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Adam Kintigh: Reducing Taxes, 3 Little Pigs & Red Flags

My special guest, for the past ten years, has focused on helping entrepreneurs and investor launch their businesses and protect their wealth. He has personally consulted and helped thousands of business owners and investors across the country. He has been featured as a speaker at the International Money Convention, World Money Convention and countless real estate and investment seminars. He is also certified as a small business consultant, as well as an estate planning and asset protection planner. Our special guest today is Adam Kintigh.

In this episode, you're going to have some fun, especially if you're looking to reduce taxes and start a business in it. We're going to talk about reducing taxes. We're going to talk about your power team, who needs to be on that team and how some of them might actually be misleading you because of their perspective and how you can overcome that. We're also going to get into the three little pigs, red flags and a whole lot more. With that said, let's get to it.

Dustin
You're living in selling insurance when you awake from a dream that tells you to quit your job and move to Phoenix. Even worse than that, you would tell your best friend and roommate, Gary, about the dream and you both decide to quit and go. You land a job in Phoenix. That doesn't last because that company gets bought out and fires all of its employees, including you. What did you do? Did you feel any guilt or remorse because brought Gary along with you?
Adam
I felt a little bit of guilt and remorse, but I’ve got a nice severance package. It was Phoenix, Arizona, it was wintertime. I'm looking at those poor schmucks back in the Midwest with all the snow. I'm thinking, "This is the life enjoying this nice pool here." Then I got a job offer in Las Vegas and up to Vegas I went. Here went my friend, Gary, with me. 
Dustin
Did he come with you?
Adam
He came with me.
Dustin
I figured you had separated ways and who knows what Gary's up to? Do you still talk to Gary?
Adam
I do. He's still one of my best friends. He's a Director for Tesla. He's a good guy.
Dustin
I want to talk to you. A lot of people reading the blog, they have to reinvent. There you were, you got some respect, which is nice because some people don't get that. They either quit their job and then they burned the bridge. Then start that business, which is great. Sometimes corporate downsizing happens and they go. Where you were at mentally when you were like, "I no longer have employment here. I've got a nice cushion. That's cool." Where did you go next? You said Vegas, but mentally, where did you go to?
Adam
Mentally, I felt like I was in that technology space at the time and we had the dot-com bubble burst. I'm getting ready to have my son. My wife's getting ready to have my son. I'm thinking, "I’ve got to do something different." I'm talking to my buddy, Nate, and he's like, "You’ve got to get into corporations, Adam." I said, "Nate, I'm not an attorney. I'm not a CPA. How in the world am I going to do that?" He said, "Adam, I've got a friend that owns a company out there. Why don't you go talk to them and see what happens?" I went to talk to this guy, Greg. He says, "Adam, you sure you seem smart. Here's a stack of books. Start reading these and be here Monday." That's what I did. 
Dustin
What kind of books are those?
Adam
About corporations.
Dustin
All these are corporations?
Adam
Corporations, estate planning, taxes and I was thinking, I was proud of myself for getting through these books. It’s like reading the owner's manual of a car. I'm getting through these books thinking, "I'm comprehending it. I'm feeling good about myself." As I start working with clients and helping them set up their businesses and choose the entities, I started realizing all that stuff I read from 1982, that was the best book ever written about corporations, is completely outdated. All the tax laws have changed. The legal side has changed. I didn't even learn that or know that until I started working with people and started further researching. The more educated I became, the more I knew I wasn't educated.
It was fortunate because I worked for this company for a few years and one day I get a call from Cort Christie. He wanted to hire me as the director. In my third interview, he said, "Adam, we're going to hire you, but you’ve got to stop reading these books. I have hired under the NCH’s roof. We have the best estate planners, financial planners, lawyers, accountants and CPAs. When you have questions, go talk with these guys. This is a lot better information than books." Don't get me wrong, you can learn a lot from reading. I read a lot. There's no substitute for being able to walk into a professional's office and get answers about specific situations. It's fantastic.
Dustin
We're a big believer in the show and what we do here at WealthFit. Consult and get a base level of education, so you can at least have an educated conversation with a professional. We're fans of that. You don't have to become the expert yourself, but you’ve got to know how to control and put someone on your team and direct them. At the end of the day, they don't know everything that's going on in your world. That's incredibly powerful. I want to acknowledge, I want to say thank you big time for creating a course for us over here at WealthFit. We talk about tax strategies and selecting the right entities. For a lot of people, it's an exciting thing, the thought of building a business and picking that entity. There's a lot of misinformation out there. I want you to break it down. I want us first to start right there. For those reading that are like, "I'm going to start that business, I need to get an entity." We should talk about maybe they don't. There could be that situation. Before we go there, I found a cute video of your son, Wesley, breaking down entities and the power of them. It's perfect. In this video, he can't be any more than five years old. He tells this story. Will you give us a little recap of what he's talking about? It's a perfect illustration.
Adam
Wesley was maybe 3 or 4 at the time. He always wanted me to tell him bedtime stories. One day, I'm working on this presentation and he comes in and says, "Dad, what are you doing?" I said, "I'm working on a presentation to teach people about corporations and LLCs." He said, "What is that?” I said, "How can I put this so that he can understand?" I came up with this quick, little story about the three little pigswhere the sole proprietor built his house out of straw. It was the general partnership that built his house out of sticks. The smart guy, the smart pig was the LLC who built his house out of brick. That was the story in the video and it was fantastic.
Dustin
I thought it was hilarious because the big bad wolf in this is the attorney or the person coming after you. I thought that was fitting.
Adam
Wesley would say, "Mr. Attorney, he would huff and he would puff and blow their house down."
Dustin
This sets a perfect foundation for our conversation. A lot of people are thrilled. I think back to when I first got into the business, making that first dollar. You're excited and you're focusing on growing that business. A lot of people aren't attorneys, they're not experts. They may grab a book off the shelf, maybe it's outdated and maybe it's not. A lot of people, especially in the trade services, they don't even choose LLC. They choose the sole proprietorship. With all of the things that are out there, Adam, how do I know what is the right entity for me?
Adam
We're filming this course and it's one of the things that I wanted to talk about is how to select the right entity. When we're talking about getting a business started, there's a lot of misinformation. I love to research things. When I look at how I can fix something in my house, the first thing I do is go to YouTube. I'll pull up a YouTube video and try and learn from that. It's interesting in this business because all the time I'll have videos pop up on LLCs or taxes or what have you. I'll start watching to see what they're saying. I find there is a lot of misinformation. The problem is that people that are not educated about these things, they don't know that it's misinformation. They might hear that you can form your own LLC. It's inexpensive and forms it on your own.
I was talking to a guy and he's a student and one of his best friends is a CPA. The guy is 69 years old. He said, "This guy has been a good fishing buddy of mine for 40 years. He told me that all I’ve got to do is go to the Secretary of State. It's a couple of hundred dollars and I can file my own LLC." As we're talking, what I realized is that your friend who thought he was trying to help you by telling you could spend a couple of hundred dollars and form an LLC has given you poor information. All the CPA looked at it from a tax standpoint. He didn't understand the legal standpoint of it. Where if you get sued, and quite frankly even if you get audited though your chances if you're set up properly, your chances of being audited are a lot less.
In his case, he was from a tax standpoint to go out and form the company, spend a couple of hundred dollars doing it. If he had been ever sued, they would have subpoenaed his record book, which he doesn't have. They would have looked for his articles of organization, his operating agreement, membership certificates, all of which he would never have had. I was thankful that we're having this conversation. At the end of the conversation he said, "He is a good fishing buddy but this isn't his thing." He admittedly said, "This is not his thing." He does taxes, but he doesn't work with business owners that much. Initially it was, "Let me help you out, buddy," and then it turned into, "It's not my thing."
Dustin
You have to be careful nowadays because it's the information era. We're past the information age, but you pick up your phone, you can type into Google and it’s like, "Where's that information coming from?" The big thing that you said is as people start to form their power team, you're asking your CPA about entity selection based on legal protection, not the smartest move. Maybe from a tax point, he might have some input, but you've got to look at things holistically here.
Adam
In working with CPAs, what I’ve found is that even some of the best CPAs that I know, they have a limited amount of information based on their experience and background. What I find fortunate about what I get to do every day is I work with a bunch of CPAs. I've learned that there are certain CPAs that know more about certain things than other things. Certain people will seek information that seemed to be a lot more knowledgeable in certain elements of the business.
Dustin
I'm curious, I imagine you get this question a lot. I’m excited about the business. Some people say out there, "Get your entity. Make a solid foundation.” Some people get a little woo-woo and they say, "Set an intention." If you're going to be successful in business, you’ve got to do what successful people do that has entities. Other people say, "Why don't you go out there and sell something and make some money?" I'm curious as to what camp you fall into and what's your advice for folks around that? Should I go make my first couple of dollars and prove my concept? Do I need to get my ducks in order and get that entity going?
Adam
Don't get me wrong, if you're going to start a business selling like a multilevel marketing business where you're selling for Mary Kay or something like that. Y, you may not need to form an LLC. If you're going to start a business and you know you're going to do it, that's the first thing you should do is form the LLC. Get that date of incorporation immediately and make the right tax election based on the type of business you have. That is not only going to save you a bunch of money in taxes, but one of the biggest audit risks that you face as a business owner is filing a Schedule C. If you have a business that you form an LLC, for example, and you do not elect to be taxed as a corporation, you're going to file taxes as a sole proprietor. All the profits and losses of the business will report on your personal tax return, your 1040, on a Schedule C. That's where we itemize all the business expenses. It's a big initiative.
I had a conversation with the managing partner of our CPA firm and we were talking about what the IRS initiatives are. It used to be they would go after people that had a Schedule C that were making good money, $250,000, $200,000 or more. It would make sense. Go after the money so we can audit these people and get something. What they found was that these people that have the money, if they get a notice that they're being audited, the first thing they do is not roll over and pay the bill. They call their attorney. They hire a tax attorney, “Let's fight this.” It was a lot of time and a lot of effort for them to try and collect. Where now, the initiative is people that are making $150,000, $100,000 or less filing a Schedule C, that's where their initiative is. Part of the reason not only is to get my date of incorporation and protect you from a legal standpoint, but from a tax standpoint, if you have an LLC taxed as an S-corporation, it will eliminate the Schedule C. Even if you make no money, you will have business expenses that will flow through to your return and offset other income that you're making. It's a win-win either way. You get legal protection because we have a litigious society, and you get the tax benefits as well. 
Dustin
Before we go deeper down here, we talked about you can choose the LLC and then you’ve got to pick some tax classifications. Before that, I think of the fishing buddy or your neighbor next-door or the person that shouldn't be giving you advice because they haven't done it. The C corporation and some people say, "Big companies or C corporations, there are benefits to the C." You seem LLC-friendly. The sole proprietorship made the straw, maybe not the best situation for you. The general partnership made sticks. Where's the C corporation in this conversation?
Adam
We talk about this in the course is that a C corporation is rarely used unless we're doing big business. If you're going to take your company public and sell stock and raise capital, then a C corporation might be the right thing. 99% of the people I work with is a small business. We're not going public. If we do go public, it's not going to be for several years. LLC is perfect. At some point later, if your business grows and we want to go public, we can always change the entity to a corporation later on. To start with, it's rare that we would use a C corporation. All these problems exist around double taxation and there are all these formalities, doing resolutions, amendments, meeting minutes. All these formalities are cumbersome to set up and operate a C corporation properly.
Dustin
I want to ask you because it came across my desk, this idea of the B. Have you heard about this? The new B corporation, do you like these?
Adam
It's one of those things where I read about this B corporation and it's supposed to be the green new deal. It's a corporation that's set up and it’s supposed to be environmentally-friendly. Someone may have come up with the idea and they might've had good intentions, but I have never seen one or the practicality of putting one in place and putting it to use.
Dustin
It’s too new. There's not a lot of precedent behind it.
Adam
Quite frankly, I don't see what advantages you could get from having a B corporation or whatever that is. 
Dustin
Let's go back to the LLC. You're an LLC, you've decided on that. You can pick different options in terms of how you're taxed. Why would you not choose an S? 'Can you be taxed as a C?
Adam
The beauty of the LLC is they have a ‘check the box’ rule that applies where you get to choose how you want to be taxed. If you want to be taxed as a C corporation, file form 1120, like a C corp or B taxes and S corp file form 1120-S. If you have a partner other than a spouse, we can elect to be taxed as a partnership. If we form an LLC and we make no tax selection, it is disregarded. There are times that we use that, for example, buying rental properties. That is passive income. I'm going to have that disregarded for tax purposes. I do not want to be taxed as an S corp. We talk about that in the video, in the course, about when to use the right entity. That's one of the things that you have to know as a business owner. If we're starting an active income-producing business, it needs to be LLC taxes and S corp. If we're starting a passive income business, it needs to be disregarded or it could be a partnership if you have someone other than a spouse.
Dustin
This is good because a lot of people get this blanket advice like, "The LLC, immediately go to the S." No one's giving thought to the person's situation like, "It's a rental property, that's maybe not the right move for you." That's why it's important to get educated, so you can have this conversation with people. Not that you have to do it yourself, but to be able to get the full picture here. Adam, I want to move into probably a fun one for you. I'm going to pick an LLC. I like this. I'm going to start my YouTube business or I'm going to start my Amazon. I'm going to sell some things online. LLC, I like the S, the big question is where? I had some guy telling me I need to go to New Hampshire because there's something there. We've heard of offshore stuff, which is a whole bag of worms. What is your thought on where this entity is? Is it my home state? Where do we need to place this entity?
Adam
The thing that I look at, you can incorporate in any state that you'd like. The fact is the most heavily litigated issue in corporate law is piercing the corporate veil. 
Dustin
What does that mean?
Adam
It's the intent of every attorney to sue your LLC or corporation and take everything your corporation has and sue you personally as the owner of the corporation. Most of these attorneys are being hired on contingency. The statistics in 2019 were there were some 1.3 million attorneys in the US. There are too many attorneys and not enough good cases to go around. These attorneys get stuck taking bad cases with bad facts trying to make a living. I get it. They try and get everything they can. If you hire an attorney, you want him to get everything he can. He sues the LLC and he sues you. While statistically, the corporate veil gets pierced almost 50% of the time exclusively with small businesses. When you have five shareholders or less, we have to worry about veil piercing. One of my clients is an attorney and he has a law practice that he sues businesses. That's what he does. For his real estate investments, which he has rental properties and other things, for his companies, he has set all of them up in Nevada. He said, "I'm glad that more people don't know about Nevada. Right here in Texas, if I see a Texas LLC or a Texas corporation, I'll pierce that corporate veil about 95% of the time." People don't operate things properly. The failure to maintain appropriate corporate records, commingling of funds, all of these things they're supposed to do but they don't do.
Dustin
How is that different in Nevada than in Texas?
Adam
Most every state have certain laws set up and over the years they've developed. In Nevada, our laws have been developed to protect small businesses. Nevada law says the only way to pierce the corporate veil is to prove that you are intentionally committing fraud. It's a big difference. Failure to maintain appropriate corporate records or commingling of funds is not grounds for piercing the veil of a Nevada LLC. Though you should operate properly from a tax standpoint, legally, the only way to pierce the veil is to prove that you're intentionally committing fraud. 
Dustin
That's going to be hard. 
Adam
We have five cases since 1950 where the veil has been pierced. It’s difficult. The people always wonder, "How and why are Nevada’s laws different?" You'll hear people say big companies should incorporate in Delaware, which I agree. Delaware has the best laws in the country for big publicly-traded companies. The laws are good that Microsoft, Walmart, all those big companies pay the State of Delaware millions and millions of dollars a year in renewal fees. If you're a small business, you pay maybe $1,000 in renewal fees to Delaware. It’s not much. Do you think they care much about you? No, they want the money, which is a big guy. All their laws are for big business. Nevada, our laws started with the mob. When the mob moved to Vegas, they heavily-influenced the politicians to create these great laws for big, publicly-traded companies. Even though the mob has officially moved to Wall Street, the laws are still fantastic and it's one of the largest revenue-generators for the State of Nevada is our corporation's divisions. The law is to keep getting better and better in protecting our small business operations. It's a revenue-generator for our state.
Dustin
I’ve got to throw it out there because I feel like it's talked about, Wyoming. People have heard of Delaware. I feel like Wyoming has come up and I'm like, "Why Wyoming?" Are you hearing that? What's the spin on why people are thinking Wyoming?
Adam
Wyoming is the state that started the LLCs. In 1977, Wyoming was the state that developed an LLC. Before that, it was corporations and limited partnerships. What we've found over the years is Wyoming is a good choice to incorporate but Wyoming is cheap. Cheap is not good and good is not cheap. There have been several court cases over the past few years where the courts, in following the guidance of Wyoming, have been allowed to pierce the corporate veil. There's a list in Wyoming, like any other state, of ways of piercing the veil. Where in Nevada, our track record is the strongest. It gives you the best standard-setting it up in Nevada. Wyoming would probably be my second choice if I was going to do it.
Dustin
What popped up in my head is this, let's say I don't live in Nevada and I’ve got to imagine most of your people don't live in Nevada. Do I need to set up an entity in my state? If I'm conducting business and let's say it's more local, the internet, it's a wild card question. They're still figuring out how to tax internet businesses. I live in Florida, let's say, do I need to get a Florida entity as well and link them somehow?
Adam
When we're forming the company, you're going to be organized under the laws of Nevada, then we will register appropriately with the state that you're doing business, usually which is the state you live in. We always do this. We always register. If you're living in Florida, we'll register with Florida.
Dustin
When you say register, you mean open another entity there?
Adam
No, what we're talking about specifically is you have one entity that is organized under the laws of Nevada. We go through a process called foreign filing. Meaning you're telling Florida, “This is a Nevada LLC, organized and protected under the laws of Nevada. We are doing business in Florida.” It's a paper we send into the State of Florida. If I were to look you up for example in Nevada, you would show as a domestic Nevada LLC. In Florida, I look up your company, once I've registered there, it will show as a foreign filed Nevada LLC. It shows the jurisdiction in Nevada.
Dustin
We're in California and I know this is such a touchy topic and you’ve got to be careful with this, which is why you have to get educated on this. You've got to work with professionals. Is there any tax benefit to filing your company in Nevada? Is that more about the legal and piercing the corporate veil?
Adam
A long time ago, before technology and other things, you used to be able to incorporate in Nevada as a way of training not to pay taxes in your home state. I never did it myself and I never advised to do it, but some people would do that. That's not a benefit. If you live in California, you work in California, you're going to pay California tax. We do not have a state income tax in Nevada, but that is not a benefit that you'll enjoy unless you physically live in Nevada or make money in the State of Nevada. What we do, we passed a law a few years ago that if your business makes more than $4 million a year in the State of Nevada, there is a gross margins tax that we charge. You’ve got to be making more than $4 million in Nevada. For example, you live in California, you're a Nevada entity. You're organized under the laws in Nevada. When tax time rolls around, you're not filing any taxes in Nevada. You're only going to file taxes in California, your state tax return and your federal tax return because you live here and you work here. There's nothing extra to file. The fact that we don't have a state income tax is not a benefit you're going to enjoy.
Dustin
Adam, we've got to knock out the big question that people I'm sure love to grill you about, which is the offshore thing, which is a slippery slope. What's your response when anyone asks you, "What about a Bahamian company or Saint Kitts and Nevis?” or insert your exotic country. What do you say to those folks?
Adam
I have always stayed away from offshore. First of all, I know guys that used to promote offshore entities and they are in orange jumpsuits, no joke. They've been put in prison for this. There may be some value for doing these offshore entities. It is not my area of expertise. I stay completely away from that. You may need to pay hundreds of thousands of dollars to work with someone who knows how to do that. At the end of the day, when I look at it, if you live and work in the US, it’s something that you're going to pay taxes in the US. There is that thought that if you set up a company offshore that this may get you outside the jurisdiction of the US. I’ve got to be honest with you that with all the laws that have changed over the last few years, Nevada is referred to as the onshore-offshore option. We offer a charging order protection, which is a unique law that protects all of the assets in your business, a lot of unique protections that you get in Nevada without having to go offshore.
Dustin
That's extremely wise. If you have something offshore, it raises a flag. Unless you got the bucks to consult the highest-level folks, it's going to cost you an arm or leg. Be careful. On the flip side of that, I want to ask you, maybe someone's reading this and they're excited. They're like, "I meant to start that business. Adam's my guy. I'm excited, but I saw that ad to insert your favorite online thing for $99. I don't know if it's cheaper at $49." What do you say to that? 
Adam
I've had plenty of people that have formed their own companies and there are a lot of do-it-yourselfers out there. They'll do it themselves. I feel like I'm the same way except for a couple of things. You would never want to represent yourself in a court of law. You never want to file your taxes, consult a professional to do it. You never want to form your corporation or LLC, have experts do it. A lot of these companies that are offering an incorporate for $100, what they're talking about is $100 of what they'd charge you for the paperwork and then they give you the option. Would you like a record book? Would you like initial organizational minutes? Would you like an operating agreement? You can say yes to everything they offer. They'll send you a bill for $1,000 and then you're going to end up with a box of paperwork not knowing what to do with it. I love working with and for NCH because we not only form the company, but we do the things that you don't even know to ask. We do all the paperwork properly. We do the registration with your home state. We do all the pieces that you need to have to comply with state and federal law. When you do it yourself, you're never going to know whether you did it right or not until you get sued or until you get audited.
Dustin
That's where it hurts. You can go for a long time sleeping, but then you get that knock. The big bad wolf comes out of your door. That's when it hurts. I speak from experience on that. You're in trouble at that point. I want to talk another big part of this, which is you're doing things right. You've got an entity, but you've got to play the game right. You've got to follow the rules. The big thing that ends up happening, especially people that are getting into business, they don't have the background, they don't have some big team where they’ve got a bookkeeper and all that. It's this idea of the commingling of funds. You're using what's easiest as oftentimes is the credit card in your back pocket. You put yourself into a little bit of a pickle here. What is commingling funds? Why do we want to avoid it and how do we avoid it?
Adam
The rule is that you cannot commingle funds. 
Dustin
What does that even mean? 
Adam
You can't use your checkbook to pay for business bills. You can't use the business checkbook to pay for personal bills. You've got to keep these separate. If you want the courts to recognize you as a separate LLC or corporation as a separate person that you own the company, you control the company, but legally you're not the company to keep it separate. We have to keep the finances separate as well. One of the things that I talk about in the course is no commingling of funds. I have a download on there for an expense report because in starting a business, your business may not have a bunch of cash to use and you are using your cash, your credit cards. We have to document things properly and have a monthly expense report or a weekly expense report where I'm showing, “Here are the things that I paid for using my cash or by credit card and the company promised to reimburse me or pay me back when it's financially able to do so.” I have that as a download is the expense report because it is a critical document. If we get audited, that's how we show the IRS that we were not commingling funds.
Dustin
You gave me a great a-ha. Sometimes you go out, you're a business owner, entrepreneur and you’ve got a business. You go to a place, “We don't take AmEx here.” It's not like you have a mall with you. You have your card. That's okay. It's not preferred to do that. As long as you document it, you show a paper trail, every once in a while if you're in a jam, it's okay to use that. As long as we're documenting it and show proof. That's what were you saying?
Adam
Correct. It's interesting because there are times where I'll use a personal credit card to pay for something for business purposes. It's okay. Always keep your itemized receipts. If you ever lose a receipt, at least print out your credit card statement and highlight what it was and make a note on there. Try and always keep your itemized receipts because that's something that the IRS wants. Years ago, it was A-Okay if you had a credit card statement, you're fine. Then the IRS came back and said, "The credit card statement doesn't show what went into this charge." I said, "We want an itemized receipt." That's the best practice.
Dustin
I like to take a picture because those receipts that you get, they disappear the next day. Take pictures or a copy of yourself. This is in line with this idea of what triggers an audit? It's in the realm of this. I'm curious and people would be interested to know what some of those red flags are? What do we need to stay away? What's questionable activity to the IRS?
Adam
The number one thing that the IRS looks for is the Schedule C. The reason is that when you have a business and you're operating with the 1040 Schedule C or an LLC that’s disregarded. It's all on a Schedule C, chances are you've been getting little or no training or guidance on what you can and cannot write off. What documentation to keep? How long to keep it for? They know when they audit the Schedule C, they're going to find something that you've not done properly probably and you will owe them money. Schedule C is the number one thing. It used to be said that also a red flag was the home office, which was heavily-abused. People would pick the biggest room in their house.
I had a good friend that he had this nice bachelor pad and was a beautiful home, with a nice pool out back. Right when you walk in the house, there's this big huge room that you start off with this nice dining room table. Go a little bit further and there’s a pinball table. Go a little bit further, there's a foosball, ping pong, pool table, all lined up as a great game room. He's operating as a sole proprietor. He gets a knock on the door one day and it is the IRS. He says, "I'm here to do the audit." He said, "I was thankful my laptop was right there on that dining room table because that was the room I was using my home office." The IRS auditor says, "First of all, this is not a home office." The IRS wants to see office furniture only. If you have a futon or a daybed in your home office, it's not a home office. They go far to see if there is clothing in the closet. It's not a home office. It has to be an actual office with office furniture only.
One of the clients that we've worked with in the past, she did a great job of keeping track of all of her receipts and everything. Her home office was perfect, just office furniture. She got audited. The IRS comes in and knocks on the door. Two guys show up and they go and look at the home office. Everything checked out perfectly. Her son, six-year-old comes in, "Mom, can I go play on your computer in your office like I always do?" It immediately was disallowed. The IRS auditors go, "No, it has to be used for business purposes." Keep that in mind. In order to write-off a home office, you had to write that off on your personal tax return. There are two problems. One, it was a red flag that is on your personal return. There was no other way around it. Two is that when you sell your house, whatever you had written off as a home office over the years had to be paid back as depreciation recapture. Double whammy on that one. The laws have changed. As part of the Trump Tax Plan, they allow us to do where your LLC taxes and S corp can reimburse you for the use of your home office. You do not have to claim it as income. It does not get listed on your personal return and there's no depreciation recapture. It’s a great reason to have an LLC taxes and S corp.
Dustin
There are these red flags that you want to be careful of. There are many different ways to keep track of things. We talked a little bit about receipts and taking pictures. I'm curious, I'm sure you see a lot of different systems for record-keeping and all that. What's your advice here? Do you like these apps that are out there? Do people need to go out and get a copy machine and scan every receipt date that comes in? What was the best way to go about this?
Adam
You should keep copies of your receipts. The receipt, you go to Home Depot and you buy something and you keep that receipt. They on purpose make disappearing ink where after 90 days, the ink has disappeared. Why do they do that? It’s so you can't return stuff. They'll give you an in-store credit, but they're not going to let you return it for cash. They do this on purpose. You should have a system like that. I love the app, Expensify. It's an app where you can take pictures of the receipt. It reads what's on your receipt and puts it into a format that uploads right into your QuickBooks. For those of you that don't have it, I recommend QuickBooks. Getting it set up is a pickle, but once it's set up, it's not rocket science. QuickBooks is a fantastic software. I also love MileIQ. We're doing mileage. I was telling about my friend that got out at it. Not only did they allow the home office, but they also looked at his miles log, which he had 20,000 miles written off on his mileage and he did not have the miles logged. It was disallowed. By the way, he spent five years paying back the IRS from all of these things he had been writing off for years. They don't audit you the year or the year after you do something wrong. They usually wait about 3 or 4 years, then you get the notice.
Once they got audited for that year, you want to go back a couple more years. You want to go forward a couple more years. What do you want to do here? I'm sure that if you did it that year, it was probably done the year before that and year after that. The app, MileIQ, is a great app to use. It tracks your mileage. You swipe it as a business trip or a personal trip. As a business, you categorize it. It takes less than 1ten seconds and it'll have an IRS-compliant miles report.
Dustin
I want to ask you about a big one. You are paying yourself. Shareholder distributions, payroll. There's much misinformation flying out there. You hear Steve Jobs when he was alive or insert your favorite business celebrity or titan has taken $1 of salary from a $1 billion company. What are the rules for paying yourself?
Adam
The IRS rule is that you're operating with an LLC taxes and S corp, you must take a reasonable salary. 
Dustin
What's reasonable?
Adam
A reasonable is typically no less than 30% of the net profit. Quite frankly, when it comes to the word reasonable salary, there's nothing in the tax code that says what reasonable is. The problem is when people look at it and they say, "I don't want to pay all of that Social Security and Medicare tax." Instead of paying myself 30%, I'm going to pay myself 5% or better yet I'm not paying any salary. I'm going to take it all as a K-1 distribution. I'm not even worried about Social Security and Medicare being around by the time I retire. I'm going to take it all as a K-1 distribution. Those are the two ways that you get money out of your LLC taxes and S corp is to pay yourself either a W-2 paycheck or a K-1 distribution. The W-2 is not subject to Social Security and Medicare. The W-2 is subject to Social Security and Medicare, the K-1 is not. People try and take a big K-1 and a little W-2. If the IRS catches you not taking a reasonable salary, they're going to make one up for you. I use the example of $100,000. On $100,000, you as a sole proprietor not having an S corp to run it through or the LLC taxes and S corp. You would pay 15.3% or $15,300 for Social Security and Medicare. If we run that same money through the LLC taxes and S corp, the rules change. I can take 30% or $30,000 as a W-2 paycheck. My Social Security and Medicare on $30,000 dropped to 45, 90.
I started at $100,000. I took $30,000 W-2. The other $70,000 is still your money, but the IRS allows you to pay that to yourself as a K-1 distribution or owner distribution, which is not subject to Social Security and Medicare tax. That will save you $10,000. That is real tax savings. The problem is if you don't do that, you don't take that reasonable salary and the IRS catches you. They usually wait about three years, they'll come back and they'll say, "We think reasonable for you was $100,000, 100% of your net profit. Instead of you owing us 15.3%, you owe 30.6%. The penalty is double." That's on your full $100,000. That is crushing. It’s super important to take a reasonable salary from your business.
Dustin
I couldn't agree with you more. I know a lot of people play games with that and it’s too risky. When you get to a certain point, you don't want that risk in your life. 
Adam
One of the clients I work with is a doctor and in his business, he makes about $5 million a year with his medical practice. He has a lot of employees. In his case, we pay him a salary of $500,000 which is only 10% of his net profit. He's a small part of that operation. He has other doctors and nurses and other people that bring in a lot of the money. In his case, it was okay to do 10%. These are things that you need to consult with a CPA on.
Dustin
I want to ask you because it popped into my head, the losing money questions. I have heard, I don't know where, but it's floating out there. When you are in business, you’ve got to be profitable by a certain point. Is that the case? For some reason no more than three years, you can't open a business and keep taking losses to get the benefit. Is that true?
Adam
Yeah. It's the Hobby Law where the IRS can come back and say, "This is not a business. It's a hobby." They would disallow whatever deductions you're taking. You should be showing that you're trying to make a profit. It is quite possible that you could operate a business for five years and have losses every year as a legitimate business. You'd be a poor businessman but it's one of those things where you've got to show a profit 2 out of the past 5 years to avoid the Hobby Law. That's something that you want to work with your CPA on. You've got three years as a loss or you're going into year four, you're trying to make this business work. You have a legitimate business operation. You have nothing to worry about. What they're worried about is people that are trying to write things off as a "business," that's not.
Dustin
When you said there are exceptions to this, there are cases where you can lose money. I think of Silicon Valley, their model, they go raise a bunch of money. These companies are historically unprofitable forever. There's a legitimate case there. It's about your intent and your belief or showing the IRS the belief that, "Something is here. I need more runway. I need more resources."
Adam
They're trying to attack the guy who's starting a business as a professional fisherman, so he can write off his boat, his travel, his gas and he's done that for five years and never made a dime. That's what they're trying to go after.
Dustin
Adam, what are some other things that people need to be thinking about when it comes to things to write-off? What are some things that are hard and fast that maybe most people don't realize that they can do to minimize their tax or be thinking creatively about reducing?
Adam
The rule as a business owner, you can write off any ordinary, reasonable, necessary expense. When you step back and go, "We can do the mileage on our car or you can do the actual cost of the vehicle." Mileage is usually how you want to start. The company can pay for your cell phone, cable TV or satellite, internet access, travel costs, marketing costs. I have a list of all possible tax deductions for 2020 that is downloadable from our class in WealthFit. One of the things that you look at is the company cannot pay for the mortgage on your house. It cannot pay for the groceries in your refrigerator. It cannot pay for the clothing you wear unless there's some type of uniform clothing. Everything else, your question is, “How do I make this a business expense?” The answer is not always going to be yes. I remember I got my taxes done one year and I had marked under my QuickBooks. I'm from Iowa, I always wear cowboy boots and I got some nice cap, their dress is nice. I'm wearing those and they were expensive. I put that into my QuickBooks as transportation and I thought, "Of course." The CPA said, "Nice try and that's not going to work." There are certain things where your CPA's job is to tell us if we're being too aggressive, we'll back it out. I would rather you keep track of too much than not enough. I'll let the CPA decide and look at it in terms of being practical.
Dustin
I might've put that under marketing, like personal branding. If you're not in Iowa, if you're in California, who's wearing cowboy boots in California? That's your thing, that's your shtick, your calling card. I don't know if it's possible. 
Adam
It's possible.
Dustin
I appreciate you big time for taking the time sharing this information because it is powerful, especially for folks that are at the start of their journey or they're down the road and they realize, "I haven't set it up and now’s that time." This could be that wake-up call. I know we talked about different things and I want to encourage folks if they're looking for more in-depth information to check out the course on WealthFit around what is the best entity? What is the best strategy for you? Be exposed to all the opportunities not to become the expert, but to have that understanding so that you can work with the right folks. Naturally, I encourage people to go check out NCH and that they can do so at NCHInc.com. Are there any other resources or tools that folks can find?
Adam
It's always tough to provide recent and up-to-date resources. I always say call and talk to one of our experts. It doesn't cost you anything. See what they have to say. We'll figure out what type of business you're doing and worst-case scenario, you'll have guidance and support on what the best course of action you should take.
Dustin
Thank you big time for being on the show. I’m excited to get your course out to the world. 
Adam
Thank you.

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