Unlock the secrets to maximizing your painting business's profits with tax strategies that can turn even a modest income into a growing wealth pool. Daniel and I take you through the crucial tactics that could save you thousands, exemplifying how a $2,000 tax credit can significantly impact lower-income earners. We'll tear down the common misconceptions that tax planning is only for the rich and show you how reinvesting in your business or making smart real estate moves can lead to an optimized taxable income. And for all the entrepreneurs out there, we'll reveal how transitioning from traditional employment to running your own show offers a golden opportunity to leverage tax strategies to your advantage.
Ever wondered how you could be sitting on a substantial net worth yet report a lower income? Join us as we dissect the difference between wealth and income and guide you through the maze of depreciation methods, including the double declining balance and straight-line depreciation. Learn why tax-deferred accounts like HSAs are your new best friends for both immediate and future gains. It's a treasure trove of insights for painting business owners and budding entrepreneurs alike. Plus, we extend an invitation to our Facebook group, Grow Your Painting Business, where you can continue the conversation and get personalized advice to help your business thrive.
Unlock the secrets to maximizing your painting business's profits with tax strategies that can turn even a modest income into a growing wealth pool. Daniel and I take you through the crucial tactics that could save you thousands, exemplifying how a $2,000 tax credit can significantly impact lower-income earners. We'll tear down the common misconceptions that tax planning is only for the rich and show you how reinvesting in your business or making smart real estate moves can lead to an optimized taxable income. And for all the entrepreneurs out there, we'll reveal how transitioning from traditional employment to running your own show offers a golden opportunity to leverage tax strategies to your advantage.
Ever wondered how you could be sitting on a substantial net worth yet report a lower income? Join us as we dissect the difference between wealth and income and guide you through the maze of depreciation methods, including the double declining balance and straight-line depreciation. Learn why tax-deferred accounts like HSAs are your new best friends for both immediate and future gains. It's a treasure trove of insights for painting business owners and budding entrepreneurs alike. Plus, we extend an invitation to our Facebook group, Grow Your Painting Business, where you can continue the conversation and get personalized advice to help your business thrive.
Speaker 1:
Welcome to the Profitable Painter Podcast. The mission of this podcast is simple to help you navigate the financial and tax aspects of starting, running and scaling a professional painting business, from the brushes and ladders to the spreadsheets and balance sheets. We've got you covered. But before we dive in, a quick word of caution While we strive to provide accurate and up-to-date financial and tax information, nothing you hear on this podcast should be considered as financial advice specifically for you or your business. We're here to share general knowledge and experiences, not to replace the tailored advice you get from a professional financial advisor or tax consultant.
Speaker 2:
We strongly recommend you seeking individualized advice before making any significant financial decision. This is Daniel the founder of Bookkeeping for Painters.
Speaker 3:
And this is Richard, tax director, on a beautiful summer day. We're going to talk about tax strategies, because why would you want to be out enjoying your summer when you could be talking about finances, right?
Speaker 2:
Yeah, that's the first thing that comes to mind when I think of fun is tax strategies.
Speaker 3:
Right? Well, hopefully, if you put a little bit of time towards tax planning and strategizing, you will have more time for fun and recreation when you get older. At least that's the goal, right, like? Try to make wise decisions now so that you have dividends in the future. And a lot of times we don't think about tax planning or we say well, that's for wealthy people, right, I have to have a team of accountants and lawyers and be able to pay them all before that makes sense, and it is definitely important for very wealthy people. But tax planning can be actually even more important when you have a lower to a moderate income, because the tax savings, even though the amounts may be less when you have less income, they often represent a greater percentage of your income. So you know, for example, a high earner would probably love to have a $2,000 tax credit. That would be great for them, but a lower earner, a $2,000 tax credit would represent a greater percentage of their overall income. If you make $50,000, a $2,000 tax credit is 4% of everything you earned that year. Tax credit is 4% of everything you earned that year, whereas for someone who earns $400,000, it would only represent about one half of 1%. So the amounts are different but the benefits can be even greater. So when we say low to moderate income, what we're really kind of talking about is people who make about $100,000 a year or less. You know the definitions for low and moderate are always changing inflation and whatnot but you know, generally speaking, this is going to describe your average American for the most part. So people who are, you know, working class.
Speaker 3:
And something you know that we should probably distinguish is that just because you are, you know, a low to moderate income earner doesn't mean that you aren't wealthy. You know wealth and income are two different things, right? You know a very wealthy person might have years in which they have less than $100,000 of income. You know, for example, you might be a painting business owner who's worked hard your entire life, you've made a lot of income over the years, and then you decide to retire and sell your business. You use the proceeds from your business to pay off all your debt and invest the profits, and now you're living off of the earnings from your hard work. You are very wealthy because you have a lot of assets, you have paid for a home and you have stocks and you have rental real estate, but your income that year might be $100,000 or so.
Speaker 3:
So you know, just because we have a lower income one year doesn't mean that we're doing anything wrong, or doesn't mean that we're not, you know, wealthy. It just means that in this particular year we're only recognizing X amount of taxable income. Another scenario where this might happen is you may have a newer business and you're in that rapid growth phase and every dollar of profit that you earn is being reinvested back into the business. You're buying more trucks, you're hiring more people, you're increasing your advertising, so you may earn a lot of money, but because you're reinvesting it in business expenses, your income for that year would be lower because you're only taxed on your profits. Another situation might be someone who invests heavily into real estate. So we're buying assets, things that are going to grow in value, and maybe we use cost segregation studies to accelerate depreciation and drive down the amount of our income. You're wealthy, you have a lot of assets, but your taxable income is very low.
Speaker 2:
Yeah, and that's a common strategy that we see with the folks that we work with the painting businesses. They have their painting business built up. They might be doing a couple million in revenue per year and they have some extra money laying around like a big bank account of cash, and so they start looking where else can I put this cash? And real estate is often an kind of a no-brainer for for painting business owners because they kind of they have the ability to to change, transfer my home, you home, from something that's not so great to something that looks awesome.
Speaker 2:
So often, rental real estate is something that we help folks with. Because of that. It also reminds me of Ted Turner. He was the entrepreneur that started CNN back in the day. He took his dad's billboard business and basically grew it to a multi-billion dollar company and he basically bought half of the United States in property. He's putting it all in real estate for many years back in the 90s. But, yeah, using your wealth to invest in real estate and to help maintain that wealth is something that we see quite often.
Speaker 3:
Yeah, there's definitely some really powerful tax strategies around that. I mentioned cost segregation. We could do several episodes around that Not today, but if you are doing something like a cost segregation study, you're going to be reducing your income dramatically, dramatically, and so, even though you have all this real estate, you're going to have a relatively low income that year. So the whole key to this is like why do we want a low income? Or maybe a better way to phrase that is how do we leverage a low income to our benefit? Kind of like taking lemons and making them into lemonade. Well, the key here has to do with the progressive tax system that we have in this country and the way the tax brackets work. So when you have a lower to moderate income, you are in a lower to moderate tax bracket. In this country, we have about seven different tax brackets, ranging anywhere from 10% all the way up to 37%, although there is some talk about maybe adjusting that. This is what we have as of recording this episode. But tax brackets, it's important to kind of understand how they work. So sometimes people say, oh, I'm in a 35% tax bracket. Well, does that mean that 35% of your income is what you have to pay in taxes. No, it means that your marginal rate is 35%. So I like to think of it like you know, you have different buckets of income and each bucket has its own separate tax rate. So when you're first, when you make your first dollar of the year, the first you know, fourteen thousand six hundred dollars that you earn, if you are a single taxpayer, is tax free. The standard deduction takes care of that. You won't pay anything on the first $14,600. If you're married, filing jointly, that number doubles because there's two of you. But then, after that standard deduction, the next $1 all the way up to $11,599. That constitutes the next bucket that is taxed at 10%. So no matter how much money you make overall that year, after the standard deduction the first $11,599 is 10%. If you're married filing jointly, that number is doubled. Then, from $11,600 up to $47,150, it is taxed at 12%. After $47,000 up to about $100,000, your tax bracket is 22%. Your tax bracket is 22%. So as you fill these different buckets, your tax percentage goes up higher and higher, all the way up to about $609,000, where your tax bracket is going to be 37%. So when we say marginal tax bracket, we mean the highest bucket that you've been able to fill tax bracket, we mean the highest bucket that you've been able to fill. The reason that it's important to understand that is, when we do tax planning, we are increasing or decreasing your income and it's those last dollars that are going to be affected. So if you're in that 37% tax bracket and we can reduce your taxable income by $1,000, you save 37% or $370.
Speaker 3:
So the key here is when you are in a lower tax bracket, when you have a lower marginal rate, like say, 10 or 12%, that is the time that you want to recognize income. So the IRS says do you want to pay taxes on this income? And you're in a 10% bracket. The answer is yes, and you're in a 10% bracket? The answer is yes. Yes, I want to pay taxes on this now, at 10%, and not in the future when I might be in a 35% tax bracket. There's kind of an expression around tax accountants that says you pick your tax rate or the IRS will pick it for you. So this is a timing issue. If we can decide when we're going to recognize income, we can decide to recognize it when the tax rate is lower and not when the tax rate is higher.
Speaker 3:
So there's different strategies around how we might do this. I'm going to talk about six of them today. One has to do with income deferment. So that is kind of a fancy way of saying I'm going to push my income off into the next year. If you're a business owner, you might do this. You know, as a cash basis taxpayer you might do this by not billing for certain work you do until the following year. We've got podcasts on how this works, but basically kicking that can down the road and recognizing that income later on. And the reason this works is because there's going to come a year when you don't have a lot of money coming in.
Speaker 3:
Maybe you've hit one of those scenarios we talked about at the beginning, or maybe you just got some bad luck. It's a down year, and you think to yourself boy, now's a great time to stop kicking that can down the road and pay the taxes, because I'd rather pay them at 12% than wait till next year, when business is booming, and pay them at 24%. So income deferment is one thing you can do. Same thing with expense acceleration. It's just the opposite side of that maybe choosing not to buy your materials and take those tax deductions until next year when your tax rate will be higher.
Speaker 3:
Another example of this has to do with depreciation. We talked a lot about bonus depreciation, section 179, writing that new car or that new piece of equipment off in the first year. Let's talk about the opposite of that, maybe. I don't want to take a huge depreciation deduction in this year because my tax bracket's really low, so I don't want to accelerate. I want to slow down depreciation as slow as possible so that I take a little tax break this year and save it for next year and the next four years to come when my taxes are going to be higher. Take that tax break when it's going to save you the most. Do the most good in future years.
Speaker 2:
Yeah, I think that's a key thing to realize is you can actually decide what type of depreciation you're going to take on that piece of equipment in your business or or a vehicle, business vehicle. I don't think a lot of people realize that, that they can actually say, oh, I'm going to choose straight line depreciation instead of bonus depreciation, makers depreciation so, and that that can be something where, like you said, maybe you're having a, you're just starting out in your business or it's it's been going slow and you expect the future years to be a lot more profitable than maybe taking the straight line depreciation on that newly bought asset would make sense instead of the bonus depreciation.
Speaker 3:
Yeah, no, absolutely. I'm glad you clarified that, daniel. It is about having control, it's about making decisions, and I'll just kind of throw this out here as a tax preparer most tax prep software is going to default to what's known as double declining balance, which is where you stretch out depreciation over a period of years, like five years for a new truck, but you take a little bit more up front and a little bit less towards the back. That does work out well as like kind of a you know a hybrid there. But if you're in a year when you want to recognize income because your tax bracket is low, tell your tax professional hey, I don't want double declining balance, I want straight line. I want to slow it down as much as possible. And you know, have them explain it to you and show you that they were able to do that for you. So another strategy has to do with deferring your tax breaks to future years. So there's a few vehicles for doing this. One is the HSA, or health savings account. This is a great strategy, honestly, no matter what your income is, but especially when your tax bracket is really low. In a nutshell, a health savings account is a savings account that you use for regular health care expenses. So doctors visits, prescription medicines, you know, surgeries, things like that. You put money in tax-free, it grows in the account and then when it comes out, it comes out tax-free as long as it's being used on qualified healthcare expenses. So normally I'd say, well, I don't want to take my tax break up front because I'm in a low tax bracket. But in this case you're kind of double dipping and it's one of the few times that you're legally allowed to double dip. So go ahead and get that tax break up front because you're going to get another one on the way out. And if you don't end up using all the money in your HSA for medical expenses, you can then withdraw it as like a retirement savings account when you turn I think it's 62. Is that when you qualify for Medicare? I think it's 62 or 65. When you qualify for Medicare, you can take the money out tax-free as like an extra savings account.
Speaker 3:
The other vehicle is the Roth IRA. So this one is just a straight retirement account. There is no double dipping on this one. But you make contributions to the Roth. You pay taxes on those contributions when you make them. And when I say taxes on contributions. I mean you're paying normal taxes on the income, right? There's no tax savings going in. That's okay because you're in a low tax bracket. So let's max up those Roth contributions, get as much as you can in there, because they're going to grow in that retirement account and they're going to come out eventually completely tax-free. So go ahead.
Speaker 3:
And if you got a traditional IRA and you're in a down year might be a good time to switch that to a Roth and make your contributions into a Roth. You can have both. And as long as you don't spend more than $7,000 per person between the two of them, you can have both. And if you have a spouse, then they also have an additional 7,000. If you're 50 years or older, that number jumps up to 8,000.
Speaker 3:
Now what if you have a traditional IRA already? Maybe it's something you've been contributing to for a while, maybe it's an old work 401k that you converted to an IRA and you're like man, I wish I had known more about the Roths earlier. I would love for this to grow tax-free. Well, there is at least, as of now, a way that you can convert your traditional IRAs into Roth accounts. The caveat is that you have to pay the taxes on that money when you do it, but you pay the taxes at your current tax bracket. So this is interesting.
Speaker 3:
Let's say you had a high-paying job as an employee and you had a company 401k and you made significant contributions and you got those tax savings when you were in a 35% tax bracket. You got those tax savings. Now you've left that job. You've converted your 401k into an IRA so you have control over it. It's not sponsored by your employer anymore and now you have a down year. You're in a 12% tax bracket. Imagine converting that into a Roth at 12%. You've got the 35% savings earlier. You're paying 12% on the money. Now it's going to grow tax-free and then you can take it out when you retire. So there's some arbitrage there. Right, we're getting higher savings earlier. We're paying a little bit now. We're getting a lot of savings in the future. So a Roth conversion is always something to think about when you're having a down year.
Speaker 2:
And then, finally, oh, I was also. Yeah, I would say also, if you're like starting your painting business, maybe you, like you said, had that corporate job and then you're getting out of the corporate grind and you're you want to start something on on your own and you know, going into entrepreneurship, you have that new business and it's it's not going to hit the ground running, probably right out the gate. You might have a little bit of a lull on that startup period. Maybe that's the time to convert that into a Roth.
Speaker 3:
Yeah, absolutely. Roths are so powerful for building wealth. Sometimes we get hung up on the immediate tax savings and I get it right Because we're thinking how can I reduce my tax liability in this year? Okay, a traditional IRA, it's great, I don't have to pay taxes on the money. But choosing to pay the taxes now, especially if you're in that lower tax bracket, so that it can grow into, I mean, you know, if we're putting $7,000 into a Roth and we're young enough that money might double five times before retirement. So I mean I'm going to use my calculator because I don't want to mess this up. You know, five doubles $14,000, $28,000, $56,000, $112,000. It's a lot of money. Tax-free, we paid taxes on $7,000. We're going to take out $112,000. It's a lot of money. Tax-free, we paid taxes on $7,000. We're going to take out $112,000. It's a great deal. So even in years where you're doing pretty good, roths are always max out your Roth All right.
Speaker 3:
So the last one this one's a little bit niche. This one you kind of have to be in the right circumstances for, but it has to do with retirement account distributions. So let's say you've got a traditional IRA or a 401k, right, it's not a Roth. You're going to have to pay taxes on it when you pull the money out, but you can choose when you're going to pull the money out. One thing you don't want to do is pull the money out early or in a situation where you're going to have to pay a penalty. We don't want to pay the 10% penalty. That's never worth it. But if we're able to make a distribution and it's going to be at a time when our tax bracket is lower or maybe we live in a state that doesn't have an income tax, that year maybe we don't need the money, but maybe it's the right time to pull it out. Pull it out and put it into a savings account, collect interest on it, but you're choosing when you want to pay the taxes on that.
Speaker 3:
If you don't pull the money out, the government will actually force you to pull the money out. When you hit 72 years old, you'll have required minimum distributions and you might not be. You know that might not be the time you want to do it right? I don't know your situation. You might be in a higher tax bracket. So if you're in that low tax bracket and you are able to pull money out of your retirement account and not get penalized, because the penalty will throw the strategy off. You might want to consider doing that. There's other options too, things like charitable remainder, trusts and whatnot. That's another episode. But if you want to, especially if you want to keep the money and not donate it, you know, pulling it out when it's most tax efficient is something that you'll want to think about. So this is just kind of you know, a few different ways of using the IRS's tax brackets to our advantage.
Speaker 3:
I think the main takeaway that I wanted to put forth in this episode is just because we're lower or moderate income doesn't mean that we shouldn't be thinking about tax planning. It can be even more important to us lower or moderate income earners to be thinking about these things. A wealthy person can afford to lose more. A person who only makes $100,000 a year or less has to be a little bit more careful. Thousand dollars a year or less has to be a little bit more careful, and using the progressive tax system to our advantage and choosing when we're going to pay the taxes puts us in the driver's seat. Picking when we're going to pay the taxes so that the IRS doesn't pick it for us allows us to have more control over our money and allows us to choose a lower overall tax rate than we might have to pay otherwise.
Speaker 3:
So if you'd like more information about this, definitely talk to your tax planner. This is something that you're going to want to have a plan for and a strategy for, or you can ask us questions in our Facebook group. It is Grow, your Painting Business. We'd be very happy to have you in our group. Drop your comments or your thoughts below, suggest topics for future episodes, or just stop by to say hi and let us know what you think about the podcast. We would love to hear from you.