What if the tax strategies you're following could ruin your painting business? Join us on the Profitable Painter Podcast as we reveal the dangerous misinformation that social media influencers are spreading. We kick off with a fun chat about Daniel's upcoming family trip to Cape Canaveral to see a SpaceX launch and visit the Kennedy Space Center, setting the stage for some serious financial talk. We dive into five common tax strategies that can lead to financial disaster, using the cautionary tale of Wesley Snipes to underline the importance of professional advice.
We then delve into the complexities of multi-state taxation and cost segregation studies for real estate investors. Learn how forming an LLC in one state but operating in another can lead to unexpected tax liabilities, and discover the benefits and risks of accelerating depreciation on your properties. Finally, we tackle the pros and cons of setting up a C-Corp compared to an S-Corp in the context of a painting business, and discuss scenarios like Rollover for Business Startups (ROBS). Don't miss this episode—it's packed with essential insights to help you navigate the financial maze and make informed decisions for your painting business.
What if the tax strategies you're following could ruin your painting business? Join us on the Profitable Painter Podcast as we reveal the dangerous misinformation that social media influencers are spreading. We kick off with a fun chat about Daniel's upcoming family trip to Cape Canaveral to see a SpaceX launch and visit the Kennedy Space Center, setting the stage for some serious financial talk. We dive into five common tax strategies that can lead to financial disaster, using the cautionary tale of Wesley Snipes to underline the importance of professional advice.
We then delve into the complexities of multi-state taxation and cost segregation studies for real estate investors. Learn how forming an LLC in one state but operating in another can lead to unexpected tax liabilities, and discover the benefits and risks of accelerating depreciation on your properties. Finally, we tackle the pros and cons of setting up a C-Corp compared to an S-Corp in the context of a painting business, and discuss scenarios like Rollover for Business Startups (ROBS). Don't miss this episode—it's packed with essential insights to help you navigate the financial maze and make informed decisions for your painting business.
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.
Speaker 3:Bookkeeping for Painters. And this is Richard, tax director. How's it going today, Daniel?
Speaker 2:It's going well. I'm excited. We're going to a SpaceX launch. We're near Cape Canaveral, so we're taking the family and we're going to spend the night at a hotel I guess the hotel is so close that you can actually see the, the rockets launch and then we'll probably go to the beach and watch the rocket from there but that's going to be tomorrow around midday hopefully and maybe go to the, the, the facility, the museum. I forgot what it's called Kennedy space, kennedy space Center. Is that right?
Speaker 3:Yeah, that's awesome. I would love to see a rocket launch. I've seen them from a distance like Orlando, but to be up close and actually see it take off would be an incredible experience. We did go to the Kennedy Space Center last summer my son. They have a playground there like an indoor playground and my son thought that was the most impressive part. I personally really loved the space shuttle exhibit because I was born in the early 80s and I grew up with that, so that was really cool, and they also have like the Saturn V rockets there, so I think you guys will have an awesome weekend. I'm happy for you. Yeah, that, uh, so that was really cool, and they also have like the saturn five rockets there, so I I think you guys will have an awesome weekend. I'm happy for you yeah, I'm excited.
Speaker 2:So, which takes us into our completely unrelated topic of this, this week's podcast, which is, uh, the five strategy tax strategies that are the worst for painting business owners.
Speaker 3:Yes, we usually always bring you great ideas.
Speaker 3:Today, we're going to bring you terrible ideas that we don't want you to use, and the reason we are bringing this up is because these are actually pretty popular ideas. There's a lot of misinformation, bad information, around some of these strategies, and if you are on Facebook or Instagram, or especially TikTok, it's likely that you've heard some people talking about these things, and so we thought we'd kind of point out the ones that we would tend to steer you away from, because we don't want you to have any bad information. The reason that this is bad strategies is usually because the people who promote these things they're not accountants, they're influencers, and their goal is not necessarily your best interests or what's going to save you money and grow your business. Their interest is what's going to get them clicks, what's going to drive up the algorithm, and so you'll see stuff that is either like incomplete information, a misapplication of the law or, sometimes you know, just plain bad advice, and you need to be very careful that you don't get caught up in something like this.
Speaker 2:Yeah, I think it was like a couple of months ago. It was like a trend on a lot of social media sites, with folks in the painting industry posting about oh, I hired my son and daughter to be models and so we take pictures of them for advertising and we're paying them some exorbitant salary per year as a write-off like paying them $40,000 a year or something, I don't remember the exact figures, but it was just like just for them being in pictures they're getting like this crazy amount of money that they're putting. You know, paying their kids, which we do. You know there is a right way to pay your kids, not saying that that's not a thing, but you kind of have to be do it within reason.
Speaker 3:Right. That's what makes these things dangerous is because there's usually some grain of truth in here and, like you said, paying your kids, if done correctly, is a legitimate strategy. But the way it's being promoted is not going to fly and we can't just say well, I was relying on so-and-so, listening to their advice. We don't want you to end up like Wesley Snipes, and I think the average age of our audience knows who Wesley Snipes is.
Speaker 3:He was a pretty popular actor in the 1990s. He was in movies like Demolition man and Blade and he got caught up into some really bad advice. He listened to a man who claimed to know what he was talking about and told him that he didn't have to pay taxes if he filed certain paperwork and that he should send in these amended returns to get these huge refunds. And it ended up where he had to go to court and he was charged criminally for trying to defraud the United States Treasury. He was convicted and he spent 28 months in federal prison and was fined $5 million. I mean, the good news for Wesley is that he came out of the situation with a much better attitude. He took responsibility for his mistakes and, you know, it sounds like his acting career is starting to rebound. But you know, no one listening to this is going to go to jail or anything. But we don't want you to make similar mistakes and have you overpay in taxes or set yourself up for an audit or just cause yourselves problems because someone gave you bad advice.
Speaker 2:Yeah, and like that whole tax protester, sovereign citizen, those ideas where you know people come up with this rationale or justification that you shouldn't have to pay taxes because it doesn't say it in the constitution. I don't know the arguments that well, but I've had one of my friends. He likes to tell me those those arguments and I mean they sound interesting. But all the people that are enforcing these rules don't buy into them and so don't don uh bet your life on it, uh, on those ideas.
Speaker 3:you know, just go with what the irs is saying are the rules and you'll make your life a lot easier, uh, that way yeah, the um, the sovereign citizen argument or the tax protester argument has been, uh, thoroughly reviewed by the IRS and like, like they have no tolerance, just no tolerance whatsoever for it, right or wrong. I mean, there's arguments people can make, but that's, that's the way it is. So. So there's a bonus one, that that probably is the worst strategy. There is the tax protester strategy, but we came up with five other strategies you've probably heard about if you're on social media. And again, it's not that these strategies are necessarily in themselves terrible, but they're usually misapplied. They're usually not right for you. Under the right circumstances, with a qualified tax professional, you might be able to get some of these to work, but for most people these are not good ideas. So number one is the Section 1202, qualified Small Business Stock, and the idea behind this is that if you have a C corporation and you grow that C corporation over at least five years, but probably more, one day you will sell that business. And if you elect to have your business treated as qualified small business stock, then you don't have to pay any taxes on the game small business stock, then you don't have to pay any taxes on the gain. So it's up to, it's like up to $10 million or a multiple of income right, which sounds wonderful. And listen, it's a totally legit strategy. It's in the IRC.
Speaker 3:The problem is that this doesn't work for most people because you need to have a very specific type of business and you need to handle it in a certain way for this to make sense. The big downfall of this is that you have to have a C corporation, so most painting businesses are going to want to structure as an S corp. Before they get to S corp, they're going going on a structure as a sole prop. And this strategy requires you to be a C-corp and stay a C-corp right out of the gate. You have to grow your business over a minimum of five years. You cannot sell it for at least five years, but you'll probably be more like 10 to 20 years before your business is worth enough for it to be worth selling. And this entire time that you're growing your business, you are suffering the double taxation of the C-corp. Now you think, well, okay, well, I'll pay a little bit more tax now, but then when I sell it I'm going to save so much money. Yeah, the problem is is you're paying it all up front.
Speaker 3:This type of structure works good for a Silicon Valley type business, where the company is making almost no money or having losses for the first five to ten years. It's being funded by a venture capitalist who's paying all your payroll. Who's paying all your payroll and then one day, right, that app is going to get developed, or you're going to have this big breakthrough and you're going to be the next. You know, yahoo or Google or whatever, and you're going to go from being practically worthless to worth tens of millions of dollars overnight. If you can pull that off, then the Section 1202 is awesome.
Speaker 3:That doesn't usually work for service-based businesses, right? You're not going to go from zero to a million overnight. You have to grind it out, you have to perform work, you have to get paid, you have to pay your employees and this whole time you're going to be paying double taxes on all the money you make. Right, when you go to sell your company, what makes a company attractive for sale? Well, the first thing a buyer is going to look at is what kind of profit do you make? So you have to make profits and pay double taxes on that profit in order to be attractive to a buyer. If you don't have profit. No one's going to pay you for the company and the section 1202 isn't going to matter anyway.
Speaker 2:Yeah, I think that's the key is, in order to sell your business, you have to show that you're profitable. Nobody wants to buy a service business that isn't making any money, or if they do want to buy it, they're not going to pay very much for it. So if you're trying to make sure your business doesn't show any profit for all this time, to not pay tax, and then you try to sell it, you're not going to get any money. Or the other option is just run it normal, have a bunch of profit, then you're paying a bunch of tax and then maybe you can sell it and get a good game. But again, you've already paid all these taxes for the last five, 10 years or whatever it's been.
Speaker 3:Yeah, and then the other aspect too is C-Corps are a lot harder to sell, especially when it comes to painting businesses. Most buyers are going to want the more efficient taxation of an S-Corp and they're probably going to want to do an asset sale instead of a stock sale anyway, and that's kind of a whole other episode. But you're really limiting your options. So, one, you're paying too much tax in the growth phase. Two, you're limiting your options for when you do want to cash out, all in the hopes that you'll be able to not have to pay capital gains on the stock sale. And yeah, there's some limited circumstances where this can be great, but for most painting businesses you're going to overpay and you're never going to be able to recoup that money. So, section 1202, qualified small business stock QSBS probably not the strategy you want to employ.
Speaker 2:Yeah, Now the next one, setting up a business entity in another state. This one comes up a lot Like folks think, oh, I'll just set my business up in Florida or Texas and then it's a tax-free, no state taxes, and I'll just run it in California and it'll be in California, or whatever the case may be.
Speaker 3:Yeah, so it sounds great. Unfortunately, the reality is that you're going to be taxed on two things. One, it's going to be based on the state that you live in. So if you live in California and you make income in Texas, california is going to want to tax you on it. Actually, if you make income anywhere in the world, california is going to want to tax you on it. And then the second aspect is where you make your income. So maybe you live in Texas Ooh, that's a tax-free state but you're making income in California, california's going to want to tax you on it. So yeah, the states are greedy.
Speaker 3:We run into these multi-state taxation issues a lot, issues a lot. And it doesn't matter where you form your LLC, it just matters where you live and where you do business. So kind of keep that in mind. Sometimes we see this on like border states. So let's say you live in Tennessee, you're in the Chattanooga area, right there on the Georgia border. You set up your LLC in Tennessee, which actually having an LLC in Tennessee comes with its own problems, but we won't get into that and you want to do business in Georgia? Well, georgia is going to tax you on that income. So if you really don't want to pay state tax, you have to live in a tax-free state and you have to do business in a tax-free state. So if you can keep everything in texas, you're good, everything in florida, you're good. But, uh, otherwise, be prepared to file some state tax returns.
Speaker 3:A third one that we come across this this is real popular right now, especially with real estate being so valuable is cost segregation studies. So if you haven't heard about cost segregation, it's a real estate strategy that allows you to basically itemize different parts of your real estate and assign shorter lifespans to them and accelerate the depreciation. So, for example, a typical residential real estate property would be depreciated over 29 and a half years. But if you pay an outside company a whole bunch of money to do up a report company a whole bunch of money to do up a report they might say that the roof on this property only has a 15-year lifespan, or the furnace has a 10-year lifespan and the carpets have an eight-year lifespan. And now you can start to build losses faster in this property and the idea is that you'll be able to reduce your taxes and that the expensive cost segregation study will be paid for with the tax savings.
Speaker 3:The problem is is that people don't talk about the passive income limitations. So the IRS categorizes income basically into two camps. The IRS categorizes income basically into two camps. You have non-passive income. This is your business income. Your W-2 wages, most types of income is going to fall into this category. And then you have your passive income. That's rental, real estate and limited partnership interests. Real estate and limited partnership interests and passive losses cannot cross over and offset non-passive income. There's like a wall between the two camps. So if you can get a whole bunch of losses on your real estate, they don't do anything to offset your business income. They just kind of sit there and collect in a bucket and then one day when you do have profit on your rental real estate, you can use them then. Or maybe one day you're going to sell the place, you can kind of empty out the bucket and take the losses then, but they're not going to offset your business income and that's where you're really looking to get your tax savings. Yeah.
Speaker 2:And I would say we do have a lot of clients that have real estate and have done cost segregation studies where it does make sense, where they can save money, but again they got to get that non-passive and active components right. Like if you have an Airbnb which is more of an active real estate investment that can be offset by active, non-passive activities in your business. So it matters, the details matter. It can make sense to do a cost segregation, but you have to know the rules and make sure that what you're doing, the type of rental activity you have going, does it qualify as a non-passive or not.
Speaker 3:Yeah, yeah, you have to find ways to get through that barrier and, like you mentioned, daniel, there's really only three ways to get through the barrier and they're nuanced and they have a lot of requirements. And if you can get through it right, like an Airbnb, short-term rental loophole type deal, awesome, right, and people have made really you know really great strategies doing that and I think that's why cost seg is so popular. But you better make sure you can get through that barrier, because if you can't, then you've just spent a whole bunch of money on a cost set that you can't really use. So if people tell you, oh, I'm a real estate professional, because that's one of those pathways through, make sure you actually qualify. I'll tell you honestly, most people do not qualify as a real estate professional. Do not qualify as a real estate professional and if you're working full-time or really any other W-2 job, you don't have enough hours available to qualify as a real estate professional. Most likely, another way through is the short-term rental loophole that you talked about Airbnb. Be careful there, because there are definitely requirements. You have to know how long your average stay is. You have to have material participation. So make sure you qualify. And then the third one has to do with the self-rental and the Dash 4 election, where you own the property, you own the business using the property and you make special elections in the very first year to be treated as like a consolidated group, and so if you hadn't done that in year one, you're probably not going to qualify for it. So yeah, before you spend a lot of money on a cost seg, make sure you have a way to use those losses.
Speaker 3:The fourth strategy has to do with setting up a C-Corp as your business entity, and I think this kind of comes from the idea like well, aren't all the biggest and best businesses C-Corps? Yeah, I mean you're Disney, you're Boeing, you're Johnson, johnson, they're all going to be structured as C-Corps. And it makes sense for those types of businesses because there is a little bit more flexibility. With the C-Corp You're allowed to do things that you're not allowed to do with an S-Corp. But they come with a lot of drawbacks too. So you know people will say, oh yeah, you know my old CPA. He told me to set up a C-Corp because I can change my fiscal year and I can defer my income and you can get more write-offs with a C-Corp and you can borrow against your C-Corp stock and not have to pay taxes, and the corporate tax rate is only 21%. Yeah, these things are all true, but you also have double taxation. But you also have double taxation.
Speaker 3:So 21% is going to be less than your ordinary rate, but it's not going to be less if you have to pay it more than once. So once the money's in the C-corp, we got to figure how are we going to get it out. I mean, you want to spend your money eventually, right, you know what? To just sit there forever. So you've already paid 21% on it. Now when you go to get it out, you're going to pay again.
Speaker 3:And there's a few ways that you can get the money out, but they're not great options. One is you could increase your salary. Now your salary cannot be unreasonable. So you're kind of limited in how much you can pay yourself to get the money out. And when you do, you're going to pay taxes on that money at your ordinary rate, which is probably going to be 22% to 24%, depending on whether you're married or single or whatnot. So you've paid 21% corporate rate on it. Now you're paying 22% to 24% individual rate, so your actual tax rate is going to be in the low to mid 40s. That's a lot more than if you had just done it with an S-corp and maybe paid 24% to 32% and maybe paid 24% to 32%. Another way to get the money out is corporate dividends. So now dividends are taxed, a lower capital gains rate, but that capital gains rate is still going to be 15% to 20%. Plus, once your personal income hits $200,000 or $250,000, if you're married, then the net investment tax kicks in. So that's an additional 3.8%. So now your actual rate's 21% corporate plus 15% dividend, plus 3.8 net investment tax, for a 39.8% taxation. Not as good as if you had done S-Corp.
Speaker 3:A third way to get the money out has to do with borrowing. We hear this a lot like borrow against your company, you won't pay taxes. There's some truth to that, but you can't borrow forever. Eventually you're going to have to pay the piper and pay the money back, and when you do you're going to need cash to pay back your corporation. That means you're going to have to recognize income. You're going to have to sell investments or stocks or up your salary or do something to get the money to pay back the corporation. And now you're right back to paying these high ordinary tax rates to get that loan taken care of?
Speaker 3:And the last part is well, what if I don't take the money out at all? What if I just leave it in the company? Okay, well, the IRS has us there too, because once you get over $250,000 of cash in your C-Corp, you have to justify a use for it. You have to say this money is earmarked for acquiring another business or research and development, or something that justifies all this cash. So you can kind of push that $250,000 up a little bit higher if you can justify it. But eventually you're going to have to either distribute the money or you're going to be subject to what's called the accumulated earnings tax, which is a 20% tax on top of the 21% tax for having too much cash in your business. And yes, there is a penalty for having too much cash in your business. And yes, there is a penalty for having too much cash in your business, which sounds crazy, right. But yeah, it's designed to prevent people from abusing C-Corps and not paying taxes on the profits.
Speaker 2:Yeah, and given all that like because there's some folks that we've worked with in the past where they have those ROBS, like the rollover for business startup situations, where they have their old 401k from the corporate job and they want to access that 401k money to start up a business, and that can be at first glance kind of useful, like, oh, I can use my 401k and not get penalized, use that to start up a business.
Speaker 2:But in the case of specifically for a painting business, the startup costs are usually pretty minimal to get the business started and, given all the restrictions that a C-corp has, is it really worth using the ROB structure? Because the ROB when you have a rollover business startup you're required to use a C-corp has? Is it really worth using the ROBS structure? Because the ROBS when you have a rollover business startup you're required to use a C-corp. So does it make sense to actually do that, to use a ROBS, to use your 401k money to start that C-corp because you're required to keep a C-corp? In that it doesn't because of all the restrictions with the C-corp. It often doesn't really seem to make sense from my perspective because the startup costs, probably for in most cases for a painting business, are not really that much.
Speaker 3:Yeah, yeah, I mean there are definitely people who have used C-Corps and I know I've been really hard on C-Corps today. It's just not appropriate for most people, right? I mean, the benefits are not things that are going to outweigh the negatives for most people.
Speaker 2:Yeah, I think if you're looking to get a lot of equity. To raise money, get a lot of investors involved.
Speaker 3:You have to you have to have a C-Corp.
Speaker 2:Yeah.
Speaker 3:Yeah, yeah, yes, if you're going to do an A-series round or something like that, you're going to need a C-Corp. But for most you know Main Street business owners, painting business owners S-Corp is where it's at All right. So our fifth and our final worst tax strategy and I did save the worst for last, because I see this on TikTok all the time is using your business to write off, hold on.
Speaker 2:You're on TikTok talk all the time. That's like an American, isn't it?
Speaker 3:Yes, it is no. I think the freedom to choose your social media garbage is is about.
Speaker 3:no, yeah, I shouldn't go down the rabbit hole of of tech talk being banned in the country. But who knows we'll see, for right now it's still on there. Um, and if tiktok does go away, I am sure that there will be plenty of american-owned social media companies to fill its place. Yeah, so don't worry, your, your venues for bad tax advice will go on despite the government's best efforts. But yeah, if you're on social media, you've probably seen people say I bought this Rolex and I had my LLC do it for me and it was a write off. They're standing in front of their G wagon or their Hummer and they're saying my business bought this for me and it was a write-off. They're standing in front of their G-Wagon or their Hummer and they're saying my business bought this for me and I bonus depreciated it.
Speaker 3:The idea being that, because you have a business or an LLC, an LLC is some kind of magical thing that now, all of a sudden, you'll be able to write off the items that you use in your everyday life. The reality is that there are rules about this, and specifically IRC Section 162,. That's the code that allows businesses to write off business expenses. It requires these write-offs to be ordinary and necessary business expenses. So a paintbrush is clearly an ordinary and necessary expense for a painter. A Rolex not so much. This is where just good common sense and good judgment comes into play. If it sounds too good to be true, that's because it probably is. And the fact that you maybe discuss a little business or you film yourself on this vacation or you film yourself wearing this Armani suit does not automatically turn a personal item into a business necessity. So be very careful of anyone who says that they are writing off their lifestyle. Know they do not need to maintain a certain brand.
Speaker 3:This has actually been litigated in tax court quite a bit. Been litigated in tax court quite a quite a bit, and I probably I'm going to refrain from referencing the tax court cases, um, but if you really are interested in this, um, it's an. It's an interesting read there. There have been only one or two entertainers who have been able to pull this off and it was under extreme circumstances and stuff that's probably not appropriate for the podcast. So go do your tax research if you want to find out about that. But yeah, hair, makeup, clothing, watches, jewelry, non-business vehicles, vacations it's personal. I mean, we talk about maybe combining a little bit of recreation with a primarily business trip, that's one thing, but the other way around, where it's primarily recreation which is a little bit of business thrown in, that's not going to fly under audit.
Speaker 2:Yep, all right. Well, those are the five worst tax strategies for your painting business. So please do not take that advice and implement it immediately.
Speaker 3:Yes, do not listen.
Speaker 2:These are the five worst ones. So yeah, if you need some help with tax strategies, definitely get a hold of a tax professional that you trust and stay on the path, the righteous path. You know, don't mess with the IRS because they're going to get their money.
Speaker 3:But any last thoughts on this one you know I like what you said, daniel. You know because again, I hope nobody walks away from this feeling offended like, oh Richard, just pooed all over my favorite strategy Because, like we said, these strategies have limited uses but they really have to be pulled off right. So get with your tax professional, talk out the details, make sure you understand all the nuance so that you don't get caught with some bad information, and social media is not the place to get that information, unfortunately.
Speaker 2:Right, yeah, a 30 second clip on TikTok. I mean there might be something to that 30 second clip, but there's probably things they didn't mention, some additional hoops you got to jump through that they can fit into that segment. So definitely, yeah, all right, cool. Well, if you have any thoughts, definitely let us know. Go to Facebook, type in Grow your Painting business. Uh, send an invite to us join the conversation. Let us know what your thoughts are on this episode or future episodes, and with that we'll see you next week.