Special Tax Strategies with Sandy Botkin, CPA, JD
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|The Lange Money Hour: Where Smart Money Talks
|Click to hear MP3 of this show|
- Guest Introduction: Sandy Botkin, CPA, JD
- The Benefits of Having a Side Business
- Roth IRA Conversions
- Top Tax Tips
- Income Shifting
- Taxpayer Freedom Day
- Factors Every Millionaire Has in Common
- The Tax Aspects of College Tuition for Parents and Grandparents
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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
Jim Lange: Hi, this is Jim Lange. Today, we’ll be learning some powerful tax strategies with Sandy Botkin, the president of the Tax Reduction Institute of Germantown, Maryland. Sandy’s both an attorney and a CPA. He’s a former trainer of IRS attorneys nationwide, and now he’s on our side! Sandy is a best-selling author and nationally syndicated writer. His recent books are Lower Your Taxes Big Time and Real Estate Taxes of the Rich, both published by McGraw-Hill and available from your local bookstore or online bookseller. I was really impressed with Lower Your Taxes Big Time. Some of the things almost seem too good to be true, but Sandy is very creditable. Again, CPA/attorney, worked for the IRS and actually trained IRS agents, and his book is very well documented, so it has source codes and revenue rulings and citations to internal revenue codes and cases. So, he’s really talking on sound ground, and there’s a lot of good ideas. In fact, some of them I didn’t know, and I went to some of the CPAs in my office and I said, “Hey, did you know this?” And a bunch of them said, “Yeah, I knew that.” But some of them, they didn’t. So, I think it is a really good book that has a lot of information for all taxpayers, but especially, I’m going to say, for taxpayers that have a small business, maybe a one-person, a two-person or a family business. For those of you who have those small businesses, I think it’s kind of a no-brainer to buy his book. And it’s my pleasure to introduce Sandy Botkin. Welcome to the show, Sandy!
Sandy Botkin: Oh, it’s my honor. It’s a real pleasure.
Jim Lange: Well, you start out the book by saying that everybody should have a side business. You know, whether you have a full-time job and you’re doing something on the side, or I even got the idea that you wanted some retirees to have, let’s say, a small side business, and I have some other reasons why I like a small side business, other than the ones that you started with, but I thought I would ask you why you think people should consider having a part-time, self-employed income or a small business?
Sandy Botkin: Well, you know, there’s really a lot of reasons for this. First of all, everybody needs to understand, Jim, that we have two tax systems in this country, and when I say that, people think, “Oh sure, one for rich and one for poor,” but that is not quite right. There’s one to make you poor, and then there’s one to make you rich.
Jim Lange: I like that!
Nicole DiMartino: I do too!
Sandy Botkin: Okay? The one to make you poor are those that are employees that have no business. They’re the ones that are taxed on dollar one, they get very little deductions, they could basically deduct a charity, the interest on their home, and probably some of that’s going to be eliminated at some point in the future, but that’s it. But if you are in business, you can write off part of your house, your spouse, the equivalent of your kids’ education and weddings (I’m not kidding when I say that). You can set up a pension plan that makes any government plan paltry by comparison. It’s just enormous. And people say, “Well, what happens if my business generates a loss?” Well, then you get the government subsidizing you, because if your business generates a loss, you can use that loss against any form of income you have: interest, dividends, wages, rent, pensions, anything. So, let’s take an example: let’s say one of your listeners makes $50,000 a year from their job or from their retirement, and they have a part-time business that generates a $10,000 loss. They only pay taxes on the net, the $40,000. Let’s assume you’re a single parent and your loss exceeds your whole income for the year. You can carry back all business losses two years and get a refund from the federal and state government. For the last two years of taxes that you paid, you actually get a check, or you can carry forward all properly documented business deductions twenty years and offset the next twenty years of earnings. And this doesn’t discount the fact that maybe that a small business will make you a lot of money. In which case, you can stop working for that job and work out of your home and create all kinds of fringe benefits for yourself. I mean, it blows me away, it really does, how people will work harder and harder for a job with less and less potential to get ahead. To me, I would recommend you put in as little as possible to avoid being fired, and get that side business started as fast as possible.
Jim Lange: By the way, that goes for everybody except for my employees.
Sandy Botkin: Right! Hopefully, they won’t be listening to this, right?
Jim Lange: Unfortunately, one’s right here!
Nicole DiMartino: I’m sitting right here! One’s right here.
Jim Lange: And I think a few of the other ones are because they are very interested. The other thing, it’s kind of interesting. I was actually talking with one of the CPAs today and she said that she had an unusually large number of people who lost their jobs during the year, and they’re trying to regroup and figure out what to do. So, some of this advice is very good for them. I also have some tax reasons. By the way, your book does a great job in talking about what kinds of things you can deduct, and even just in your start, you were talking about some of the things that people in small businesses can usually deduct, assuming it is a legitimate business expense, that people who are employed cannot. But one of the things that I like, and you mentioned it briefly, is that the retirement plans available to small business owners are just so much more favorable than those available to employees, in terms of how much money you could put away, both in terms of the percentage of your salary and you can put in up to either $16,000 or $22,000 in a one-person 401(k).
Sandy Botkin: Actually, you can do more than that.
Jim Lange: And actually, a lot more than that.
Sandy Botkin: A lot more than that.
Jim Lange: Right. That’s if your income is relatively low.Sandy Botkin: Correct.
Jim Lange: And the other thing that I like to do is, I sometimes am using those when creating retirement plans for self-employed people, or even people who have traditional jobs, or maybe they’re retired from traditional jobs. If they have some self-employment income, then they can start a one-person 401(k) plan, and a lot of our clients have after-tax dollars, or non-deductible IRAs, and we have an interesting method. We’ve gone through it a couple of times in prior shows, and I’m not going to do that again now, but by jumping through a couple hoops, we can actually isolate some of those after-tax dollars, do a Roth IRA conversion for free, and the other advantage of having a self-employed retirement plan, like a one-person 401(k) plan, is that you can actually do a Roth IRA conversion on that plan even after you die, which is nice, and it has better creditor protection.
Sandy Botkin: Gee, I didn’t know I’d be able to come back from the dead and do it after I die. That’s a good trick. You need to show me how to do that one!
Jim Lange: All right. Well, let’s assume, for discussion’s sake, that you have…
Sandy Botkin: Now, someone else might be able to do it, but I’m not so sure I’d be doing it.
Jim Lange: Well, that’s true. On the other hand, let’s say you have whatever it is, let’s use a nice round number like a million dollars in your IRA, and let’s say that you die, and let’s leave the spouses out of it for the moment, and you leave it to your kids, and your kids basically have an inherited IRA and they are not allowed to make a Roth IRA conversion from it. But if you leave them a million dollars in a one-person 401(k) plan, which, while you’re alive, is essentially the same thing, in fact, it’s even better while you’re alive, then they can make a Roth IRA conversion. You get better creditor protection because it is an ERISA plan. So, there are multiple advantages of having a one-person 401(k) plan.
Sandy Botkin: While you’re mentioning this, let me get into this because that seems to be like the ‘in’ thing, where everybody’s saying, “Well, convert your 401(k)s to Roths,’ and to a large extent, I’m a fan. I tend to agree with that. When I said ‘converting,’ just to make sure everybody understands this, this is where you take the money in your 401(k) or your simple IRA or your SEP, and you actually transfer it directly (you have to do it right) to a Roth IRA, and you’re taxed on the money. You actually pay the taxes as if it was a normal distribution. The advantage of that is that it is all tax-free for the rest of your life. But the problem is, there are a lot of side effects. Now, it’s not like the drug companies where they talk about side effects. I love when you watch these drug commercials. They’re beautiful commercials. You see the ocean, and then they say ‘side effects: blindness, loss of hearing, death (that’s my favorite side effect).’ The side effects are not quite that bad, but there are side effects. They really need a professional to go over this to see if it’s valid. For example, a lot of deductions and credits phase out, like the American Opportunity deduction for credit for college. Phased out based on income. If you were applying for financial aid for your kids, the last thing you should ever do is do a Roth conversion in the year that the financial aid application is looked at. So, I mean, there are all these side effects.
Jim Lange: And I’ll tell you the big side effects. By the way, I would agree with you completely on this, and we crunch numbers all the time. The most common one for most of the listeners that I imagine are listening tonight is that the taxation of their Social Security often goes up, and it also has an impact on the Medicare Part B premiums.
Sandy Botkin: Absolutely. That’s when you’ll pay a higher tax on your Social Security. That’s right, you’re right.
Jim Lange: So, I would agree with you completely on that. On the other hand, sometimes what happens is, it’s a great idea anyway, and our office does a lot of number crunching on this, and we’ve actually had multiple shows on this issue.
Sandy Botkin: Well, I think that one tip may have not been said. I was looking at doing a Roth conversion myself, and I was saying to myself, “You know, I’m not that far from retirement. What am I going to do when I retire?” And the answer is, move to Florida. And I’m thinking, “Well, if I’m going to move to Florida relatively soon, why don’t I do a Roth conversion when I’m in Florida and not pay any state income tax?” Which I would have to pay here in Maryland.
Jim Lange: Well, that’s a good point. Now, in Pennsylvania, Pennsylvania’s not a good state to work in because they don’t give you a break on your IRA or retirement plan contribution. So, that’s why most of us, if we’re preparing our tax returns right now, and we are employed, or even if we’re self-employed and we’re making a contribution to a retirement plan, we get to deduct the amount for our federal tax return, but for Pennsylvania tax purposes, we have to pay the entire amount. We don’t get a deduction.
Sandy Botkin: Ewww, that is horrible!
Jim Lange: That is horrible, but when we retire in Pennsylvania, we don’t have to pay income taxes on IRA distributions, we don’t have to pay taxes on pensions and we don’t have to pay taxes on Roth IRA conversions.
Sandy Botkin: Well, you know why they do that, don’t you?
Jim Lange: Well, they get you up front.
Sandy Botkin: No. Because everybody’s moving to Florida, so they’re not going to have to worry about it anyway.
Jim Lange: Well, actually, in your case, you probably know, let’s say that, for discussion’s sake, that you are at the peak of your earning career. You know, you’re writing books and you’re doing lectures and you’re doing consulting, etc. etc., and then, let’s say, I don’t know if you’re going to actually truly retire, but let’s say that you truly do retire, you’ll be in a lower tax bracket, and you’re going to be, let’s say, in Florida, it might make a lot more sense to wait until after you retire to do the conversion.
Sandy Botkin: I think that’s true, although my goal is to be in a higher tax bracket so my kids can live to the style that I want to be accustomed to. That’s the second point.
Jim Lange: I like that. So, there really are a lot of advantages of being self-employed, and particularly for taxes. Actually I like a lot of things about your book, but one of the things that I liked is that, you know, you sometimes see…I want to almost say sensationalism, saying all these things that you can do. I was one time on a TV show with Irwin Schiff, and he’s one of these tax evader guys, and at first he said, “Don’t file a return,” and then he got thrown in jail. So, he didn’t like that idea.
Sandy Botkin: I was going to suggest that if you listen to Irwin Schiff, you can also wear orange. It’ll look good on you.
Jim Lange: Yeah, and then he said, “Okay, no, that’s wrong. File a tax return but write zero for your income.”
Sandy Botkin: Oh, he is such a nut! In tax court, you know, when he finally went to jail and he had to testify against somebody, he looked at the guy and he said, “What do you get listening to me?” Oh, he is such a nut!
Jim Lange: Well, he is a nut, but I guess my point is that some of the things he was saying were kind of sensational, but it couldn’t be backed up. Some of the things that you’re saying, even though they’re not sensational, they are like, “Wow, it sounds great. You know, deduct the cost of your children’s education, deduct the cost of your wife doing all these things,” and then when you read…
Sandy Botkin: I said deduct the equivalent of those things.
Jim Lange: Fair enough.
Sandy Botkin: I didn’t say deduct the education.
Jim Lange: And then, when I read it, I say, “Oh, I see what he’s doing, and yeah, that makes a lot of sense,” and even things like employing your children, you know, I think is a good idea. You know, I always caution people, but then they should really do a little bit of work, and not just a sham transaction.
Sandy Botkin: Yeah, you’re absolutely right. I say that in Lower Your Taxes Big Time. But I want to emphasize a couple things here: you know, we Americans have been really bad when it comes to tax planning. I actually did a blog on this. I have a special blog that I do every single day on tax and financial tips. It’s on my Facebook which is facebook.com/loweryourtaxes. And one of the things I say is that we Americans have been really bad when it comes to any kind of tax planning. We will spend tens of thousands, hundreds of thousands, if we get into trouble. But to spend one percent of that on planning which would avoid the trouble, people are not willing to do. And that’s the very sad fact of what goes on in life, and I think if there’s anything that they get from this conversation that we’re having, you know, it’s don’t be cheap. Go do tax planning every year, especially if you’re in business. Don’t be cheap. You know, get my book Lower Your Taxes Big Time. Discuss it with your accountant. Do estate planning certainly every couple years, and if you have any family changes or you change your residence, do it again. You know, do some business planning. Go to a good business lawyer when you set up a business. Don’t just try to do it yourself. Don’t do your own will. Always do estate planning. Forget about LegalZoom. That’s garbage. You want to get a contract and have it read by a professional. Don’t just do it yourself. People try to save money. They become penny wise and dollar foolish and it’s the dumbest thing I’ve ever seen.
Jim Lange: Well, I’ll tell you, something pretty dumb would be to try to do some tax planning and not get your book, because honestly, if you go through your book, it even gave me a couple ideas. You know, for example…oh, you know something? I think we have to take a break.
Nicole DiMartino: We do have to take a break. We will be right back on The Lange Money Hour, and actually, please remember we are live tonight. So, if you want to talk to Jim and Sandy, please give us a call. (412) 333-9385. And we will be right back.
Nicole DiMartino: Welcome back to The Lange Money Hour. Again, as I said before the break, the show is live. Give us a buzz. (412) 333-9385. One thing, before you get back into it, I promised one of our listeners. Sandy, this is a question for you, and we sent out the e-blast promoting the show, and right back, one of our loyal listeners, Jim from Michigan, wanted to ask you a question about Lower Your Taxes Big Time.
Sandy Botkin: Okay.
Nicole DiMartino: Okay? He said he will be listening to the show tonight, but he was wondering if you will be coming out with another update to that book to include the 2010 tax bill. And if you will, when will it be out?
Jim Lange: I think it’s out.
Sandy Botkin: It’s out right now.
Nicole DiMartino: It’s out now?
Sandy Botkin: I update it every single year.
Nicole DiMartino: Okay.
Sandy Botkin: I included the new hires act. I included four new chapters. I included a chapter on scams, slams and shams, which are the latest scams that are hitting North America, including how to avoid being Madoffed.
Nicole DiMartino: Okay. So, it’s out?
Sandy Botkin: It’s out right now.
Nicole DiMartino: Where do you want people to go? Where can they get this book?
Sandy Botkin: They can go to either Amazon.com…
Nicole DiMartino: Okay.
Sandy Botkin: …or they can go to Barnes & Noble. They can go to any bookstore and order it. It’s called Lower Your Taxes Big Time.
Nicole DiMartino: Big Time, okay.
Sandy Botkin: That’s the best way to do it, and I would strongly recommend they also go to my daily blog, which is facebook.com/loweryourtaxes, to get a new tax or financial tip every day.
Nicole DiMartino: Okay.
Jim Lange: Yeah, and for whatever it’s worth, I was running a little short on time to get the hard copy, so I downloaded it and I went through it. I really enjoyed it. You say that you have five top tax tips for 2011. Could you start us off and we’ll get into a couple of those tips?
Sandy Botkin: Well, I cover mostly the tax mistakes that people make! First of all, let me mention a couple of things here. There’s a big article that was written up. It was in Reuter’s all over the country. The first thing that I think people need to understand is that the most important thing in a small business is to get a good tax organizer. People ask me, “What do you need to do to bulletproof your records from the government, to really never have to worry about an IRS audit again?” I mean, if that’s not worth something, I don’t know what is. The answer is you’ve got to have a good tax organizer. Now, a tax organizer looks like an expense log, but it isn’t. It really has all the tax questions right in front of you, 365 days a year, for entertainment, for travel, for automobile, all of those things. So, it’ll avoid procrastination, which is a big killer of deductions, and force you to do what you need to do, and when the IRS sees these tax organizers properly filled out, that’s the end of the problem, and all your deductions will survive.
Jim Lange: Well, I’ll tell you one of the things that I really liked in your chapter about how to turn your car into a deductible goldmine and you actually mentioned a smartphone app.
Sandy Botkin: That’s correct. We are currently working on a smartphone app that’s about five months away. I thought it’d be ready already, but it’s not.
Jim Lange: Oh, I thought it was ready. I was so excited about it.
Sandy Botkin: Not ready yet.
Jim Lange: All right.
Sandy Botkin: It was almost ready, and then we had a problem, so now we have to fix it. But the bottom line is, we are coming out with a smartphone application that will have…it’ll be with most smartphones, with the exception of the Blackberry to start, but it will be with the iPhone and the Droid, where you have all your tax questions right in front of you 365 days a year. It’ll upload it to a website and store it for you. It’ll store your receipt and attach it to it so you can take a picture of the receipt and store it, and then we’ll have an automatic mileage tracker between business and personal. It’ll keep track every five minutes of where you went, what the mileage is, and finally where your address is where it’ll actually do it automatically.
Jim Lange: Okay.
Nicole DiMartino: That’s amazing.
Sandy Botkin: Oh yeah.
Jim Lange: All right, but it’s not there yet?
Sandy Botkin: Not there yet. There are some things we have to do. We have to get licenses. I mean, it’s delayed about four or five months, but it will be available probably around July.
Jim Lange: All right, well, that sounds good. Now, are most of the other tax tips just for businesses, or are they also for individuals without businesses?
Sandy Botkin: Well, my specialty, I’m a small business tax specialist. My specialty is for small businesses and for small real estate transactions. That’s my primary specialty. I mean, there are some things that the average individual can do. But again, remember, there’s a lot less if you’re an employee than if you’re self-employed. That’s just the way it is. Certainly, for the average person, there are a couple things they need to be aware of for the last minute tax tips for 2011. One of the biggest things that people need to be aware of is the fact that you can still contribute to that IRA, or even pension plan, as long as the pension plan is in existence. You can still make the contribution before you file your tax return and get a deduction for last year.
Jim Lange: That’s correct, and you could do a Roth IRA for $5,000 if you are 49 or younger, or for $6,000 if you are 50 and older, and then also the same amount for your spouse, even if your spouse isn’t working.
Sandy Botkin: That is correct, and even better than that, if you’re in business, you can put a Roth 401(k) in, and instead of $5,000 or $6,000, you can put away $16,500.
Jim Lange: And I am a big fan of that, and with the one-person Roth 401(k), just like a regular plan, you have both an employee and an employer share. So, you can put away a lot of money. The other thing, by the way, that I am encouraging people to do is if you have the money, to make your 2011 Roth IRA contribution now, and that way, you get an extra year of tax-free growth.
Sandy Botkin: You know, it’s a very interesting point. A lot of people don’t realize this, early birds catch the worm, the old saying? Particularly true with pension plans. Here’s an interesting story: if you put away $5,000 a year into an IRA every year for forty years, but you do it at the end of the fortieth year (it’s like everybody else does, the end), but instead, you do that same $5,000 a year at the beginning of each year, same $5,000 a year, same forty years, but by the time you retire, you will have an extra $60,000 at retirement on the average.
Jim Lange: Well, that’s pretty significant.
Sandy Botkin: Extra by simply doing it at the beginning of the year instead of the end of the year. This is a really big deal that people don’t realize.
Jim Lange: And I think that that makes a lot of sense. The other thing that I will just mention on things that you can do, let’s say, between now and April 15th, and this is for a lot of people who already made Roth IRA conversions last year, because Sandy, I spent a lot of time on the radio doing multiple Roth IRA conversion shows, and then most of my workshops, in fact, all of my workshops last year involved Roth IRA conversions. So, I know that there’s a lot of people who made Roth IRA conversions in 2010, and what I would say to them for this year is rather than committing yourself to keeping the Roth IRA, or determining if you’re going to recognize the income in 2010 or half in 2011 and half in 2012, that you might be well-served by filing an extension, not an extension to pay, an extension to file, and you file that by April 15th, and that gives you an extra six months to see how the market does, see if your investment goes up or down, see what’s going on with your tax rates and whether you’re better off recognizing it in 2010 or 2011 and 2012.
Sandy Botkin: Well, that’s a good point, but there’s one more thing I think we should point out. If you made that Roth IRA conversion in 2010, what’s interesting is, you have the option to treat half of that income as taxable in 2011, and half of that income as taxable in 2012. You actually get a two-year deferral. Unfortunately, if you make that same Roth conversion this year, all of it is taxed this year. You do not get that conversion, as far as I know.
Jim Lange: Yeah, that’s right. Although, we actually found a little way of getting around that in 2010. One of the issues that I wanted to do, I’m a big believer in doing Roth IRA conversions up to perhaps your existing tax bracket, the top of your tax bracket, assuming some of those things that we talked about earlier…
Sandy Botkin: Do a partial conversion, yes.
Jim Lange: Correct. I was really big on that. So, let’s say, for discussion’s sake, that you could do three years of conversions of $33,000 each and still be in the same tax bracket, but what you weren’t allowed to do is to do a $100,000 conversion, recognize $33,000 in ’10, $33,000 in ’11 and $33,000 in ’12. You could either do all hundred in ’10, or $50,000 in ’11 and $50,000 in ’12. But what we found is, and this is new, in fact, it’s even after my book came out so it’s not in my book, that you could have one spouse, let’s say, do $33,000, recognize it all in 2010, have the other spouse do $66,000 and recognize it half in ’11 and half in ’12.
Sandy Botkin: Right, because each spouse can elect to treat that two-year deferral. That’s correct.
Jim Lange: Right. Yeah, that was a really cool...
Sandy Botkin: Yeah. By the way, that’s a very good point that you brought up. When you make this conversion, everybody who’s listening, you really want to use other money. You do not want to use Roth money, as tempting as that is, to pay the taxes on the conversion. You’ve got to use other money, and a lot of times, people ask me, “Well gee, you know, if I’m converting a couple hundred thousand dollars into a Roth IRA, I don’t have that money!” Well, the answer then is, do a partial conversion. Maybe you only convert 10%, 20%. You don’t need to do the whole thing.
Jim Lange: I agree completely. You know, I think one of my favorite chapters in your book…by the way, for the small business person, I think probably all the chapters are good, and, you know, we could talk a lot about some of the chapters on entertainment, and hopefully, we’ll have time to do office in the home, but one of the things that I really liked was your Chapter Four on income shifting.
Sandy Botkin: Mmm-hmm.
Jim Lange: And that’s something that I think could apply to everybody, whether they have a business or whether they don’t.
Sandy Botkin: Oh absolutely. I’m going to give you a good example of this. My mother was a teacher. Now, teachers do not have businesses. My dad had a business, but she didn’t. And she used to have me grade her papers and pay me to grade her papers, and she would take a deduction as an employee business expense, although that’s not as good a deduction as it would be if you were self-employed. Still, she was able to get that deduction, I got that money mostly tax-free because today, you can earn up to $5,800 income tax-free, believe it or not, as an employee, because you get a standard deduction for that amount, and everybody wins! And I used that money to help pay for my college education. It’s even better though if you’re self-employed. I hired my son to come with me to various seminars, and he uses that money to pay for his own education. I hired my daughter to do my website. She designs websites. She’s going to school for digital design, which is sort of like web design, and she charged me an outrageous amount of money, Jim, to do my website. It just happened to cover four years of tuition.
Jim Lange: You’re braver than I am!
Nicole DiMartino: That’s one expensive website!
Sandy Botkin: Well, you know what? And again, in my book, it provides that you have to pay a reasonable wage. You can’t go crazy. So, what I did was, how do you figure out what a reasonable wage is? Well, a reasonable wage is what you would pay an outside agency to do the same thing. So, what I did was I actually got a quote from a web design company on what they would charge me to design my website from scratch, doing the things I want it to do, and I just paid my daughter something less. It just so happens that that little bit less covered her four years of tuition at a state university.
Jim Lange: Right.
Sandy Botkin: I mean, there’s lots of things people can do, but the key is if you don’t do the planning, if you don’t know to hire your kids, if you don’t know what kinds of documentation you need to do these things, then you don’t get the deductions, and you become one of the poor people. You’re in the poor system at that point.
Jim Lange: Right, and then there’s a bonus in that you didn’t have to pay Social Security on those wages that you paid to her.
Sandy Botkin: That is correct. That is absolutely correct. Well, she’s actually over eighteen, so I would have to pay Social Security, plus I’m a corporation.
Jim Lange: Oh, okay.
Sandy Botkin: But you’re right. If I was self-employed and she was under eighteen, there is no Social Security on wages. You’re absolutely right about that. By the way, everything has to be done correctly. That’s why it’s so important to get that book Lower Your Taxes Big Time and to meet with your professional. You want to do it right. If you do it right, there’s nothing the IRS can do to you. If you don’t do it right, then you’re asking for trouble. But, you know, it’s kind of like driving on the highway. If you’re going within the speed limit, even though there’s a radar gun there, they’re not going to pull you over. That’s the whole point. Just do it right.
Jim Lange: Well, I think that that is good advice. Could you talk about taxpayer freedom day?
Sandy Botkin: Okay. There is a day that the average person has to work until to pay off their federal, state and Social Security taxes, and if you go on the web, you’re going to find it varies. It depends on your income and based on the state you’re in. But generally, it’s around April 9th. It could be as high as April 19th, but it’s around April 9th. Now, to put that in perspective, every day you’re working in January is for the government. Every day you’re working in February, every day you’re working in March, and about half of April. So, the average person is working over three months a year, almost four months a year, for the federal government. In fact, you’re still working for the federal government. Even worse, so if you take 109 divided by 365, roughly 30% of what you make is going out in taxes. And here’s another sobering statistic, by the way: somewhere between 18% and 30% of what the average person makes goes out in debt service. Debt service being education loans, mortgage loans, consumer loans, auto loans, everything. Well, you don’t need to be a CPA to figure this out. If you’re paying roughly 20% in debt and 30% in taxes, that means 50% of what you make is already committed. So, you only have 50% left to pay off all your living expenses: your education for your kids, your retirement, your insurance, your repairs, your medical, everything. So, if you wonder why you can’t get ahead, hello? That’s the reason! And that’s why it is so essential to get your taxes down to the legal minimum because we all have those expenses, but by getting your taxes down with proper planning, we can then use that to help pay our debts, to help fund our retirements. I mean, I’m a CPA. I’m not that smart. I’m really not. I’m okay. But I put away $2,000 when I was a kid. I had a paper route and I put away $2,000 at that time into an IRA, I didn’t maximize my simple IRA and I put away money every single year, and now I am debt-free and I’m a multimillionaire. Was I that smart? No, but I simply followed my advice of trying to get my taxes down to the legal minimum, saving money every single year, putting away the maximum amount into an IRA or into a pension plan, and when I had a little extra money, I used that to prepay my debt. That’s all it took.
Nicole DiMartino: You know what? It is break time again. We’re going to take a short break. You’re listening to Sandy Botkin and Jim Lange on The Lange Money Hour. We will be right back.
Jim Lange: Sandy, one of the things that I also know that you say is that there are three major factors that every millionaire has in common, and I think that some of our listeners certainly would be interested in what these three things are.
Sandy Botkin: Actually, it’s interesting. I’ve actually changed that to six and I will be putting that in the upcoming book.
Jim Lange: Okay.
Sandy Botkin: You know, one of the good things about being a multimillionaire…let me put it this way. One good thing about being a tax lawyer is you get to associate with rich people. I mean, let’s face it, the average homeless doesn’t come to a tax lawyer. And there are a couple of things that I’ve noticed that every major tax lawyer that I’ve known has said the same thing, and I’ll share a couple of the major criteria of it that they have. First of all, most multimillionaires have an incredible belief system. They really believe that they want to be rich. Now, it sounds funny, but I was talking to the guy who wrote Chicken Soup for the Soul. His name is Mark Victor Hansen.
Jim Lange: He’s a character, isn’t he?
Sandy Botkin: He’s a character. I like Mark very much. He’s one of my favorite people. But Mark was saying that most people feel that they don’t deserve to be rich, and when he first said that, I thought, frankly, the guy was full of it until I was watching television, somebody winning a Powerball lottery, and she said, “I can’t believe I won this! I didn’t think I deserved it.” I heard it myself. If I hadn’t heard it, I wouldn’t have believed it. So, one of the things that I recommend everyone to do, and I give them a little exercise, and those of you listening to the radio, I would strongly urge you to do this, and that is, every day, I want you to point to yourself, and if you’re not doing it, I would do it now, and say, “I deserve to be rich.” And then point to yourself and say, “I want to be rich.” That exercise is very important because it’ll really motivate you to get over the hard days and things like that and get that belief system that you need.
The second thing that most millionaires have is…which is also very, very interesting, is the fact that they…first of all, this came out of the book The Millionaire Next Door. Some of you may have heard about the book where they interviewed multimillionaires, and they found that people who are rich, and you think well, maybe they did some sophisticated investing. Nope. Maybe they just made lots of money. Nope. 85% of all multimillionaires in the United States were average folks. Teachers, people you would never think. But they did one thing that the average person didn’t do, and here’s the one thing they did: they were savers. They saved a minimum of 10% of what they made, they put that away for retirement and they never touched that money. They didn’t touch it for their kids’ education. They didn’t touch it for the dress that they wanted or for vacation. They never touched that money, and they learned to live on the other 90%. That’s really critical.
And the final thing is that almost every single multimillionaire said, “If you want to be a multimillionaire, you’ve gotta get your taxes down to the legal minimum.” I was the warm up act for Donald Trump. I met him. I met his bodyguard. I met his secretary. I met everybody. And he used to always say, “You want to be a multimillionaire? You gotta get your taxes down to the legal minimum.” Sam Walton said the same thing before he died. Bill gates set up a foundation. Why? To save taxes. And the reason for that, and this is so important, is it is very easy and simple to do. It really is. The number one comment that I get around the country is where were you five or ten or twenty years ago? The number two reason is that it’s effective. You know, it’s very interesting. I ask this at my seminars, and you probably know the answer to this, Jim. I say, “If I were to give you a $17,000 raise, you actually get an increase in income of $17,000 a year every year for the next ten years, or I will cut your tax bill by $10,000 every year for the next ten years. Which would you take?” Most people figure the $17,000 is the wrong answer, because by the time you pay the taxes on the $17,000, you end up with less than $10,000. Having $10,000 in taxes saved is like earning almost $20,000. It’s almost that much of a difference.
The third reason tax planning is so important is that it’s the ultimate residual in the world, and when I say that to people, they think, “Oh, what is he talking about?” You know, residual income is where you work once and you get paid year after year after year. A good example of that would be writing books. Another good example would be oil wells. But the problem is, for every one book that’s published, people write 5,000 manuscripts, and maybe one in a hundred really makes money. For every oil well that’s drilled, sure, some oil wells make huge amounts of money, and many oil wells just hit water. But with taxes, everybody pays them. You probably paid them last year. You’re probably going to pay them this year, and with a $14 trillion deficit going up, you’re probably going to pay even more next year. So, if you get a good idea on how to save taxes, it’s good this year, next year, the year after that. It is the best guaranteed residual in the world. And anyone that doesn’t do tax planning is really…I mean, I don’t want to call them an idiot, but they’re really missing the boat.
Jim Lange: Well, I would agree with that, and it’s interesting that you said that the people who tend to do very well over time are the long-term savers. For whatever it’s worth, unlike you, Sandy, who obviously specializes in small business and that’s probably the best market for your book, I specialize in individuals. Although frankly, I think a lot of those things apply to everybody. Most of my clients actually are not businesses, but they are individuals: engineers, college professors, teachers, mid-level managers. And the people who have significant amounts of money, they never necessarily even made a huge amount of money, but what they did is they regularly, on a consistent basis, put the maximum into their retirement plan, often working for companies that either matched at least a portion of it, and they did it, like you said, year after year after year.
Sandy Botkin: And they never took that money out. By the way, I want to emphasize a couple things here that you know, but I want to make sure your listeners know. When you put that money into a stock market, most people who do this, especially mutual funds, have averaged over a 9% rate of return, long-term, and yet, the average investor has probably done less than five percent. You might wonder why would the average investor do five percent when the mutual funds do nine. Are they lying? No. Here’s what happens: there’s a fear-greed cycle. People put money in their mutual fund every year and they put money every year, and then what happens is, the market starts going down because the market goes up, the market goes down. They go, “Oh, I’m a little nervous, but I’ll wait it out.” The market drops even more. Now, they’re getting nervous. Now, their friends are telling them about killer crocodiles and all the horrible things going on in the economy. All you have to do is read the paper. The market still drops. The pain becomes enormous. They sell. But like everything else, everything has a cycle. The market then starts going up and they go, “I’m not sure. I’m going to wait.” The market goes up a little further and maybe a little further. Then they buy. So, what happens is, most people who do not use a planner, who do not have their money managed for them, who become emotional, buy high and sell low. That is what happens. So, what people need to do, and you know I’m right, Jim, they need to put their money away every year, and if they don’t need it in the next three years, don’t worry about it. Now, I would start lightening up on the market if you need the money. Let’s say your kid is going to college in two or three years. At that point, I might start putting it into more fixed type things. But you don’t touch the money. You leave it for retirement. Your retirement is just for that: retirement.
Jim Lange: Well, I would agree with that, and by the way, I actually have a little bit of a rant on…and it’s partly inspired by Jonathan Clemens, who agrees with me, who says, “Take care of your retirement first, then your kids’ college education second.”
Sandy Botkin: Absolutely.
Jim Lange: Because you can’t make up for your retirement.
Sandy Botkin: You know, it blows me away, completely blows me away, how people will spend a hundred, a hundred and fifty, two hundred thousand in debt, or compromise their retirement forever, in order to send that kid to that wonderful school instead of the state university with a full scholarship or state university with a partial scholarship. I don’t get it!
Jim Lange: I have a very good friend, one of my best friends in the world was in that situation, and his daughter had a full boat to a very good state school and not a full boat to a very expensive school, and I was thinking, “Boy, you know, if she wants to go to the expensive school, it should be on her dime.” And by the way, when I was growing up, I really wanted to go to Syracuse, which was pretty expensive at the time, and my parents said, “Well, we’re going to pay for state school tuition. If you want to go to Syracuse, go ahead and just pick up the difference.” When I realized how much debt I was going to be in, I thought, “Well, maybe I’ll just be happy with the state school.”
Sandy Botkin: You did the right thing. I don’t know anybody to this day, and I’ve met a lot of people in my life, I can’t think of one who was happy having $200,000 or $150,000 of debt for a college.
Jim Lange: Well, what I would say is if you’re in a fortunate position, and it sounds like you are, and let’s say that your daughter was able to get into a good school and you could afford it, you know, great. Why not? But for people who are not in that situation, I think it’s really hard. Now, one of the things that you do in your book is you say, “Okay, well, whatever you’re going to be paying, let’s try to take advantage of some of the tax aspects of college tuition and planning for college tuition.” So, maybe we could talk about that for a little bit, because I know we have listeners who have children in college. And then, the other thing is, I probably have more clients who have grandchildren who are approaching, or are in, college than parents. So, if we could look at it from both?
Sandy Botkin: Let’s talk about it. Let’s talk about the best way to save for college. First of all, I want to emphasize something: most financial planners will tell you, (and I think you’re an exception to the rule, by the way, Jim) ‘Well, save up for college,’ but they leave out the other half of the equation, and the other half of the equation is if you can, hire your kids in your business. Pay them a wage. Wages that you pay an assistant in business, if it’s reasonable, are deductible, and then if they use that money to pay for their own college or their own education, aren’t you, in essence, getting a deduction for those things? It’s the same money, but in one case, it went from non-deductible to deductible wages. You can hire them for things like licking envelopes or addressing envelopes. If you live in Washington DC or Houston, Texas, shred documents! Maybe the listeners will get that one!
Jim Lange: I haven’t heard that one!
Sandy Botkin: No extra charge on that one, Jim. But the point is, you know, do those things. Now, the question is, let’s say you hire your kids, which is what I did, then what do you do with the money? Well, the answer is, you have a couple good options. One of the options is every state university in every state that I know of has what they call a ‘prepaid tuition plan,’ which is what I used actually for most of my kids, and the prepaid tuition plan is you put a fixed amount of money in and it covers them for four years of tuition and required fees, regardless of the tuition, regardless of what it is, when they go to school, and that’s really, really good. Your rate of return on that, with the way college has been appreciating in tuition, has been enormous. And that’s called a prepaid tuition plan. It’s a qualified tuition plan. It’s highly recommended. And people ask, “Well, what happens if my kid doesn’t go to a state university?” Well, that’s what happened to my daughter. My daughter, in fact, you mentioned my daughter, actually got into a state university in Cincinnati because she wanted to go for digital design, but she also got into Carnegie Mellon on a wait list, and they called her up and she said, “Well, what kind of a scholarship are you going to give me?” And they looked at her like, “What do you mean, scholarship? You’re on a wait list!” And she said, “No problem. I’ll go to the one that’s giving me money. Thank you.” I was so proud of her, I can’t tell you.
Jim Lange: Now, by the way, the people in Pittsburgh are wincing because this is a Pittsburgh show. I’ll just happen to remind you, but this is a Pittsburgh show.
Sandy Botkin: I understand that. I think Carnegie Mellon’s a great school.
Jim Lange: We are home to Carnegie Mellon. My wife is a graduate of Carnegie Mellon. She has a math degree, and then she actually has a Master’s in electrical engineering from Carnegie Mellon.
Sandy Botkin: I understand. I think Carnegie Mellon’s a great place.
Jim Lange: Okay, very good.
Sandy Botkin: But if it’s a tossup between $55,000 a year and $8,000 a year…
Nicole DiMartino: Exactly!
Sandy Botkin: Okay? Anyway, that’s beside the point. It’s because I had a prepaid tuition with Maryland, but what Maryland did (and this is true of a lot of other plans) is they will pay out what the tuition would have been at the University of Maryland. So, every year, her college (which is the University of Cincinnati School of Design, Art, Architecture & Planning) gets a check on what the tuition would have been, which covers probably 80% of the tuition.
Jim Lange: Right, and by the way, I should point out to listeners, a prepaid tuition plan is a variation of a 529 Plan.
Sandy Botkin: That’s the next one. That’s the next one I’m talking about. Now, the second one is the section 529 Plan, which is also a qualified tuition plan. Now, a section 529 Plan is where…it’s like a mutual fund, in a sense. You put money in. It’s set up by a financial planner, probably by you or by other financial institutions.
Jim Lange: Well, I’m kind of a cheapskate, so I tend to use the state ones. Pennsylvania actually has the Vanguard set.
Sandy Botkin: Pennsylvania has the 529?
Jim Lange: Yeah.
Sandy Botkin: Okay.
Jim Lange: I think all the states do, but Pennsylvania used to have, and I’d better watch out, they had a set of funds I wasn’t such a big fan of, and then recently, maybe five years ago, they switched to Vanguard as the custodian of their plans, and I was much happier with the investment choices.
Sandy Botkin: Got it, okay. Well, the 529 Plan is different in that it will also cover…well, it doesn’t cover guaranteed tuition. That’s the one thing it doesn’t do like the prepaid tuition plans do. But the 529 Plan is like a mutual fund, which can be used to pay tuition anywhere, plus required fees, plus I think it can also cover room and board, if I remember correctly, although I could be wrong on that. I think it does.
Jim Lange: Yeah, and computers and supplies, etc.
Sandy Botkin: Correct, and it’s tax-free for an undergraduate’s education.
Jim Lange: Right. So, what you have to do is, you have to compare, let’s say, the rate of return that is above a market rate of return in terms of tuition inflation with the prepaid plan versus the, let’s say, additional flexibility of being able to go anywhere.
Sandy Botkin: Sure, and you can do both! You can do both.
Jim Lange: Actually, that’s probably even the best solution.
Sandy Botkin: And you can switch any relatives. If you have a kid that doesn’t want to go and you want to use it for your grandkid or you want to use it for your niece and nephew, you can switch relatives.
Jim Lange: Right, and you can switch between first cousins, for example.
Sandy Botkin: That’s right! You can do both. Now, the third type of thing I want to emphasize is something new that came in within the last couple years. It’s called a ‘prepaid tuition for private schools.’ There is a private prepaid tuition plan (and for the life of me, I can’t think of the name of the plan, but if you do a search on Google, you’ll be able to find it) where there are 300 major private institutions that subscribe to it, and you put a certain amount of money away and it will guarantee four years of tuition at any of those private schools, including required fees.
Jim Lange: Right, but then again, now you have to guess, “Gee, is my kid going to go to a private school or a state school?”
Sandy Botkin: Correct. That’s the problem with it. That’s the downside.
Jim Lange: Right, but maybe if you know…I know, for example, I would probably prefer, my daughter, I think, would do better at a smaller school, and it might very well likely be a private school. So, that might actually be a reasonable choice for me. Her mother, by the way, wants her to go to CMU, of course.
Sandy Botkin: Of course.
Jim Lange: But she’s actually a math kid. She’s takes after her mom. She’s a whiz in math. But that might be a reasonable choice. If somebody’s kids or grandkids are more realistically going to a state school, then a prepaid state tuition plan might be good, and if you’re just not willing to make that commitment and you’re willing to accept, in effect, a lower rate where you’re not actually buying credits, you’re just investing the money in having it…in effect, it acts like an IRA, where you don’t get a tax deduction going in, but the money grows income tax-free.
Sandy Botkin: Correct.
Jim Lange: Then a traditional 529 Plan’s probably a good answer. Or your idea, which I like, is some combination.
Sandy Botkin: Some combination, which I think is the idea with the most flexibility, but I want to emphasize one more thing before everybody goes. You know, every now and then, I like to give one really ‘wow’ tip, and I want to give a really ‘wow’ tip to everybody who’s listening in so they’re going to love this show! And here’s your ‘wow’ tip: remember I talked about hiring kids and you can deduct the wages? Well, how would you like to get in-state tuition for an out-of-state student?
Jim Lange: We like that.
Sandy Botkin: Let me mention this, and let me tell you the difference. My daughter went to the University of Cincinnati. The tuition there was, at that time, for an out-of-state kid, about $24,000 a year. In-state was $8,000. Okay? Most state universities have an option to be able to get in-state tuition. They have a couple options. Some of the things were a parent could move to the state, you can join the military, some of these things are not viable. But, you know, they have those options. But there’s one other thing that’s kind of hidden in most states. Not everywhere, but it is in Ohio and it is in some other states, and that is, if you can show your kid is truly independent of the parents, then they can get in-state tuition. Independent means they pay their own tuition, they pay their own room and board, they pay out of funds in their name, or they’re working and they’re paying these expenses out of their name. So, here’s the point: we’ve been hiring my daughter for years, okay? Particularly when she designed the website. We had a lot of money in her name. Her tuition was completely paid in year one by her. Her room and board was paid by her. She established residency. She filed Ohio tax returns. We stopped claiming her as a dependent (that’s very important, by the way). She also had a voter’s registration. When year two came around, we filed for residency status based on the fact that she was independent.
Jim Lange: You have about thirty seconds.
Sandy Botkin: Done.
Jim Lange: Okay! All right, very good. Anyway, Sandy, it has been a pleasure. You’ve given our listeners a lot to think about. The book is Lower Your Taxes Big Time by Sandy Botkin. Thank you so much. This is Jim Lange at The Lange Money Hour, Where Smart Money Talks.
Sandy Botkin: And make your life less taxing!
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James Lange, CPA
Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania. He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again. He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans. His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans. Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA). Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.
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