Tax Strategies for High-Earners with Steve Smith

Jan 12, 2023

Welcome to Season 3, Episode 1 of Meet the Expert® with Elliot Kallen!

In this episode, Elliot Kallen brings on Steve Smith to discuss tax planning strategies for high-earners and business owners.  Learn more about tax loopholes, regulation changes, and charitable deduction strategies. Press play to get ahead of tax planning for 2023 so that you can get the most out of your money. 

Meet Our Guests

Steve Smith, CPA and Partner for Comyns, Smiwth, McCleary & Deaver

Steve Smith | Partner | Comyns, Smith, McCleary & Deaver

Steve has worked in accounting since 1977, involving a wide range of planning and compliance for federal, state, and local property and tax filings on behalf of corporations, partnerships/LLCs, individuals, fiduciaries, franchises, and estates. He also has international income tax experience, both inbound and outbound. He is qualified as an expert witness and has testified and been deposed on a variety of issues, including accounting malpractice, wrongful termination, lost profits, and fiduciary responsibility.

What can a high-earner do to get ahead of tax planning in 2023?

Elliot Kallen: Good morning and good afternoon, everyone. This is 2023. It’s a new year and thank goodness 2022 is behind us. We haven’t had a negative year in a market like this since 2008. And hopefully, we won’t have it again for another 15 years. So today we have on our show, somebody that’s going to help everybody with higher means, higher net worth, and owns a company that’s trying to do some tax planning with some really sound sanguine advice. What do I do and how do I do it? That’s who this is for.

So we have today Steve Smith on the line. He’s a senior and founding partner of Comyns, Smith, McCleary & Deaver. That’s a Walnut Creek mid-sized accounting firm. And the reason I invited Steve on is that every time I ask around us who’s the best tax guy? We’re here with the people I just mentioned, his name keeps popping up coming out of originally a big eight accounting firm. And now like I said, with a midsize accounting firm, so welcome Steve Smith.

It’s the beginning of 2023. Sometimes we have to finish up what we’ve done for last year, but I’m talking as a business owner and high net worth person. Net worth is a relative number. I’m not talking about a $100 million high net worth person it’s just somebody of higher means who’s going to pay, you know, 39% federally. Plus, so much more. What do they do to start the year off to plan for a better 2023 or to finish off 2022? What are some good ideas that one?

Steve Smith: Well, there are a lot of good ideas. Make sure that you set up a 401(k) plan in your company, make sure you set up a Roth IRA, a SEP IRA any kind of profit-sharing plan that you can start putting some money away for your retirement. Because remember, it’s not how much money you make, it’s how much money you save.

That’s my biggest pitch–start saving some money.

And if you put that money away into a retirement plan, a qualified retirement plan, it’s tax-deferred, and you can’t get out very easily. So there’s a very good inclination you will probably end up saving that money. And, you will appreciate that some years down the road, but it’s there and available when you retire. 

What else would I do? You know, one thing that’s interesting is that if you are a member of a partnership or an LLC, you have until April 15 of the following year, to go back and amend the operating agreement or the partnership agreement and still have accounts for the prior year. Now, why would you want to do that?

I’ll give you an example. Suppose because this has been a tough year, suppose it’s when he had a loss. Okay. So you might want to alter the agreement. That says if the loss goes only to those people that can actually use it. So some of your priors may have a basis and some may not. And so you’d say well, let’s give it to the guy that we have cash basis because then they can use that loss. So that’s something that can be done up until April 15 of 2023. So that’s something to think about. 

 The other thing is, if you’re a high net-worth person, you’re used to spending or paying money for estimated taxes. So I think it’s important that you learn how what the rules are. For federal purposes, your estimated taxes can be based on the prior year, either 100% or 110% of the prior year, depending on your level of income.

For California, they follow the same rules except that if you go over a million dollars guideline, you have to pay as you go so you have to pay to get the first quarter qualified for the prior year. But after that, you pay as you go. So you have to keep current. There it’s really important that you keep that you make up whatever the shortfall is and make it up in the fourth quarter, whatever they do.

Okay, so what does that all mean? It means that for federal tax purposes, regardless of what the next year is, you can rely on the prior year. So if the prior year’s low you don’t have to pay any taxes to the government until April 15 of the following year. For California though, if you make more money overnight, then you do have to see what else.

Man digitally tax planning

Are cash-balance retirement plans gaining in popularity?

Elliot Kallen: Oh, let me ask you a follow-up on what you just said. The first one is when you talk about 401k. We didn’t mention smaller corporations, more professional organizations. We didn’t mention defined benefit plans such as cash balance plans. Are you finding those are gaining in popularity?

Steve Smith: Yeah, they are. Many people want to allocate more of the profit sharing to their own to the higher-paid individuals and they have a lot of rank-and-file employees. And they will likely pay them the least amount and pay them a higher amount. And so the way to do that is with a cash balance plan and other kinds of planning, that kind of stuff.

You need to get a retirement plan expert and meet with him and they’ll do a census of your employee, then you’ll be able to tell what kind of plan you should do, a detailed rollout, and how much money you can save. Which money goes to you and how much money goes to them? And so that that would be the best. If you don’t have employees, if it’s just you, then you don’t have to deal with any of that.

LLC, LLP, S Corp, C Corp…What’s best?

Elliot Kallen: So we are retirement plan experts in there. So as a person, Steve, if I ever have a small business the advantages to me? All for retirement and tax purposes that’s what we’re talking through. C, S, LLC, and LLP, even professional services corporations. So I’m an example of a business owner of an S corp. Everything passes through to me. I’ve never understood why I’m not an LLC or an LLP. And why am I not an individual service? So you can see that a lot of letters I’m throwing out here.

Steve Smith: That’s a very interesting question. So a lot of people are LLCs. An LLC is like a partnership. You can elect to be treated as a partnership. And lawyers love it. So whenever you go to a lawyer and say, new business off the ground, the first thing we think of is LLC. The only thing I’ll say the problem is if you make money and earn you have a  business and earns income, you have to pay self-employment income tax on that. So in addition to paying income tax, you pay 15.3% tax on the first whatever it is, it keeps going up by inflation, the first $130 or $140,000 of income.

That’s an expensive proposition they have to pay. So a lot of people might be better off with an S corp. The income from this work was not treated as self-employment income. So it doesn’t matter how much income you make. You don’t have to pay that 15.3%. Instead, you must pay yourself a reasonable salary. Okay, and when you pay the payroll tax, that reasonable salary can be far far less than the total self-employment income that you might otherwise.

So it’s if you want to save on self-employment taxes, an S Corp is the way it is just a pad to consider you through another one. What is LLP? What is the limited liability partnership, it just has to do with liability. Okay. So, if you The other change that’s different is if you have an S corp, the only income that you can base your retirement plan on is your salary. Okay? So you might want to make your salary high enough to absorb that. And the maximum salary for a retirement plan is about 280,000 I believe this year, so it goes up every year by inflation. Okay, so that’s what it is.

Are you a business owner looking for a retirement plan expert? We can help you create and establish a plan for you and your employees save for the future.

Get started today, no strings attached.

What should people and business owners know when looking for someone to do their taxes?

Elliot Kallen: You’re obviously a wealth of knowledge. We’re talking with Steve Smith, who’s a founding partner of Comyns, Smith, in Walnut Creek. And you’re about 30-something or so accountants there, which is different than sole practitioners. And that’s different from a tax preparer. I know we’re talking to people that have all of them, they have sole practitioners, one-person firms and your firm is going to have to be buying hair just by having 35 people and an infrastructure you’re going to be more expensive than a sole practitioner and that person is going to be more expensive than a tax preparer. It’s just it’s, it’s baked in a pie here.

What’s the motivation for somebody to say, I need somebody who’s more qualified to do my taxes but I’m worried about the amount of money. I have no idea for taking all the right deductions. Give me the delineation so that people can make a well-informed decision.

Steve Smith: So you’re right. I mean, if you go to a single kind of guy or Enrolled Agent, you might get the cheapest return. But the problem is, inevitably you find out when you’re just starting out your life is simple. Life doesn’t stay simple and becomes complicated. Especially for taxes. It’s worth a lot to pay more money to have it done correctly. You can sleep at night knowing that things are perfect. 

Maybe he finds a big deduction that he didn’t otherwise know about, and already finds an error that was being done. The cost is how much additional tax you might be paying because it’s not done properly. So I think if your story is really simple that you’re better off going to h&r block or some other traditional kind of guy, but the minute your return becomes the least bit complicated and has lots of interesting things involved, and if several businesses or several properties or any kind of complication like that, that’s when you should consider using a more high powered firm to do that.

Person tax planning on the laptop

How do tax deductions for charitable contributions work?

Elliot Kallen: I’m going to switch gears if I could stay. Americans are the greatest charitable givers on the face of the planet. And I get asked all the time about that because I run a charity. Besides Prosperity Financial Group, we run A Brighter Day and I run that. Obviously, I put my money where my mouth is. Most business owners give to a lot of charities because we get hit up just so often. Boys and Girls Club, National Cancer Society, plenty of good ones from local or national brands. How does this work? We’re getting a tax deduction, and at what point do I want to create and use other strategies where I can get a bigger deduction this year, or even one day create a family foundation?

Steve Smith: Most Americans giving to charity or making contributions, they’re not tax beneficial to that. The problem is, a couple of years ago, the government changed the standard deduction. It’s so high now. And when you consider the fact that you can only get a $10,000 tax deduction, so you need quite a bit of charitable contributions before they become tax benefits. So what do you do? So if the standard deduction is $27,000 and you get a deduction for taxes of 10,000, it’s limited. That means that if you have no other, if you don’t have a mortgage or you don’t have a huge medical bill, that means you need $17,000 in charitable contributions before they become there’s an additional tax benefit to you.

17,000 is a pretty high bar to reach. What you might consider doing is contributing more than you normally would. Let’s say you do 15,000 a year. Then I will consider doing a contribution of like $50,000 to a donor-advised fund. You get the full deduction then because it’s $50,000, you get a deduction, but you don’t dole out the money to the various charities. You can give them the same amount that we’re used to getting every year. So that way, the next year, you don’t have to make a contribution at all, because you just skip it. You’ve already given the 50,000 away. And so that’s how you would do it. You’d alternate years or go several years before you have to make another contribution.

How do donor-advised funds work?

Elliot Kallen: So I’ll go back to this donor-advised funds because I’m not sure everybody understands that and we set those up for people. Steve, I’ve got a chunk of money it was you know, made some money in 2022 or the year before. How much can I put away in a donor-advised fund for 2022 all the way through April 15? That would have value to me.

Steve Smith: You can do up to 60% of your adjusted gross income. So in some cases 100%. So yeah, don’t worry about that. If you hit that limit, you are very charitable. Yeah. So that’s not going to be an issue. So you can put a ton of money away but as I said, you don’t have to give it out. It goes into a fund. And then later on you can direct who gets paid out of that fund. But you can do that at any time. The deduction is when you make the contribution to the fund itself.

Home buyer considering taxes

What are some tax loopholes everybody overlooks?

Elliot Kallen: Steve, what are a few loopholes that just everybody overlooks?

Steve Smith: Well, you know, there’s one I think that people overlook, for sure. And that is recently in July last year, the state of California passed AB Assembly Bill 150 which provided a workaround so that the state tax deduction which I indicated before taxes is limited to $10,000. If you have a pass-through entity, partnership, LLC, S Corp, then you’re allowed to make a contribution or pay your taxes before the end of the year to California and get a deduction in the business for your California taxes. So if he made $100,000 and you pay $9,300 to California before the end of the year, you get a $9,300 deduction on your federal return. It doesn’t count or become part of your $10,000 limit. 

Now, a lot of people are doing that. But what many people are not doing is considering the following. Let’s suppose you have a lot of interest in dividend income, and investment income, because you’ve got a good broker like Elliot earning money for you. like yeah, earning money for you.

You can form a general partnership, between say you and your wife, put your brokerage account into that and then have the brokerage account and then get a k one with the interest and dividends on the k1 and pay the federal California tax on that income and then get a state tax deduction. Now in that particular case it goes it’s treated as another tax deduction outside of the 10,000 limits, but it is a tax deduction.

So that means that you have to earn enough income at a higher rate to avoid the problem with AMT. So it’s only for people that earn a lot of income and pay 37% tax on that income federally, then they don’t have to worry about AMT. And if you don’t have that, you should proceed with caution. It’s one of the things I would do a projection for, but we’re at the start of the new year. So that’s the time to start doing this stuff. But a lot of people don’t think about taxes until April 15 when they have to sign their name to add an extension to the return itself. But now’s the time to actually think about that. 

Elliot Kallen: You brought up some really good points there Steve. I get asked this all the time, as a business owner, is it better to make the checkout from my company or check out from my personal taxes?

Steve Smith: It makes no difference. What’s going to happen is it’s going to flow through to you as though you had donated personally. So it really doesn’t matter.

Elliot Kallen: Okay, so you brought up a lot of tax points, things that I know nobody’s heard about, which is great, which is why we have you on here. It’s January, and nobody’s happy with your investments this past year. Lots of people aren’t happy with their tax situation. They file it they get a tax deduction for California on their federal return, which they missed the day. Lots of things happen this year. When does somebody look for a new CPA who’s someone like you?

Steve Smith: If you’re going to make a change, you should make a change in January. You may not have to do anything until later on in the year, but you should let the prior CPA know that. Hey, we’re switching gears, and thank you for your service. But we’re moving on.

For high earners, taxes likely make up the single biggest expense incurred over the long haul — and a too-high tax burden can spell disaster. 

Your Prosperity Financial Advisor will work with your current CPA or provide new counsel to ensure you have the best tax strategy possible. 

What can I do to avoid poor communication with CPAs?

Elliot Kallen: Okay, along the same lines stay the same. I have found and I’ve been doing this now for my entire adult life with running companies, selling companies, buying companies, and so forth. Communication with CPAs seems to be horrible, just horrible. They don’t teach you communication one-on-one in accounting school. Yeah. Why is it so bad? And how do I know when I’ve got a firm that knows how to communicate with me before I’m in crisis mode?

Steve Smith: It’s a good question. You know, the biggest complaint that people have is about that. I’ve heard people say, I sent in an email, I call them at the voicemail, I never hear from my CPA, and I think so why wouldn’t be here? I think it’s how they were trained. I think that some CPAs that weren’t thoroughly trained, become really busy. They’re thinking that the only thing they have to do is get their work done. And they look at getting a voicemail or an email as a distraction to that to that job. So what do you do with distractions, you ignore them? And they don’t realize that that’s their business. They should be answering voicemails, answering emails, doing that first, and then jumping on the pile of work that they have later on, but first, respond. That’s the best way.

 We’re supposed to let people know. And even if the answer is, I don’t know. I’ve got clients who say, Hey, have you heard anything back from that letter you wrote to the Franchise Tax Board or the IRS, even if they don’t have anything to report? Saying that you don’t have anything to report is better than nothing because even if there’s nothing to communicate, communicate. I think it’s just what you’re saying. I know why people that are trained would diverge from that. But to me, sometimes I spent a whole day communicating and they’ll have to work at night to make up for it. 

Did you enjoy this episode?

We’d love to hear from you.

If you’d like to learn more about any of these topics and how they affect your financial goals – contact me anytime.

All my best,

Elliot Kallen

925-314-8503

Elliot@ProsperityFinancialGroup.com

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