eliot.
Eliot: We’re doing fun. We’re going to go through questions that you’ve sent and—
Barley: We’re doing fun.
Eliot: Yeah, we’re doing a lot of—
Barley: I was like, did he even […] our taxes. I was like, am I in the wrong workshop here?
Eliot: No. Taxes are fun, enjoyable—
Barley: Saving money, sure is.
Eliot: Exactly. It’s a good time. We got to save some money. But yeah, these are your questions that you’ve sent in. I read them all and…
Barley: It sure does.
Eliot: …we picked out some and we’re going to try and explain some of the tax code to you today.
Barley: That’s right. Bringing tax knowledge to the masses. We definitely appreciate you guys being here. As Eliot said, these are your questions. We go over these every two weeks. Try to combine them together for some congruency.
You guys always have great questions. Got a few fun, obscure ones this week. Some different topics, so that’s fun. So definitely happy to be here with you guys. Every other Tuesday, Tax Tuesdays going over your questions live.
We get the usual. For anyone joining us for the first time, we have the Q&A feature. Please post any questions as we go, any questions that you have, on- or off-topic. Then we also have the, not the Q&A, what do we call it? The chat. Post in the chat if you got any questions for us, any questions about the services, about how this whole thing works.
If you’re here for the first time, shout us out in the chat. Tell us where you’re tuning in from. Give us a holler. We’re up here talking taxes, so we’re going to need some good questions from you guys to keep us going.
Eliot: Yup. We don’t have anybody coming in from where they’re at yet, but…
Barley: Yup. So you guys know the deal. Submit the questions to taxtuesday@andersonadvisors.com. Again, we go over these every two weeks. Eliot really does read through every single question. I watch him and we try to put them together in a format that works for you.
Just to let you know, if you are looking for a tax consultation, tax planning, we can set that up right away. If you are looking for more detailed responses, calculations, specific guidance, set up a tax call. We can get that set up right away if you need a detailed response. Again, fast, fun, educational. We’re giving back, help and educate all of the above. This is your every other week Tax Tuesday.
That said, we’re going to skim through the questions and then we’re going to hop right in.
What are we going to go over today? Opening questions. “What’s the most efficient way to get my books ready for filing taxes?” We talk about bookkeeping a lot, guys. This is the foundation of our business, the structural foundation, the skeleton of our business, if you will. “For filing taxes for my first time rental business,” we’re asking about bookkeeping, “I just acquired them this year. I’m a first time landlord without bookkeeping experience.” Great question.
Eliot: Next one. “My S-Corporation owns a fully depreciated truck. Can I transfer the truck to my personal name and start taking mileage reimbursement instead? What are the tax implications?” We see this quite a bit.
Barley: Yeah, we get a lot of questions on that.
Next, “For the eight years now, my prior tax preparer never took depreciation,” That’s actually common. We see that all the time, “for any of my rental properties or my property assets for the building along with the components.” He mentioned water heater there. “What do I do now?” We’ve got a solution for that.
Eliot: “I’m considering moving into my parents’ home while we’re still living there. I’m curious about the best way to either transfer the house into my name or should I stay there and wait until they pass because they intend to leave the house to me anyway.”
Barley: Good question. Inheritance, stepped-up basis will be a key there.
“How do I pay federal income and employment taxes working as an independent contractor?” So you get a 1099. “How do we handle the taxes?”
Eliot: “What tax filing structure do you recommend for a single owner LLC, wanting to not be a disregarded entity? Why? Pros and cons of the options.”
Barley: Great. We’re going to talk structural questions there. Excellent.
“I’m a Schedule C solopreneur,” Love that term; thanks for coining that, “and looking for ways to avoid being overtaxed.” Hey, you are in the right place. “I made over 100K this year and I’m the only breadwinner in my family of four. Two kids under 18. We’re in Florida. What do you recommend for ways to lower my taxable income?”
Eliot: “Is there any way to defer for tax reporting a distribution from my traditional IRA? I recently heard someone talking about this and was not sure if they were referring to a qualified longevity annuity contract, commonly know as a QLAC.”
Barley: We’ll have to see how that works. Finally, “How does a 1042 fund work?” I’ve never heard of that. We’ll have to see what that is all about. We got some great questions.
Eliot: That’s a mystery.
Barley: That’s right. Stay tuned. You don’t want to miss these answers. Again, thanks for joining us, every other Tuesday, going over your tax questions live.
Guys, make sure you turn into the YouTube channels here. Toby and Clint. We’re up to a thousand videos on Toby’s, almost there for Clint’s. Lots of content. As most of you guys are familiar, I really like using these guys as YouTube pages just to stay on top of industry, keep your finger on the pulse of what’s going on out there. Just a lot of great content, a lot of great guidance there. And we have an event coming up.
Eliot: Oh boy. Dallas.
Barley: Tell us about it.
Eliot: Dallas, 4th through the 6th. We’re going to have the live TAP event down there. Great barbecue down there. I think we have Mr. Stolkin from our team’s going to be down there.
Barley: Nice, great. I was just down in Dallas not too long ago. The whole town smells like brisket.
Eliot: Yeah, it does.
Barley: Really. Everyone won’t be shy to tell you about that at all.
Eliot: Not at all.
Barley: I saw big texts and everything, but yeah. So join us down in Dallas. That’ll be a great event, Tax and Asset Protection.
Then we got some virtual events, too. We got a little bit different here. November 1st virtual event. October 5th virtual event. The live event in Dallas, December 4th through sixth. So depends on whatever your needs are. I know many of you have been to these live events. It’s a lot of fun to meet you guys, to meet your fellow solopreneurs and other entrepreneurs out there doing it.
That synergy’s been really effective for a lot of you just buddying up, sharing stuff, what works, what doesn’t work. I’ve got a lot of great stories back from you guys. I love hearing that. How do you quantify that, right?
Eliot: You can’t.
Barley: That’s just your network. It’s just a great, great—
Eliot: Real benefit to all.
Barley: Great benefit, absolutely. And as we go guys—this is always onboard—scan this QR code, set up a call right away. We definitely recommend if you have a specific situation, want to do some number crunching or something like that, talk with one of us one-on-one, talk with a CPA or our tax planner one-on-one. It goes a long way.
I remember hearing Toby say way back in the day, you can expect a good 8:1, 10:1 return. Spend a couple of hundred dollars to talk to somebody for an hour, sometimes save you a few thousand dollars. We love that. Plus gives you some peace of mind. Just make sure you’re going into the year doing everything you can. So you can set that up right away if you want.
We’re going to hop into questions. Any notes or things we want to touch on before we hop in?
Eliot: No, I think they got the questions under control, so I think we’re good to go.
Barley: Excellent. So let’s dive right in, guys. I would love this first question. We’re going to just hit from multiple angles here. “What’s the most efficient way to get my books ready for filing taxes? It’s my first-time rental business, multiple properties. I just acquired them this year. I’m a first-time landlord without bookkeeping experience.”
Well, you know what I always tell people. The very first thing I like to recommend is you Google Form Schedule E. IRS Form Schedule E PDF. Start there. That’s a pre-made profit and loss statement from the IRS. This is a list of expenses they expect to see each year.
We don’t have to have some on every line, but they made the P&L for you, so that’s a great way to start your bookkeeping, at least conceptually. I guess if there was a more detailed answer, I’d encourage you to get some help starting bookkeeping. Maybe hire somebody to help you with the service for the first year. But if you’re going at your own, you’ve got some forms.
Eliot: Exactly, and when you have that particular form that Barley mentioned, again that’s Schedule E from the IRS. Just Google as a PDF. Some of the other ones out there might have some viruses or something like that, so I always take the IRS one, irs.gov.
However, once you have that and it shows all those categories, if nothing else, just make your own Excel spreadsheet. Pop in all your expenses into those various categories. Your tax preparer’s going to love that. If it happens to be you, everything’s organized, and it’s going to match up exactly to the form that the IRS expects (in fact demands) to see.
Take those categories, make an Excel spreadsheet, pop all the things in there. We do recommend hiring a bookkeeper—that would be the best—but if you don’t have that option right now, even for your bookkeeper’s sake, try and get it into those categories. Those are the expenses you’re in, the categories you’re expected to use, so it is fundamental. If we don’t do that, we’re going to see through almost every question that we have today that if you don’t have this thing going on, you’re going to be in trouble.
Barley: For taxes, for asset protection, for all kinds of stuff.
Eliot: Absolutely.
Barley: Right now, a bunch of directions we could go here, but I just want to throw in the banking portion. You mentioned you’re just getting started. A lot of times it’s overwhelming for people to hear, I need a bank account for my holding company and my management company and my rentals? Yes, we do recommend that because it’s going to help with this bookkeeping and help with the cashflow part a lot.
For example, if you have a bank account for each of your rentals, once you get those up and running, you print the bank statement at the end of each month. You’re halfway to your profit and loss. A lot of those expenses will be related to the rental, the income related to the rental. Then of course the bookkeeping part is just going to what we’re really looking for the final product.
For example, if you’re using QuickBooks to do your own bookkeeping, the end result is a profit and loss statement. What you earned and what you spent, your income and loss, profit and loss statement. Second, you need a balance sheet. That’s what you own and what you owe the balance, so the difference of that is your equity. An equity statement, balance sheet. Then if you’re using QuickBooks, just a general ledger. If you can give those three docs to any tax preparer, they’re going to give you the thumbs up and be like, you are on the ball.
Eliot: They’re going to hire you.
Barley: Right. Then now maybe you don’t calculate depreciation or whatever. You can leave the balance sheet portion. The most important part, that Schedule E, that profit and loss statement, that’s going to get you most of the way to your tax preparation.
What else to touch on there? I really like the idea of hiring someone the first year to help you set up the chart of accounts, that kind of stuff. Just depends on how detailed you want to get there. We really like to have these financial statements pretty airtight. What else there? First time landlord without booking experience. I think that’s about it. Set up a bank account for each rental and use that Schedule E Form PDF.
Eliot: Only thing I’d add, and we’ll probably address this again in some of the other questions later today, as far as the structure usually we put those in an LLC, a box around that rental, keep it safe. Often that’s being held by your holding company. That could be disregarded as well.
There is a benefit to having that Wyoming holding, having a tax as a partnership that we often talk about. You might get better lending choices out there. They’re allowed to lend more on the equity if you’re in a partnership than you are if it’s disregarded. That’s something thrown out there as well.
It doesn’t have so much to do with the bookkeeping, but the difference between setting up bookkeeping for a partnership versus maybe a solo LLC would be the only difference there.
Barley: Let’s keep it going. These are all going to bleed in a little bit to each other, going to get a lot of crossover here.
We’re going to get in the weeds for a second. We get a lot of questions about vehicles in an S-Corp, usually about the tax deduction. But what we’re looking at here is the end result. What if I want to take the vehicle out?
Okay. “My S-Corp owns a fully depreciated truck. Can I transfer the truck to my personal name and start taking mileage reimbursement? What are the tax implications?” So what are the tax implications of pulling personal property out of a corporation is the question.
Eliot: Before we get there, just the first part here. Can I transfer it out into my personal name? Absolutely yes, you can. Whether or not we want to and start taking a mileage reimbursement if you set up an accountable plan, we know that’s part of our mileage reimbursement. If you have an administrative office, certainly you can from there. But the big question here really is what are the tax implications of doing this? We got a lot to deal with.
This is the same concept when people have come to us and they’ve already put a rental property in there, any asset that’s gone up in value. Now, the truck was fully depreciated, but that’s just a tax gimmick where we take depreciation each year on the cost of it. It doesn’t mean the truck has zero value, it still has some value. So we’re going to pay tax when we take this out.
How do we calculate that? We have to treat it as if we sold that truck to an unrelated third-party. Let’s do some numbers here real quick just so we can see what it looks like.
Let’s just say that the fair market value of that truck is $30,000. We’ve already been told that: (1) we’re an S-Corp, (2) that it’s been fully depreciated, so we have no adjusted basis. What’s our adjusted basis? It’s the original purchase price, in this case, less the depreciation which was the full amount. Let’s just say that there isn’t anything left there.
Again, you wouldn’t know this if, going back to question one, you didn’t have good bookkeeping. That’s another example of why it’s so important you have good bookkeeping. But at this point, we now know that the fair market value is $30,000. We treat it as if we sold it to an individual third-party. Tat’s going to create a gain of $30,000.
This is a special gain. It is a capital gain. However, this property is special property, which we call section 1245. That means we’re going to have some depreciation recapture. That depreciation recapture is going to be at our ordinary tax bracket rates.
Barley: 1245. Just personal property not real estate.
Eliot: Exactly. So now we have $30,000 of ordinary income hitting our 1040. It’s going to come straight through the K-1 onto our 1040. It’s not being taxed on the S-Corporation. It flows through. It’s a pass-through entity. That’s our first battle right there, is just knowing that we’re going to have to pay tax on that.
Now, there are other things that we have to look at as far as the distribution of that truck from the S-Corporation. We had this fake sale and we had to see the cost of it come through to us. Now we have to actually take it out as a distribution to the shareholder.
When we sold the property and recognized gain, that’s going to increase our shareholder basis. Actually, it’s going to also increase (likewise) another account called the AAA (Accumulated Adjustments Account), which we won’t get too much. Both of those are going to go up by $30,000.
Just real quickly on the AAA, that’s something where if this had previously been a C-Corporation and we had some earnings and profit, that might be of concern to us. The reason why is that C-Corporation, every time you take a dollar out, it’s been taxed twice, the double taxation. Once at the corporate level, once is a dividend to the shareholders. Well we don’t have that as an S-Corp.
Many people could take a C-Corporation, make an S election thinking, hey I’ll get around the code that way. I don’t have to pay tax twice. I only have to pay it once.
Barley: They thought of that one.
Eliot: They did think of that one. They had this come up, that adjusted account, this AAA account, and they take the earnings and profits that were not taxed twice from the C-Corp when you moved it over. That’s what that’s all for. That’s a little bit more in-depth. We’re not going to get in that today because we have no sign that this was a C-Corporation. Suffice it to say we stole it for $30,000 gain, our shareholder base rises by that $30,000.
Barley: And that’s key because that determines, if we take some out, how much is taxable.
Eliot: Exactly. Let’s just say we didn’t have shareholder basis, it was zero, and we took that asset out. This is the second time it’s going to get taxed. $30,000. It’s a distribution. You’re going to pay tax on that as a shareholder. You’d pay effectively tax on $60,000 of income in this case.
However, we did sell it for $30,000. Our shareholder base did go up by $30,000. When we do the distribution of the asset, we have $30,000 of shareholder basis, so we reduce our shareholder basis to zero, but we have no tax being incurred there. We just have that first calculation of the $30,000 coming through our 1040, which is subject to depreciation recapture, in this case $30,000 of ordinary income.
Barley: We’re saying when the $30,000 increases your basis in the S-Corp, it’s like the S-Corp sold the vehicle and got $30,000. So your account went up $30,000. It’s not really being sold, but we have to treat it like a sale when we’re taking assets out of the corporation. Your basis goes up $30,000. Now you have basis to work with. If you didn’t, you’d be taxed taking it out. But if you do, it’s like a return of capital.
Eliot: It’s exactly what it is.
Barley: So it’s not taxable.
Eliot: So our shareholder basis after we take it out is going to drop by $30,000, but we don’t care. We didn’t have to pay tax. Now, we might care later on on some other items, but that’s not part of the question, and that’s tax planning. We’re not going to worry about that today.
Barley: And that’s a big issue right there. Your basis, your capital account within the S-Corporation, we use Form 7203 (I think it is) for tracking S-Corp basis for the individual shareholders, because this is the ultimate question. I want to take some cash out of my S-Corporation. Will there be additional tax?
You’ve already paid tax on the distribution on the K-1. But if you take more than your basis, that’ll be an additional, typically capital gain tax, unless to the sale of a property. But it’ll be an additional tax incurred as if you had appreciated stock and took it out of the property there. Great question.
Eliot: Now, just a couple of more thoughts on this. Now that the truck’s in the shareholder’s hand, what happens now? Well, your holding period begins the date of distribution. It starts all over. What’s the basis going to be? It’s going to be the fair market value. In this case. $30,000. Now, the individual has a new truck but they’re not going to probably depreciate because it’s in their personal name now. But we want to know those factors.
Barley: Actual versus mileage as we talk about this.
Eliot: Exactly, because now we get back to the first question, can we do the mileage? Sure. Seventy cents a mile in 2025. I haven’t heard what 2026 is going to be yet. I don’t know if they’ve announced it. But we run that truck for 10,000 miles, we get $7400 back from the S-Corporation tax-free to us, and it’s a deduction to our S-Corporation. It could be that this thing will pay for itself over time just on reimbursement.
Barley: That 70 cents is going to cover a good chunk of oil and gas, depreciation, mileage. That’s a great reimbursement since gas stabilized price-wise a little bit there. That can be a great reimbursement. Yes, you will have tax implications, but if it’s within your basis it should be awash all else being equal there.
Eliot: Except for that initial $30,000, which is ordinary income.
Barley: To the corporation. It’ll pass through to you. Exactly.
Eliot: You will pay tax on that. But we can make it up with our mileage reimbursement over time.
Barley: And Eliot mentioned this already, but you have to have an accountable plan for reimbursements. We recommend a C- or S-Corporation. When you incorporate, you’re considered an employee. You can take advantage of an accountable plan, be reimbursed for all these common expenses. Set up an accountable plan. You can reimburse for the mileage. Good to go.
Eliot: Just make sure we get that accountable plan set up for your S-Corp. Take some of your 280A meetings, and you’ll be flushed with cash.
Barley: That’s right. Let’s see. A lot of ways you can go from there and certainly have more resources if you need it. Let us know if any questions on that. What’s next?
Eliot: Here we missed out on some depreciation. “For eight years, my prior tax preparer never took depreciation for any rental property assets—building, water heater, et cetera. What do I do now? We run into this all time.” Again, not patting ourselves on the back by any means, but we have done a lot of two year reviews, and we see this all the time.
Barley: Reviewed a lot of Schedule E’s.
Eliot: Oh my gosh, yeah. And depreciation. The most common reason I hear is, I don’t know about you, well my prior preparer didn’t think it was wise to do so because they’d heard about depreciation recapture and I didn’t want any of that. Okay, I get that. I accept that as an answer. Or number two, I just forgot or my preparer forgot or what have you.
Barley: Almost a better answer.
Eliot: Yeah, we almost would take that one.
Barley: Almost rather have that.
Eliot: But what happens if you sell this property? You never took depreciation.
Barley: The IRS says it. You’re going to take depreciation whether it was allowed or allowable. In other words, meaning if you didn’t take it and if it was allowed, you did take it and you’re going to be treated as if you did. That can not be to your benefit.
Eliot: Exactly. All of these questions you’re going to realize they just keep building. If you had good bookkeeping and you’d done this, you would know your adjusted basis.
Okay, Eliot. We solve two questions of that. Why do we care? The reason we care is because adjusted pay basis minus that sales price is the gain that you’re going to pay tax on. Well if you didn’t take any depreciation, problem is that your basis is all messed up. So you don’t really know where you’re at. But the IRS is going to treat you as if you did take it even though you didn’t, so you’re going to miss out on that. It’s going to create a lot of havoc for you. You need to do something, so that’s why we care.
Barley: […] even overstating your income, paying too much tax.
Eliot: Exactly. Maybe you don’t care about that. Well, we do as tax advisors.
Barley: That’s my job.
Eliot: Exactly. And what can we do? We can do what’s called a Form 3115. Aactually, what’s going on here, by the time you get to the second year of having forgotten and taking your depreciation, that’s considered impermissible by the IRS.
It’s an impermissible accounting method, and we have a tool for that. It’s called the Form 3115, where we change from an impermissible accounting method to a new accounting method. I.e., we’re going to take the depreciation and we can just catch it all up. All that missed over the prior year, you can catch up in a single year.
Now alternatively, you could go back and amend, but again, if you have to go back too far, more in two years, you’re into an impermissible method, so you really have to use the 3150 and just do it all this year.
Barley: You don’t want to pay for an amendment. Just file that one form, get you caught up there. That’s a great, great option. Plus depreciation, it’s just one of those things. If you’re not calculating it, it’s typically something calculated by your tax preparer, your accountant, added to your balance sheet there. It’s just something we want to pay attention to for sure.
Almost like the answer better of, I just forgot, because then we can add, because the IRS requires that depreciation is taken if the asset life is longer than a year. A couple of other factors there. It’s not optional.
Eliot: Correct. We don’t know what the values of these buildings or assets were. This could be a significant dollar amount. I have seen definitely into the $100,000 that got missed over time, probably far more in excess of that, multiple times. So don’t feel bad.
I always tell clients when this happens, look. We are where we are today. Let’s not worry about yesterday, but let’s get that form filed. Because that can play tricks on what our tax planning is going forward as well. This is a really critical issue we have here, and it does happen quite a bit.
Barley: Yeah. Great question. Keeping it moving. We’re not running over anybody, are we?
Eliot: No. I think we’re good.
Barley: “I’m considering moving into my parents’ house while they’re still living there. I’m curious about the best way to either transfer the house into my name,” we’ll see if that’s a good option, “or if I should stay there, wait till they pass because they intend to leave the house to me, anyway.” We’re talking about inheritance, legacy planning, stepped up basis is going to be a key key term that comes in here.
First of all, if you move into your parents’ house, just stay there, and don’t transfer anything, that’s fine. Still in their name and their house. I think that’s okay. That doesn’t affect your inheritance necessarily.
Eliot: Correct. If they leave it to you upon passing, well you do get that stepped up basis, and that’s what we really want.
Let’s look at the alternative. What if we didn’t? What if they decide to just gift it over to the child? We run into that a lot. Even if this was a personal residence, but we’ve seen this with rental properties where I just want to help my child get used to the business of rental, so we want to give them a rental property that we’ve had. Bad idea, because you’re not going to get stepped-up basis.
We just talked, goes all the way back to our bookkeeping, keeping track of basis, and why it’s so critical. Because if we don’t know that, then we are going to run into a worse tax scenario. In this case, if we just gifted, they’re going to take over the basis at whatever the parents had, whatever it was.
They may have bought this house a long time ago, let’s say for $100,000. Maybe it’s worth $500,000 now. They just missed on $400,000 of stepped-up basis. Why do we care? What if the child inherits and wants to just sell it? I spent enough time in that house growing up and went back to it, lived with the parents. I’m tired of that house. I want something new. Well, upon passing they get stepped-up basis to $500,000 now in our example.
Barley: Sell it for $500,000 fair market value assumed.
Eliot: No tax whatsoever. Exactly right. They get that stepped-up basis.
Barley: But if they had gifted it to you, now you inherit their historical basis at $100,000, sell it for $500,000, now you have $400,000 capital.
Eliot: Exactly, and no 121, which we haven’t even touched that. We do a regular sale. Now (let’s say) they decide that they go ahead with a stepped-up basis, wait until the parents pass, child inherits.
Let’s say lives there for three more years or something like that. It’s gone up to a million dollars of value, but they got the stepped-up basis at least $500,000 upon passing, so that’s good. They sell later for $1 million. Well, it’s $500,000 a gain.
Even if the child is single, they’ll be able to wipe out a lease $250,000 because they have correct stepped-up basis. They’ll be able to take off $250,000 there if they’re married filling joint. They’d be able to wipe out the other $500,000.
Barley: We’re talking about that Section 121 exclusion.
Eliot: Exactly right. Stay there two years, own it, and use it as a primary residence for two of the last five years. If this inheritor, this child who inherits, again, meets those conditions and then sells later, but if they’d gifted it all the way back when it was $100,000, now you’ve got $100,000 basis and now it’s at $1 million, we pay tax. Even if they stayed there and they could do the 121, you’d still pay tax. Even a $500,000, you’d still pay tax on $400,000.
Barley: Well, let’s say they made it into a rental and didn’t get the stepped-up basis. Your depreciation expense is going to be this little tiny amount compared to the actual value of the home. Let’s say your depreciation expense on the $100,000 is whatever it is per month. Your monthly is going to be very low compared to a million dollar asset divided by 27½ for your annual depreciation there. Major difference. It could be the difference between reporting income or not. Or capital gain on the sale.
Eliot: Exactly. So documentation, always critical. We’re not really talking right now at this point about a rental. We don’t see any evidence of that in the question. However, if either the child who inherits or the parents had added on some additions or something like that, you’d want to have documentation of that because that’s going to adjust our basis. That’s going to increase our improvements. We’ll increase that basis.
Again, while we don’t do maybe formal bookkeeping here, this would be the parallel to that, in a sense you at least want to have good documentation, so we keep that adjusted basis accurate. It’s so critical.
Barley: Yeah. If you’re doing personal financial statements maybe, but yeah. Other than this, you just got to track your invoices. If you added a pool or a sunroom or a new roof or something like that, those will increase the adjusted basis, lowering the gain on the sale when you actually sell it. Very, very important that we track that stuff.
Eliot: And we run into this one, this type of scenario a lot too.
Barley: Yeah, on both ends. Parents saying, hey I want to help my kids out. I want to give them a house so they can manage it. Or the kids saying my parents have enough investments going on. I want to take control of this and manage it for the experience. You can make your kids a bonafide manager of the rental properties without putting any assets—
Eliot: […] the income you want.
Barley: Totally. You can just—
Eliot: Don’t take away their basis.
Barley: Exactly. You can give them that responsibility. They’ll get the financial literacy, the business operations experience, all that stuff. You can do it without actually transferring ownership. I know it feels good to own stuff in your name, but tell them about the stepped-up basis and they’ll understand.
Eliot: Well, and the anonymity. It’s good not to own things in your name.
Barley: It’s good not to also. Great, any questions on that so far?
Eliot: No, I think I’m good.
Barley: Taking care in the background there.
Eliot: Moving along.
Barley: Just as a reminder, hop onto the YouTube links, guys. I don’t know, when was this? Is this current? Semi current? Because you got a thousand videos on here. Be your own bank. Endless passive income. If you got a big chunk of passive losses from a cost seg study, you can start generating passive income. Oh, I like that one. The greatest wealth boom is coming. We’ll see. And Clint, of course, for asset protection. Tons of great information on there.
Eliot: Love that picture, Clint.
Barley: That’s our guy right there. And of course, scan that QR code. You can set up a strategy session right now, and plenty of ways to get in touch with us guys. The platinum portal for submitting written questions. You can come into the Platinum knowledge room five days a week, five hours a day.
We’re closed for the day now, but 9:00 AM to 2:00 PM Pacific, five days a week, five hours a day, staffed by CPA, attorneys, all day long. Let your friends know that you have a CPA and an attorney on call every day. Brag about that, and then use that service. And then come see us in Dallas.
Eliot: Exactly. Great networking. Just a lot of fun. We love it. We get to meet the clients, client’s going to meet us, meet each other and things like that.
Barley: Yup. Great to see a lot of you guys. What was that, just last month?
Eliot: Yeah. It seems like it was…
Barley: It seems like so long ago. It was September 11th, 12th, or so right there. It was great to see you guys here. We had a great session down at the Durango there.
All right, back to tax. Let’s hop right back in. Oh, this is a great one. “How do I pay federal income employment taxes working as an independent contractor?” Again, we’re going to try and come up with some patterns here. We’re going to talk about incorp, where the benefits of incorporating your operations as a sole proprietor. But let’s start from the beginning here.
Eliot: The next couple of questions are going to keep building and building and building around the central theme here.
Barley: It sounds so exciting.
Eliot: Exactly.
Barley: Just wait for the climactic ending.
Eliot: But just from a basic standpoint, how do I pay the federal and employment taxes working as an IC (independent contractor)? Well typically, that means you’re probably a solepreneur with a Schedule C. That means it’s all on your 1040 a special form.
Just like we talked about with the rental property and that Schedule E, I would suggest, again, Google up IRS Schedule C PDF. It’s going to give you the Schedule C. Why do we care? Because when we look at it, we’ll see that the bottom half are all these categories of expenses. Getting back to the essential element of, you got to have good bookkeeping, okay?
So now you’ll know how to categorize the expenses. You’ll see what the IRS is expecting to see, what your tax preparer would love to see. Get all that now. Why do we care? Because all this tax that we’re talking about in this question only comes from the net income. It’s not from your gross income. So you get to subtract all those deductions and things like that.
We have income minus all those expenses and deductions. That’s our net. Now it’s time to pay tax. The federal income tax will simply be whatever your tax bracket is. We’d have to wait to see that.
The employment taxes, that’s an interesting one. If that’s the term you want to use, typically it’s 15.3% for that. On an independent contractor, you’re your own employee, if you will. So you’re paying all that 15.3%. 12.4% of that is social security, just taxes like that.
That’s why the IRS cares so much about these types of things—Congress does—because it goes into retirement, social security fund. That’s a real important part there. Then 2.9% Medicare tax.
If you’re over $200,000 of that net earnings single, or $250,000 married filing joint, you’re going to get that 0.9% additional Medicare tax. That’s another little add-on there. But really the 15.3% is what we commonly focus on.
Now, when you’re a sole proprietorship, Schedule C, there will be a factor. You only have to pay tax on 92.35% of that. That’s 100% minus one-half of your employment tax. The IRS—
Barley: […] adjustment.
Eliot: Exactly. The IRS says well look. We got to make it fair because an employee would only have to pay half, so they take a little bit away from the amount that’s going to be subject to it. So you take that net income, multiply it times 92.35%, that’s the amount that will be taxed with that extra 15.3% of the rest. That same dollar amount will be taxed at the regular full bracket amount, depending on where your bracket falls.
Barley: Now, just FYI, one scenario, what if you did nothing? You could just report this 1099 as other income. 100% of it’s like your W-2 check, subject to ordinary tax plus employment taxes. But for some of you that maybe you sit on the board at a hospital or something, you get some board fees, it’s like, oh, you maybe drove 12 miles to the hospital. Are you’re going to put that on Schedule C? Maybe you just put that as other income and just pay the tax on it.
It’s going to be up to you. For somebody lazy like me that, if there wasn’t expenses associated with it, I’m going to ignore that Schedule C audit risk and just report it as other income.
But you mentioned you’re an independent contractor. I’m thinking more you’re doing construction, maybe broker-dealer earnings and commissions. You’re probably earning maybe over $30,000, $40,000, $50,000. That’s when we really want to take a look at these taxes.
But a lot of you, like I said, sit on a board or something like that. Collect a little bit of 1099 income. You’re not too worried about it. This is more when we’re earning some good income as a sole proprietor, as a solopreneur. We consider the employment taxes on that net income to be excessive because we don’t have the opportunity to pay a W-2 and have the rest of it be a distribution.
Eliot: Just along the lines of how do you pay, you’d want to pay quarterly, make quarterly estimated payments. April 15th is not just a due date for our taxes. It’s also a due date for the first quarter of the current year.
Last April 15th, while a lot of people were trying to file their taxes, they also needed to pay estimated taxes for the first quarter of 2025. That’s one of the things you’d want to look at, maybe making estimated quarterly payments. The second quarter is June 16th, 2025 this year. Third was September 15th. And lastly the fourth quarter will be January 15th, 2026. So make those estimated payments so you don’t get hit with any penalties and late fees, or at least minimize the amount.
Barley: And remember, those will be likely as an individual making those payments. If you’re a working W-2, you got to factor that in. If this is your only income, a little easier to guesstimate, but you got to factor those other things to determine. If you’re going to anticipate owing $1000 or something like that at the end of the year, you’re required to make estimated tax payments.
All right. Keep moving?
Yeah, I think we’re good on that.
Barley: All right. “What tax filing structure do you recommend for a single owner LLC wanting to not be a disregarded entity? Why? Pros and cons of either option.”
Just building on what we went through before, typically we’d recommend maybe a disregarded entity there, solopreneur, sole proprietorship, depending on the level of income. But now, I’m getting my business built up a little bit. I don’t want to be a disregarded entity. What should I be and what are the pros or cons?
Eliot: Well we have a lot of options here. Well first of all, it does depend on the business. If it was a rental property, we would never put that in any corporate structure. No S- or C-Corp. But we’re going to assume it’s a business here, a single owner. You could be an S-Corporation or a C-Corporation.
What if we went with the S-Corporation? Well, as we just talked about, we didn’t really do much tax strategizing in the previous question. But let’s assume that you have $100,000 of income coming in. Well now if we’re an S-Corporation, two streams of income. Not just one, not just a net income.
With an S-Corporation, you got to pay yourself W-2 wage. That’s going to be subject to every tax that the world can throw at you. It’s going to have employment tax, half paid by you as the individual employee, and half paid by your S-Corporation, which is the employer. Then of course the income tax, we’re going to have that.
But what about that distribution that Barley has here, that K-1? That’s not subject to that employment tax. A lot of you are already thinking way ahead of us. It’s like, well I get this one. I’m not even going to pay myself any W-2, so I don’t have any of that 15.3%. What do I need Tax Tuesday for? I know how to do that one.
Okay, fine. We put all that under distribution. The problem is that the IRS and Congress has said, no, no, no, no. You must pay a reasonable wage if you have an S-Corporation, that we do get some of that Social Security, because it’s all about the bigger purposes. They know they got to fund social security.
Barley: Keep the world turning.
Eliot: Exactly. What is that amount reasonable? Well, it’s the same test over and over. What’s a reasonable person make in the area you do with your experience, et cetera? There are all kinds of things like that. But they don’t really tell us. We just take that from court cases and things like that. Publications from the IRS, but it’s not actually in the code.
Nonetheless, in this case, let’s say it’s $50,000 of W-2 that we paid. Now again, employer, the S-Corp’s going to pay one half of that 15.3%. You as the employee will pay the other half, but it’s still your money. Effectively, you’re still paying the 15.3. And then you’re going to have ordinary income on the tax bracket for that rest of that income, the W-2 income.
On the other hand, as Barley put up here, $50,000 of distribution, K-1 is not subject as that 15.3%. So we get a break there, because on the previous question it was. We just saved 15.3% simply by making that nonelection. Just a structure, that’s it. Arguably, better asset protection being an S-Corporation potentially in your state. That’s one thing that we would recommend.
Now also, let’s start talking deductions. We talk a lot about things that we can do in a corporation, maybe getting some of that money back. Any ideas?
Barley: Well, we talk about an accountable plan for reimbursements. I think you guys have heard that term.
Eliot: Tell about Augusta rule?
Barley: And why we recommend that in corporate? Because when we talk about corporations, S- and C-Corporations, you’re considered the owner. You’re also considered by default to be the employer or employee. You wear both of those hats. Keep that in mind. That creates a lot of benefits. But as an employee, now you can be reimbursed through an accountable plan for reimbursements.
You can have employees in a partnership or a sole proprietorship, but you’re just considered the owner. You’re not an employee of those businesses. Again, you can have an employee in a partnership, have employees doing your work for you, but you’re not considered an employee. You’re only considered an owner.
S- or C-Corporation, when we incorporate, as long as you’re the majority shareholder, over 5%, you’re considered not just the owner, but the employer and employee. As the employee, you get all these benefits being reimbursed just like an employee normally would, except we got a little more control because we’re also the employer. A lot of benefits here.
Eliot: We can do corporate meetings. We talk a lot. We’re going to see that. Of course, we’re just building off each previous question here. We’re going to go more in-depth on that. But you can do your 280A. You can do your accountable plan reimbursements. You got a home office. Mileage reimbursement for that truck we just took out. All kinds of good stuff. If it’s a C-Corporation, medical’s important. We can do medical reimbursement. We’re going to tie all that back together on the last one.
Barley: Meals, miles, travel, cell phone, internet. With an accountable plan, you can take a copy of your cell phone and internet bill for every month, turn that in, get 100% reimbursement, and a tax deduction for your business. That’s a pretty good bill for me. It’s probably a good $4000 or $5000 just right there. Embarrassing to say.
Eliot: The next question. We’re going to pull it all even more in together here. We can really start throwing out all the deductions. But you’ll see that each of these questions are building up to what we have going on here. We were Schedule C. What do we got going here?
Barley: Let’s see. Pros and cons options, real quick. The only thing I want to touch on there, S versus C. S is a pass-through entity, a C-Corp’s not. C-Corp can reimburse for medical. That’s going to be the two primary. I know we already touched on that, but just to keep that in mind. I know that’s confusing. A C-Corporation, the income doesn’t pass through to you via form K-1. It’s just a different thing.
Eliot: Pretty much a W-2.
Barley: Right, W-2 or first year reimbursements, a W-2 or dividend.
Eliot: And it’s really not a pro or con. No matter what, you’re in a better world than you were.
Barley: Absolutely. Just by […].
Eliot: We would usually go down to, well, do you have any medical reimbursement that you need? That’d be your C-Corp choice. Then If not, if that’s not a big player for you, then we’d go with the S.
Barley: Should we throw education in there?
Eliot: Can.
Barley: Right, because C-Corp is going to take first year education for new line of business. That’s unique to that as well. Just throwing it out there. A couple of points while—
Eliot: I can’t even think of learning how to flip properties or something like that. You’re getting into a new line of business? Typically you can’t deduct that education anywhere on a return. It hits our return. That means no Schedule C, means no S-Corporation.
But what we can do is deduct it on a C-Corp. Why? because it just has different rules. It says a C-Corporation can deduct the cost of training its employees. We would take it if we have that thing going on as well. Medical and I would say education, probably the big reasons we would do it as C-Corp.
Barley: The IRS just sees that if we’re incorporating, they just assume we’re paying more attention to the details. We have compliance issues, tax filing issues, such like that. That’s just why they view it that way (I think) as part of it. But yeah, certainly big benefits there. God, what do I want to say about that? The corporations. There are a lot of benefits to incorporating versus being a sole proprietor.
Carrying on right onto the next subject here. “I’m a Schedule C solopreneur looking for ways to avoid being overtaxed. I made over $100,000 this year.” So we’re up in that range where we don’t want to be paying self-employment tax plus ordinary tax on all of that income, which would be the case as a Schedule C solopreneur. “I’m the only breadwinner in a family of four. I have two kids under 18 in school. We are in Florida. What do you recommend for ways to lower my taxable income?”
Well, as we’ve been talking about, one of the best ways is going to be to incorporate yourself and your business for a lot of tax benefits. Over $100,000, we talked about the self-employment taxes. Just to reiterate, on Schedule C, your net income is your paycheck. Your net income is your W-2 paycheck. 100% of that is subject to ordinary tax plus self-employment tax.
When we incorporate, we get to pay a smaller part of that, that’s subject to the excess tax, but the rest of the distribution is subject to ordinary tax only. Right there, we talked about that portion already. That definitely helps us.
But then, just so we can building on here, then we add the accountable plan, all these benefits of reimbursements. So we’re looking at pretty good tax savings just from the self-employment taxes alone. But then, you know the laundry list—cell phone, internet, meals, miles, travel, home office, 280A meetings, medical reimbursements. We attack that on there. Now we’re compounding savings.
Eliot: Exactly. Barley’s right. Effectively a sole proprietorship to schedule C. That is your paycheck right there, your W-2. Don’t get confused. That doesn’t mean you actually have payroll. You’re not going to have to go out and do payroll or anything like that.
Barley: You’re not an employee.
Eliot: Yeah, but that is your net.
Barley: It’s all subject to that employment tax.
Eliot: Exactly. But sometimes we get asked that. Well you mean wait, I got to cut myself payroll? No, no. Don’t worry about that. But you do have to pay the taxes, and that’s the key. Approximately 15.3% on $100,000, that’s almost…
Barley: $15,300.
Eliot: Exactly. That’s a lot of extra tax. If we just walked through an example as an S-Corp where we cut that in half just by doing nothing. Then what happens when you add on the 280A, the Augusta rule meetings, reimbursements for administrative office and mileage because we got our truck out now, all that good stuff, there’s a lot. We would be able to chop that $100,000. All that money goes back in your pocket tax-free, reducing the taxable $100,000 down to maybe by $30,000. So you’re paying tax and a lot less income.
But we got another thing going on here. We have two kids under 18. Now we got some more opportunity here. We can go ahead and set up another LLC in Florida and have the kids actually be employees, W-2 wage employees of that LLC. As long as it’s owned by mom and dad or mom and dad if it’s a partnership, or mom or dad if it’s just a disregard, nonetheless they’re employees there.
You can pay them up to $15,750 standard deduction for 2025, and you’ll pay no federal income tax, you’re not going to pay any of those employment taxes, that 15.3%. You shifted all that income. It would not be unrealistic with two kids, that’s over $30,000 of all those reimbursements we’ve been going on to wipe out $60,000 is the income without doing anything.
Barley: That sounds great. Assuming your high tax bracket, maybe 37%, maybe more, higher percent down to your kids, effectively zero.
Eliot: If we could draw this up real quick, just so they understand what we’re saying here. Let’s make the S box, the S-Corp, put it right here. Then another one to the right. That’s another one where we pay the kids. That’s a disregarded or partnership owned by the parents. We got the two little ones in there.
Your S-Corps going to pay, have a contract for employment, to use the labor out of that LLC. $15,750 times two. What is that? $31,500 I think from that ballpark, but $30,000-plus. That’s all going out. That’s a deduction to our S-Corporation because it’s going to pay for some outside help.
The LLC there, it’s going to show that income coming in, but it’s going to pay it all back out. It’s wages to the children. And they don’t pay any tax on that.
Barley: Wipe the LLC in now.
Eliot: Yes sir, exactly. We’ll have no income on that LLC, money in money out. Zeroes it out. No tax there. It all shifted. That’s an earned income to them. They can put that into a Roth. They can do whatever they want with it. They could start their own business, you name it. All kinds of things.
We don’t have to do that, but just on top of all the other things that the S-Corporation can do that Barley’s gone over, the accountable plan, things like that. Just to give you a visual what’s going on, how we shift that over.
Now we may not want to do this in every state, but we were really fortunate that this individual asking us said, hey, I’m in Florida. Well, there are not really a whole lot of consequences setting up that extra LLC.
But we run into this in California. If you do it there, there’s no hiding that. California Franchise Tax Board, $800 fees. All of a sudden that’s really going to start eating into our savings. It may not be worth it there because we’re going to have to report. There’s no hiding that. It’s got employees in California, which can be an issue as well. Just getting your own children set up as employees. A lot of red tape in California.
Maybe it doesn’t work there. But in a state like Florida, there’s just really very little into what can be done here to wipe out some of this income. But certainly incorporate, what if we have a lot of medical? Kids are growing, they got braces, et cetera. It’s really to the tune beyond what an HSA could be. Well then maybe you want to C-Corporation, get that medical reimbursement in time. You could go ahead and make an S election once the kids are older or something like that. You don’t have the medical.
Barley: We’ve given them options or what?
Eliot: Barley brought up a really good point. What about a retirement plan? Well, if we’re going to have a retirement plan, we got to remember that we can’t have the kids as W-2 employees in any business that we control. There, we wouldn’t wouldn’t have them as employees if we did have a retirement plan. So just be aware of that one. I think we talked about that one earlier today, did we not?
Barley: Yeah, and I just want to touch on this. That shifting paying your kids, that gets it out of your high tax bracket down to their lower tax bracket, that’s a huge benefit. Plus then we add on the accountable plan for reimbursements. A bunch of benefits there.
You guys hear me say this, but what I want to just stress here is we’re maybe saving $20,000–$30,000 plus shifting income to the kids. This isn’t a one-time event. We’re trying to set this up in perpetuity. Or maybe not for the kids. Once they age out. But as far as these, all these reimbursements, all these benefits, medical reimbursement, we’re going to do this every single year.
We have non-reportable income that we don’t have to pay tax on. $20,000–$30,000 is not a small amount. To some of you making millions of dollars in investments that might not be, but over a course of 10–20 years, that’s just paying your base level living expenses.
If you’re like Eliot and I, you’ll go out and blow that on a weekend. But if you’re smart like you guys, you’ll go and reinvest that, or pay it down to your kids and put it in a Roth IRA. So much good valuable learning lessons there for the kids too. A lot of ways we can go with just by incorporating, especially in a tax-friendly state like that.
Eliot: We got the solopreneur, we got perpetuity, we got big words, big tax savings, all kinds of good stuff.
Barley: Big tax savings.
Eliot: Again, you see all these questions. They all came back from bookkeeping. It all started with bookkeeping. All of them have built up to this point where we’re at now. The next two, I don’t think really have anything to do with bookkeeping.
Barley: Well we’re changing gears. The QLAC. Like Eliot said, we got a couple of off-topic. Honestly guys, we love these questions because we want to talk about the heavy hitter real estate tax deductions all the time. But we also want to expose you guys to… you guys submitted these questions, so you’re obviously aware of them, but this isn’t something everybody’s heard of.
Again, just the theme here. If this applies to you, if this is something you want more guidance on, certainly let us know. We’re going to just expose you to these types of topics. We can always provide more detail on this.
What are we talking about here? “Is there any way to defer for tax reporting?” Deferral of income, deferral of expenses, just means pushing it out to a later date. “I want to defer for tax reporting a distribution from my traditional IRA. Recently heard somebody talking about this and was not sure if they were referring to a qualified longevity annuity contract.” A QLAC.
Eliot: We had to look this one up a little bit. I think I’d heard it in the past, but wasn’t really sure how it works. So we looked into it a little bit to get a little more information on it.
Now we’re going with the assumption that maybe the reason we have this distribution is your required minimum distribution, which as many of you may know, once you hit about 73, you’re going to be required to start taking distributions from a traditional IRA. We don’t have a choice. It’s going to hit our return.
So we went through, found a couple of ways that maybe we could, some better than others, that we might be able to get around some of that. Certainly one of them being the QLAC that we’ll go in more depth here, but hidden some of the other ones.
If you’re still working at 73, we can’t defer it. That required minimum distribution is still going to hit us with our traditional IRA even if we’re still working. However, what you could do is if you rolled it all over into a Roth IRA, well there you don’t have the requirement of the RMD. So that might be a plan, but you’re going to pay the tax.
It’s a taxable event. We didn’t really like that. We weren’t crazy about it. Toby often talks about that. How long is it going to take you to catch that basis to invest back up? You probably are far worse off by doing that. Don’t want to make anybody feel bad if they went with that and just did it last week. But it’s just a thought.
Barley: Our job is just to throw it out there. What we’re saying is that if you have a traditional IRA, you can roll that over to a Roth. But the amount that you’ve got the benefit from, you’ll end up paying tax on that.
Eliot: Ordinary taxable income. It’s going to be at your ordinary brackets. Not a great choice. Number two, if you happen to still be working and you’re working for…
Barley: So you have earned income.
Eliot: …exactly, working for (let’s say) Big Co., and they have a 401(k). Depending on what their plan allows, you might be able to roll your IRA into that. Then if it’s a 401(k), well then you don’t have to take required minimum distributions. You can push it off for a little bit. But their plan has to allow for it. We can’t just necessarily do this.
Barley: The plan language, yeah.
Eliot: And we try to get sneaky sneak here. Well what about our clients with their C-Corporation? Their their Solo 401(k)? It’s a 401(k). Why not? No. You can’t own over 5% of the business, and no we can’t put together all these different boxes and entities to try and get around that. These are all related parties. So that’s not going to work for our clients with their C- or S-Corporations or anything like that.
Barley: As far as rolling the plan into your own.
Eliot: Exactly. It’s got to be a completely unrelated employer that you’re working for. You got your own IRA and you work for some unrelated company like Amazon and they have a 401(k) plan. If it happens to allow you to roll over, you can roll over into that. But that’d be about it. Unless you want over 5% of Amazon, which in case you probably aren’t really worried.
Third, qualified charitable distribution. Last time I remember talking about this was actually with Toby, and I could not get it right. I kept saying qualified distribution to charity. Messing the C the D up.
Barley: Two CD for the RMDs?
Eliot: Exactly. Now this is a little bit different if you’re over 70½. You do have RMDs, some we just talked it could be at 73 but maybe some are taking it earlier. But nonetheless, you can go ahead and tell your administrator—
Barley: Donate it.
Eliot: Exactly. Donate up to $108,000 into your nonprofit. So it just goes there. Now, it’s not a deduction. You’re just moving the income off—
Barley: […] your return.
Eliot: Exactly. Where’s the tax savings? Well, as you said, it doesn’t hit the returns, so there’s no tax. But you don’t really get a deduction for making a charitable contribution or anything like that. It just doesn’t hit your return.
Barley: But it’s better than if you took it, paid tax on it, and then donated to the charity.
Eliot: Yeah, the charity—
Barley: Would get less.
Eliot: Exactly. We did an example that last week in Tax Wise.
Barley: Right, donated appreciated assets. That was great.
Eliot: We have an example […] put together. We use that. Really great, great example of that.
Barley: So after 73, required minimum distributions kick in. If you’re already doing charitable, you can donate effectively more to the charity not having it hit your personal tax return.
Eliot: All right. Then fourth we finally get into it, the qualified longevity annuity contracts, which I know you’ve all been waiting all hour to hear about, the QLAC. This is it. This is something you’re definitely going to have to work with specialists. We don’t set these up. You’re going to want Google do your due diligence.
But what’s going on here? It’s an annuity contract that if you use what would be your RMD to go out and purchase, that amount that you send out there can be used against that year’s RMD. It can help lower—
Barley: It fulfills that.
Eliot: Exactly. That’s one thing that you would have going for it. That’s what they’re referring to here in the question. The value that you put in there, it’s exclude for the RMD calculation. Typically, these QLACs can last up to 85.
You’re going to pay tax again sometime. That’s all we’re trying to do is defer. Keep kicking the can down the road. That’s all we’re doing. The max that they can be kicked down is till you’re 85. It just depends on that particular QLAC that you’re signed up for.
You’d want to check when do you have to start making payments because it could be earlier, but the latest you could kick it out is to 85. It’s something. It helps defer. It may not do everything for your RMDs, but if it takes a chunk out, you’re okay with it, looks good, then it’s an option, certainly.
Barley: And it provides more opportunities for tax planning. More timelines that we can potentially pursue there.
Eliot: Yup. That’s pretty much what we have for that.
Barley: The QLAC?
Eliot: Yup. Good stuff.
Barley: Any questions on that one?
Eliot: Not that I have.
Barley: Obviously, when we’re talking about deferral, we’re just talking about time value of money. We want to push the burden out to the future. Maybe in the initial part of our retirement, we’re still in a higher tax bracket for whatever reason. And then the later half our retirement, maybe we’ll be in a lower tax bracket. All of these things pretty much just tee up opportunities for tax planning. They’re not all going to work for everyone.
We’ve got to look for which one of these specifically relate to your situation. If we get the benefit, then we’ll go for it. But yeah, we’re just deferring, just kicking the can, time value of money. We’d rather have that deduction or lowered taxable income today than in 10 years or whatever the case may be.
Barley: Great question. Keep it moving?
Eliot: Yup, and here it is. This is the biggie.
Barley: 1042 fund?
Eliot: Yeah.
Barley: What the heck is that?
Eliot: Good question. What is it?
Barley: Not related to a QLAC.
Eliot: No, exactly. Unrelated to that. Again, I don’t know that—
Barley: Changing gears again.
Eliot: Can’t find out really how bookkeeping’s going to help us here either.
Barley: It’s just one of those questions, but thank you for the great questions.
Eliot: These are great questions. We’re talking about a specific condition. We maybe worked for a larger company and they had what’s called employee stock ownership plans. Kind of a retirement thing. It’s a defined contribution. ESOPs, exactly.
Microsoft always comes to mind because we’ve had clients who’ve had these in there and we certainly have had them from other companies, but they just always come to mind for me for this. Let’s say you work for Microsoft. What’s actually going on?
Microsoft itself is going to put stock into a trust called an ESOP. It’s a trust. It’s separate. It does it on behalf of all the employees that it wants to give this award to. Anderson has (let’s say) I don’t know, we’re at 500 employees. If we had something like this going on, the ESOP would be collecting stock on behalf of all the employees.
Now, it’s not taxable to the employee. So that Microsoft employee, no tax. But it’s going into this trust with their name on it under their account. Over time all these stock awards grow and grow and grow. Now, when you first put it in, the fair market value at that point is where we get to the concept of basis in this scenario. So that’s going to be the basis. Whatever fair market was 10 years ago when the first one went in.
Barley’s been there at market stock for 10 years now. If you want to take out, there’s probably been some growth. Well that would be your ordinary capital gain like if you ever sold it. Now that’s what the ESOP. That’s what it is. Microsoft keeps pumping all this in here.
But what if Barley leaves? If he leaves, then he gets hit with all that taxable income. Some would be ordinary, some would be capital gains. He gets this big, big tax bill, tax liability bill just for leaving. They will show you, give you a ton of money but make you pay a lot of tax on it.
What you can do is put it into a 1042 fund. Now you’ll not going to find that 1042 fund language in the code, but Section 1042 is definitely there. It talks about you can go out there and buy or put those proceeds, Barley takes the proceeds he got, puts them into qualified replacement property. Starts to sound really similar to our friend at 1031 with real estate. He’s going to take the funds—
Barley: I’ve got some gains. We don’t want to realize yet.
Eliot: You guys last week said you can’t do 1031 with anything but real estate. That’s right.
Barley: But you could do a 1042.
Eliot: But you can do a 1042 with an ESOP. So he gets all this money when he leaves his employment, cash comes to him, he takes these proceeds, it depends on the plan, anywhere from 3 to 12 months, typically he’s got to buy qualified replacement property. Now this is not some entity or anything like that. He’s buying the stocks or bonds of another—
Barley: New tip stock property.
Eliot: Exactly, of another C-Corporation that’s unrelated to the original Microsoft that gave him the ESOPs. He goes out, he takes all these funds, buys it. Of course there’s going to be some paperwork, some documentation. He’s going to get signed off.
Once he purchased that within 30 days, he has to have a notary signature on that statement showing that he bought those. You got to hold onto those records. Don’t lose them. Don’t let the dogs chew them up or anything. You got to hold onto that. Now if he does that, it just defers it. It’s a way you can defer all that tax that you got from leaving the company that was so kind to put into that ESOP originally for you.
The basis goes in. Well what is the basis of that new stock? That’s the important part, number five. He takes it. Now he goes to Tesla. He buys a bunch of shares there. His purchase price, the fair market value minus the deferred gain that he just had is going to be his new basis in that stock.
Barley: Why we care about that? Because when you go to sell it we want to know how much our gain is going to be.
Eliot: And that is exactly how we treat replacement property at 1031. That’s why we make that analogy. You do an exchange, you get a new house. What’s the new basis? Well it’s the sales parts of the purchase price of the new house less the deferred gain. Same thing going on here. Barley bought the new stock. His basis in it, though, is not the fair market value. It’s a fair market purchase price, less the deferred from the previous plan. The IRS can track it.
Barley: Just like a 1031. In the 1031, you have 45 days to find the replacement property. Here we have 30 days to find an in-kind replacement for the stock. So real similar transaction. Obviously, the IRS has thought of this stuff.
Eliot: For the replacement, depending on the plan, you get 3 to not 12 months but you have 30 […] notification. There are definitely steps you want to follow, you want to work with a good provider of this. We don’t do these kind of plans, but that is your 1042. It’s a fantastic idea if you run into this thing with the ESOPs.
Barley: So now you can drop that obscure tax term on people on your next cocktail company.
Eliot: Exactly. You’re going to be Mr. Excitement or Mrs. Excitement there.
Barley: People will say that’s not a real thing. You can just look at them. Knowing something you don’t know there, buddy.
Great work. Again, if this applies to you, submit a platinum portal question, come into the Platinum Knowledge room, set up a call, certainly provide more detail. Just want to expose you guys to these tax topics because somebody out there is going to, this is going to work just perfectly for what it is you’re doing coming out of a Microsoft or something like that. You want to roll these into another blue chip stock and keep going. That’s definitely what we’re talking about here. Good work. Any questions we got to hit?
Eliot: No, it looks like they’re tearing it up. There we’re almost 100 questions already.
Barley: Oh wow. Really?
Eliot: Yeah.
Barley: Geez.
Eliot: Go team. Good job guys.
Barley: Go team. Thanks guys n the background there answering. We got tax repairers, EAs, CPAs in the background answering your questions. Very big shout out to them.
Eliot: Patty running the show here.
Barley: And of course Patty running the show as usual. Couldn’t really do it without her. Great work today guys. Any other questions, please submit those. Of course, tune into the YouTube pages. You guys know the drill. Got events coming up. We got a QR code you can scan if you want to do a tax advising session. We can set that up right now.
And just to let you know, we’re doing this again in two weeks, with Amanda Wynalda will be here. Amanda and I go back and forth. I’m the CPA, debits, credits, financial statements. She’s (of course) an attorney head of the Land Trust and Deeds Department here. Just a wealth of knowledge in that field. We just take turns on Tax Tuesdays and go over your questions. We love it.
Eliot: Yeah, all your questions.
Barley: Your job is to email us at…
Eliot: taxtuesday@andersonadvisors.com.
Barley: That’s right. Send us your questions for next Tax Tuesday, and can’t wait to go over those with you again in two weeks. Anything else from you, sir?
Eliot: No. Thank you all and great questions. And really appreciate it.
Barley: Guys, if you have any outstanding questions, again submit them to the Platinum portal, we’ll get those answered for you. But thanks so much for joining us today. Have a great rest of your day and we’ll see you next time.
