Case Study: Maximizing After-Tax Income From Your Business

A Home Run in the First Year of a New Business

We recently started working with a new client, Eric,  who saw an opportunity in his industry in 2021 and successfully capitalized on his idea.

He took the time to develop a solid business plan, did considerable market research, and saved enough to be sure that he could invest in the business properly to fund necessary operations. With a streamlined business plan, creative marketing and a high-value service, he was poised for success.

And it worked! His business planning, and a year of very hard work, paid off handsomely; he not only generated revenue in his first year in operation, he ended the year with $475,000 in self-employment income for 2021.

The problem?  He planned for his business to be successful but had no plan in place for minimizing his tax bill and maximizing his return from the success of the business.  Not surprising, this is something we see all the time and are always excited to help with.  

But How Do You Minimize a Massive Tax Liability, After the Tax Year is Over?

Eric was facing a $175,000 tax bill for 2021. When he set up his business, he opted for the simplest structure possible and had not done any business or personal tax planning.

Working closely with Eric’s accountant, we completed a tax projection based on 2021 income.  Eric would pay $175,000 in taxes for 2021, given no changes. When he set up his business, he opted for the simplest structure possible and had not done any business or personal tax planning.  The structure he selected provided no tax advantages for Eric and potentially exposed his personal assets to business liabilities.

Specifically, Eric needed both immediate and long-term help, including:

• Minimize his existing tax bill and build a plan for reducing taxes going forward

• Understand and implement further financial planning into his business

• Create a comprehensive financial plan that mapped to his new income source as business owner

• Set up a plan to value his business and fund future growth

Comprehensive Tax, Retirement and Business Planning Solutions

Tempus Pecunia worked with Eric to review his business structure. Eric was operating as a sole proprietor, which meant all income was subject to self-employment tax. In addition to the tax issue, he was also personally liable for the business.

To correct this, our recommendation was to retroactively elect S-Corporation filing status, back to January 1, 2021. This required creating a limited liability company, and then filing IRS Form 2553, which we helped him implement in conjunction with his tax professional.

The S-Corp status lowered his payroll taxes and self-employment taxes. We analyzed his revenue stream and the tax implications, and determined that declaring a salary of $75,000 and then taking all the remaining income as distributions from the business, which do not incur payroll tax, would be an effective strategy to lower taxes.

The retroactive S-Corp election provided approximately $18,000 in total tax savings.

Next up, we recommended establishing a Solo 401(k) retirement plan. Eric contributed the maximum amount of $19,500, and the business contributed an additional $18,750 as a profit-sharing contribution.

The tax savings from the retirement plan was another $17,000.

Setting up a retirement plan for the business has other benefits besides tax savings. It allows Eric to continue to invest outside of the business, which diversifies his overall risk.  We also helped Eric to take advantage of a Backdoor Roth strategy inside the 401k plan, helping him build a bucket of investments that will grow tax-free. 

In less than a month of working with Eric, we were able to reduce his tax bill by $35,000 and help him build investments of over $40,000.  The change in business structure also reduced his potential liability to his personal assets.  Now we’re working with Eric to develop a comprehensive financial plan that helps him use his new business success to fuel his vision of his ideal life!

The Outcome: Tax Savings This Year – And Every Year

Working with Tempus Pecunia, Eric was able to achieve his immediate goal of reducing a big tax liability. As a business owner, he now has additional ways to think about tax planning and he has a better understanding that taxes are likely the largest expense he’ll pay over his lifetime. Tempus Pecunia helped him set up a comprehensive tax plan that will create significant savings going forward.

Tempus Pecunia also suggested some tax-saving measures for next year:

• Solo 401(k) rules permit the spouse to contribute, as long as they work in the business. Eric’s spouse will join the business part-time next year, and will contribute the maximum, which will increase tax savings and boost retirement savings for the couple.

• The variable cash-flows of the business allow for multi-year tax optimization strategies.

• Eric is currently leasing his business premises and may consider buying.  We would then evaluate real estate strategies like cost segregation studies and 1031 exchanges to add to his tax plan.  

Changing a business structure and setting up a 401(k) are complex strategies that demanded proper implementation, but done correctly they resulted in tax savings that will compound year after year. For more on tax planning for business owners, see our piece on tax planning as a year-round activity.

Tempus Pecunia created an investment plan for Eric that effectively moves some assets away from the business, which helps manage his overall risk through diversification. We also embarked on a new valuation plan for the business, given the strong first year revenue and the changing growth trajectory. The new business valuation is important to keep the business tracking, for potential lending options as needed for the business, and for the new estate plan that Tempus Pecunia set up to protect Eric’s family.