Tax Mitigation is Not a Viable Financial Plan

Are You Losing the Forest for the Trees?

Picture of by Dr David Phelps

by Dr David Phelps

Nobody likes to pay taxes, particularly what we might consider excessive taxes.

Taxes, however, are a part of our world as much as you and I don't want to pay them or have a reasonable concern with paying them to a government that has been irresponsible for decades.

The trend of government deficit spending is not likely to end, and there’s not much way for us to fight the consequences of this fiscal irresponsibility.

It seems we should shift our focus on mitigating taxes in our capital. And while I believe in mitigating as much tax as possible, there is a limit to how much we should pursue this.

Tax Mitigation is Not a Selling Point

Everybody is selling investments that can “save you” taxes. Sometimes, promoters will use this as a main selling point for their investment. And many have been hooked on thinking this way.

I often push back on this thinking. You can not let the tax tail wag the dog.

Don’t get me wrong. Tax mitigation, tax offsets, and tax deductions that are legitimate should all be used. We should all take advantage of them for our businesses and investment assets.

But we need to acknowledge that there's always a trade-off with these tax mitigation strategies. It's never just a pure win-win. And you should never allow yourself to invest in assets purely for the tax benefits.

Cost Aggregation and Bonus Depreciation

There are some viable tax mitigation strategies in real estate, such as cost aggregation and bonus depreciation.

However, these are often used as the moniker in many syndications where I see people selling oil and gas investments. It contains some opportunities to offset active income with actual losses and appreciation. Another big seller is working interest from oil and gas investments.

Too often, I see people running towards investments for tax benefits without looking at the economics of the underlying assets.

If the asset investment itself is not viable without the “tax benefits,” I wouldn't touch it.

Opportunity Zones and Conservation Easements

Many have lost money in these “opportunity” zones that have been set up by the government to try to infuse capital into economically depressed areas.

Many operators or promoters use that title as a hook to catch your money in their nets. Who knows whether or not the potential project they're putting your money into has any relevance.

Again, I would be cautious if an investment is sold to me as a tax benefit.

Conservation easements are another big one. There are companies that specialize in “saving” you taxes. They construct what I call schemes.

The schemes will work until they don't. Some may want to game the system while they can and exit when they know it won’t work anymore, but how do you know when these schemes will work?

Is it when they have some letter of authorization from the IRS, or they have XYZ attorneys that have looked this over, and they can say “by the letter of the law” that this is going to work?

I’ll tell you the truth, it doesn’t matter if those criteria's are met.

Once you are in front of the IRS auditor, that's the day you know whether or not your tax strategy is going to hold up. I’ve seen it go either way. It’s not a risk I would take.

It’s Not Worth it to Fight the IRS 

I've seen too many people fight on principle. “I know this is right; they're just after my money. I'm going to fight this thing.”

Be prepared to write a big check and spend a lot of time waiting for a decision to be made because it always takes a long time to sort it out with the IRS.

I’m not saying that you can’t do it. I’m sure there is an exception, but if you decide to fight the IRS (the government), you’ll need a lot of capital, a high-stress tolerance, and a lot of time. These battles can last years.

I'd rather have peace of mind. I'd rather know that I've paid taxes and not pushed the envelope.

There is a gray area in which you operate along with your CPA or tax advisor.

You can choose to step into the gray area, but I wouldn’t do so on large items. Not on things that can come back and bite me with large potential tax liabilities. 

Getting hit with penalties and interest can be huge, particularly for business owners and professional practice owners at the end of their career path.

Don’t Risk Your Business Sale with the IRS

When it comes time to sell business equity, you will once again have to pay the taxes. It’s very easy to be tempted to offset the taxes owed through promoters or companies claiming to be able to offset capital gain taxes.

I would not put my money there. It's not worth it. They will not be the ones on the tax hook for the penalties and liabilities that come down on the day you get audited.

Remember, the government has 87,000 new IRS agents out there that are looking to pull out more money. This is not a time to be overzealous.

I suggest you focus on ensuring your investments and businesses are running well. Because once you receive your money, tax-paid, it’s yours to use for whatever you want.

But if you invested capital from the sale of your business in a tax-promoted asset last year, two years ago, even five years ago… Do you really want that hanging over your head?

Will you always have to keep that potential negative audit in the back of your mind? How would that make you feel? How would it make you feel waiting for an audit that may or may not come to disrupt your plans, capital base, and livelihood?

How Much Do You Really Need?

When I sell business equity, I want to be done. It comes back to how much I really need.

Many don't know how much money they need to live off of indefinitely. Most never learn to make their assets work for them. As a result, they are forced to try to stockpile larger and larger sums in an effort to create some sense of security.  

It is a perplexing phenomenon and conundrum that we all face. It’s a simple question for which many have created complex solutions. How can you keep more of your money?

If you can play games with the IRS and get by, then maybe you’ll be okay. But to me, that’s not a winning formula. Once I knew I had enough – once I had real certainty – it gave me permission to stop taking unnecessary risks in trying to avoid taxes.

I don’t have to play that game anymore. Sure – I don’t want to pay more than absolutely necessary, but I don’t have to stretch that to its limits and expose myself to the risk of future audits or uncertainty. 

My Winning Formula for Wealth Preservation and Growth

Find investments and businesses that allow you to pivot and move your capital going forward where it makes sense. And as you move capital,  just pay the darn tax.

Tax rates will only rise, so when you defer taxes by all the cost segregation, bonus depreciation, and everything else that is available, you are not saving tax. You are deferring it.

You are deferring it to another day when the tax rates will be higher. Probably much higher. Would you rather pay the tax now or later?  Like I said before, I want to be completely done with paying taxes once I receive my capital.

So, make that money work for you on a basis where you have no strings tied to it at all. You can just move forward with your life without worrying about potential audits, errors, or regrets.

Operating in investments that are more stress-free takes a little bit of work. It takes knowledge. It takes being around the right people who can show you how to make it work in your favor. 

That’s what I do today, and I am living with much less stress. I want the same for you! 

To your freedom!

– David


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