Tax Strategies For Wealth Building You Probably Didn’t Know (Ep. 31)

Welcome to the Ideas by Mike podcast, where your one-of-a-kind life meets a one-of-a-kind financial plan. Every week, we're not just talking about money, we're negotiating with Wall Street, outsmarting insurance companies, and navigating the ever-changing financial markets. So you can win on your own terms. Here, you'll find the energy, optimism, and straight talk you need to take control of your financial future. This isn't cookie-cutter financial advice. It's about crafting a plan as unique as you are, built around your values, your priorities, and your vision for the future. Whether you're planning for retirement, investing for growth, or protecting your family, I'll share insider insights and stories to help you make your next move with confidence. So buckle up and get ready to challenge the status quo, negotiate like a pro, and build a financial life that's truly one of a kind. Let's dive into today's episode and start making your money work harder for you. What if you could design a financial plan that not only fits your unique life, but also leverages one of the world's And the United States' most attractive tax incentive programs. Today, we're going to talk about taxes. Hey guys, this is Mike Milligan. I am the founder of Ideas by Mike, and we have done this podcast for the last 30 episodes to help you build a one-of-a-kind financial plan for your one-of-a-kind life. Today, I'm going to dive into taxes. And I'm going to reveal to you one of the most attractive tax incentive programs that's out in America today. So hope you guys are doing well and hope you're ready to learn more about taxes. You know, there are 6 US income tax hacks that often are propagated by one-size-fits-all financial planning firms, and they talk about this is the way to build true wealth. And they start by maximizing contributions to tax-advantaged retirement plans. They go on to say, utilize health savings accounts, do tax loss harvesting, invest in tax-efficient vehicles, and have proper asset location. They then tell you to hold those assets for a long term. That's the buy and hold strategy. that's out there by Warren Buffett and so many others. And then they tell you to leverage charitable giving and tax credits. Well, see, I'll tell you, those are all great starting points for tax planning. We call those the foundations of all true tax plans. And then recently, and I'm sure you've heard this on TikTok and Facebook and Instagram and the stories, A new innovative approach to tax-free retirement called an indexed universal life. See guys, that's a product, a product that if not properly designed will only make one person wealthy in that. That's the person who sold you that policy. But here at Ideas by Mike and in the One Oak family, we talk specifically about strategies that really build wealth. After you take advantage of the basic blocking and tackling, like saving money to your tax-advantaged retirement accounts, helping get that triple tax advantage through a health savings account, even tax loss harvesting. After we talk through the basics there, we go different. Or we— the thing that makes us different is we go deeper and look at real tax strategies that can help. So, I'm going to walk away from the one-size-fits-all world for a second and start helping you negotiate with the IRS tax code and some tax codes beyond the IRS to actually help you with real tax savings. So that first one that I want to explain to you as we're negotiating with the tax code is the Augusta Rule. It's also known as Section 280A in the tax code. Well, what is this? Is it allows homeowners to rent their primary residence to their business or for events for up to 14 days per year, pocketing that rental income tax-free. Well, how does that work? Well, the business deducts the rental expense while the homeowner receives tax-free income, provided the rental rate is fair value and the 14-day limit is not exceeded. Let me give you an example. Let's say you hold a company meeting or retreat at your home. You then can invoice your business and receive, receive the payments from your business tax-free because the business claims it as a deduction. Let me give you a practical application of this. I'm going to give you a little insight into the Ideas by Mike corporate world. Just back on July 3rd, we held a company party at my personal home where there was some business talked about, but we actually reveled in hamburgers and hot dogs. And then we jumped in the pool and some kids and family and friends were invited. That event ended, by the way, with a massive thunderstorm where we were up under our outdoor shelter and just marveling at nature popping and crackling around us. No, it wasn't the fireworks of July 4th. It was the thunderstorms of a summer hot and humid day in Norfolk, Virginia. Well, at the end of that, One of our employees' daughters said, I bet a rainbow's getting ready to appear. And right out back of our home is the river. And the end of the rainbow was right there. See, that day was not only— is not only going to be infamous in the standpoint of that little girl is going to remember that rainbow right at the end. It was within 100 feet from where we were. Right at the end and seeing the actual end of the rainbow. But it also was a huge tax benefit for me and my wife because that event, if we would've gone and rented a public pool at Norfolk Yacht and Country Club and had the food catered in by them, would've easily cost us $8,000 to $12,000. Well, we could take that same rental cost as an expense from Ideas by Mike, And use that as one of our 14 days for the Augusta rule. And now it's the expense to the business and it's free income into our household. That's how the Augusta rule could be used. And it's one of the biggest wealth hacks used by small business owners, real estate agents, anybody who's receiving a 1099. That's, that, that's being used every day. Now, imagine that many people may not have a pool in their backyard with some great space to entertain, but imagine just having 3 of your coworkers over for dinner to review your annual budget for the year, where you spend 3 hours deep diving and masterminding together to do that. And just find a comparable meeting space room in your community and what they would cost For that event or what that would cost for the event. And you've got that instantaneous tax-free deduction from your business. Then let's go on and look at how the ultra-rich and sophisticated planners employ other advanced, lesser-known strategies to minimize taxes over a lifetime. The next one, the next strategy doesn't come necessarily directly from the tax code, But boy, is it a great one. It is buy, borrow, and die. Okay? This is often— this could be used in the buy and hold strategy. It could be used in real estate, but it's basically, it happens this way. Wealthy individuals buy appreciating assets, borrow against them for living expenses because loans are not taxable. Then pass assets to their heirs who receive a step-up in basis at death, eliminating capital gains. Well, why does this work? It avoids triggering taxable events and leverages the step-up basis in estate planning. So let's imagine you've got, um, $1 million in your bank and you're like, how in the world Can I actually— and by the way, that bank is giving you, for the most avid of investors, they're giving you 4% interest or $40,000 per year that's taxable. Imagine instead you take that million dollars and go out and buy highly appreciating stocks or dividend stocks in a managed portfolio that costs you 0.4% to 0.6% to pick and manage. And then you create a leveraged amount off of that, meaning that you create a loan arrangement off of that. So, $1 million goes in. The S&P 500 and the Dividend Aristocrats more specifically has averaged about an 8.6% return dating back into the 1950s. Now, the S&P 500's averaged more than that, over 11. during that same period of time. But the reason that we use Dividend Aristocrats is because they're high-paying dividend companies, companies that generally over time have increasing dividends over time and are relatively price stable. We also call this a value portfolio. So imagine putting your $1 million in that dividend portfolio, that the dividends now Are taxed as at the qualified dividend rate, not ordinary income. CD, bank savings is taxed as ordinary income. So if you're in the 22%, 24%, 32%, 35%, 37% bracket, having a portfolio of dividend-paying stocks that is then as leveraged is even bigger in this buy, borrow, and die strategy. So the million dollars goes in, it produces dividends, it appreciates Because stocks do go up and down in value, but it appreciates. But then you leverage maybe 50% to 70% of that as a line of credit to use as you need to pay for expenses. And you allow the dividends to pay the interest back against that loan and maybe even the principal with growth. And then when you pass away, if there's any loan left, You pay it off and then your family gets a step-up in basis. So that's a double whammy when it comes to a wealth hack in taxes, right? Instead of paying ordinary income on interest in banks, you're getting qualified dividend tax rates that are less than the 22%, 24%, 32%, 35%, 37% rates. And you're also able to take principal out without selling. This really works well in a highly appreciated portfolio also. So imagine you purchased Nvidia in 2020 and you bought it for $250,000 and it's now worth $1.5 million. Well, you don't want to sell that Nvidia to be able to generate the gains on that, the 15% or 20% gains that would occur on that. So instead, you just leverage that portfolio. And then later on in the future here, you will actually be able to, at your death, you can either sell when the market's down to cover your loan, or you can actually allow the step-up in basis to happen. So that's a wealth hack, right? That the ultra-wealthy and sophisticated planners employ to minimize taxes over a lifetime. Let me give you a couple more. Donor-advised funds and charitable trusts. Well, donor-advised funds are catchy phrases, right? Like making a donor-advised fund is you make a large tax-deductible charitable contribution in high-income years, then distribute to charities over time, optimizing deductions and supporting your philanthropic goals, your impact. Or, and that is in high tax years, right? So as opposed to giving money over a 10-year period, you have a high tax year, you make that large gift now, and then you just spread the gifts out over 10 years, but you get the deduction in the current year. Another charitable strategy you can use is a charitable remainder trust. Boy, trusts can become tricky. And I'll tell you, it makes them really hard to actually dive in and use unless you're working with A financial planner that's got 22+ years of experience and has a team of attorneys and CPAs ready to help guide you through these strategies. But a charitable remainder trust is a tool that you can donate appreciated assets, avoid immediate capital gains, receive an income stream, and reduce estate taxes. Man, what a great tool to be able to use in years of high income. All right. A couple other tools, especially when it comes to estate planning and legacy planning, is there's a tool out there called a dynasty trust where it preserves wealth for generations, minimizes estate tax, and protects assets from creditors. And then there's the grantor retained annuity trust, or a GRAT, where you transfer appreciation to heirs with minimal gift tax. Now, Why would you give an asset that has a lot of appreciation to your heirs now? Well, maybe they're in a much lower tax bracket than you are, and paying tax at 15% is better than waiting 20 or 30 years to receive the asset. It just gives you the grantor retained annuity trust. The GRAT gives you the ability to pass money sooner to the next generation with little to no gift tax. Especially if you can use your unified credit exclusion to help offset that. And for people who have $30, $40, $50, $80, $100, $200 million of estates, now's the time to be looking at those legacy planning tools and how you can, you can pay, you can get large sums to the next generation with very little impact now. And then a couple other things that are out there, and these are a little more mainstream, but these are huge wealth hacks that affluent people use. One is real estate and depreciation. So you purchase real estate as an investor and then use the depreciation to offset rental income, often resulting in little or no taxable income while properties appreciate. And then when it's time to sell that property, but you're not ready to pay taxes, you can use 1031 exchanges where you defer capital gains taxes. By reinvesting proceeds from the sale of an investment property in the new property. So those are— real estate is a great tool to be able to help with current income because of non-cash depreciation. And then the last tool that we use that is the wealth hack is the mega backdoor Roth IRA. So high-income earners use after-tax contributions That could either be a non-deductible IRA or your 401, and then do in-plan Roth conversions to move large sums into Roth accounts for tax-free growth. For the wealthy who never thinks they're going to be able to get out of these large tax brackets in the future, the mega backdoor is awesome.

Yeah.

When you do that though, and you complete the tax strategy for that, then you've got to put your highest potential earning stocks or highest growth into that Roth. Because once it's inside that Roth, you'll never pay tax again. Well, that's what those folks in the United States are doing from a mega backdoor. But I promised you one big one at the end. All right. And there's the one big one that I want to give to you is like I started this podcast episode is what if you could design a financial plan that not only fits your unique life, but also leverages one of the world's most attractive tax incentive programs? I'm going to dive into Puerto Rico Act 60. In the next three minutes, okay? I am I am filming this podcast today from San Juan, Puerto Rico because my wife and I are becoming Act Sixty residents. We are moving to Puerto Rico to check all the boxes to be closer to this island than we are. To our previous home in Norfolk, Virginia, so that we can get tremendous tax savings. Now it also helps that Liana is half Puerto Rican, and that she is becoming fluent in Spanish. And I also am learning Spanish, and hopefully one day we'll be able to do podcasts in Español. But one of the things that's critical about becoming a Puerto Rico Act 60 is you have to. You have to think about the personal and emotional toll of being away from your family and your loved ones for 6 or more months a year because you have to invest significantly in this island, meaning you will have to own a residence. You will need to go to church here. You will need to change your gym membership. Here, and this be the primary place you conduct your business out of if you're still working. Act 60 consolidates Puerto Rico's tax incentive laws to promote investment, innovation, and economic development. It offers significant tax benefits to both individuals and businesses that relocate to and invest in Puerto Rico. This program is so attractive to U.S. citizens because Puerto Rico is the United States. It is a territory. So residents keep many federal benefits while enjoying unique tax advantages. Let me tell you some key benefits of Act 60. If you own a business and you can relocate or import money from the mainland onto the island that is properly structured, right, by creating a business down here, by doing proper consulting work back to that business on the mainland, that income tax is 4% on money you send over. Now think about that. Your business may still be running in the United States. It still may be a business of Texas or Nevada or Montana, but instead of it being a pass-through Especially this is true for those who have pass-through entities. Instead of passing it through to your personal, your personal income tax return and paying 22%, 24%, 32%, 35%, by being a Puerto Rico Act 60 resident, you are now out of the federal tax code for money that's imported because it's an expense to your business back in the United States. So let's say You have a million-dollar business and you export to Puerto Rico a million dollars of income. Instead of paying a tax on that after your expenses of, say, 22% in the United States or $220,000, you import that to Puerto Rico and you pay 4% at the corporate level. And then when it's time to take money out, It's a dividend out of your company. So it's $160,000 to $180,000 tax savings for your business. You want to talk about a wax— a really wacky, out-of-the-box wealth hack when it comes to taxes? Here's a couple of other benefits, Act 60. Capital gains. Any capital gains on Puerto Rican-sourced capital gains for bona fide residents, so you live here, And you have capital gains here, 100% exempt from income. Interest on dividend, interest and dividends. Puerto Rican income taxes on interest and dividends are exempt. Property tax on eligible properties. So when you buy your residency, it's up to 75% exemption. The municipal tax is significantly reduced in Puerto Rico. And the period that you can receive these benefits is standard 15, but they're routinely getting extended all the time. So who's eligible to do this? Because, Mike, this is an amazing tax hack. And if you're doing it, it must be something that is worthwhile. As a 48-year-old, you know, business owner and somebody looking to live a truly one-of-a-kind life, you know, this fits the mold of who I want to be. As the one of the top financial planners in America, a person who inspires others to live one of a kind. Well, individuals, you must meet the physical presence test, meaning that you are generally in Puerto Rico for 183 days a year. There are some exceptions to that, but they are very closely guarded, and it's something that you would need to contact one of the tax professionals We have in Puerto Rico that can help you with this. The second is you need to establish Puerto Rico as your primary tax home, having no closer connection to another jurisdiction. So, for instance, I need to be closer to Puerto Rico because I go to church here, I work out here, you know, I bring family here to for celebrations like birthdays, you know, and major holidays. Puerto Rico has some of the most vibrant holidays you would ever want to witness in your life. Look up three key.

Puerto Rico.

You know, they have other days throughout the year that this island just goes into party mode, and it is an amazing place to be. The next thing you have to do for individuals, you have to purchase a primary residence in Puerto Rico within 2 years. And then the last thing is you must make an annual $10,000 donation to local nonprofits, with half going to organizations fighting child poverty. I don't know about you guys, and if you're an IRS agent listening to this, I need you to have a heart for a second. You know, being here in Puerto Rico and saving hundreds of thousands of dollars of taxes and being asked to help solve the child poverty issues on the island of Puerto Rico, what's more noble? Giving money to Uncle Sam to fund continued more programs that fail in the United States?

Right.

In the pit, you know, the, the, the, the continued pork belly projects and others, or making donations on an island where real problems can be solved.

Well, I'm all about that.

There's other eligibilities for businesses and, and there's a lot of practical considerations that go into this. But I'm going to tell you, right, Act 60, and really the other things we talked about on this, right? For those who are not looking to move overseas and live in paradise on a Caribbean island, but the other things we talked about, like the Augusta Rule, buy, borrow, buy, borrow, and hold, right? When rules that come around to GRATs and donor advised funds, those are all real practical here, but don't throw away your shot. Act 60 lets you seize unique financial opportunities. It allows you to build a legacy. So Act 60 allows you to support long-term wealth and legacy planning. You have to plan for the change though, because the change is about, it's going to be for your family. There's going to be changes in your business. Like today I'm recording a podcast instead of Out of the comfy confines of my Norfolk, Virginia office, where I've recorded so many podcasts before. I'm now doing it on a laptop in an Airbnb while we're establishing residency down here. And there will be changes that come to your business and family and from your business from a compliance standpoint. But then most importantly, when you move and you look at this, it's giving back. It's the role of the required charitable donations and the community impact those make. So, Puerto Rico Act 60 isn't just about tax savings. It's about designing a financial life as unique as you are. And if you're ready to explore these initiatives that might fit into your one-of-a-kind plan, connect with us. See, One Oak Financial and Ideas by Mike is, is here to help educate you on the key components of the one-of-a-kind financial plan. That's tax, retirement income, investment, long-term care, and legacy. Because when you put a plan in place that is unique about you and not from the one-size-fits-all guys out there, then you are free to live a one-of-a-kind life. Until next time, we'll see you soon. Thank you for tuning in to today's episode of Ideas by Mike, the show where I share how to build a one-of-a-kind financial plan for your one-of-a-kind life. If you found the information on today's episode helpful and want to talk more clearly about your specific situation, go to our website at ideasbymike.com. Find us on the socials at Mike Milligan, CFP on LinkedIn or at Instagram or Facebook using @ideasbymike. Also, don't forget that in the comment section will be more show notes.

One last Message from our compliance team. As a reminder, Mike Milligan, Certified Financial Planner, is an investment advisor representative of Advisory Alpha LLC, an SEC-registered investment advisor. All opinions expressed by me, Mike, or any podcast guest are solely our opinions and do not reflect the opinions of Advisory Alpha. This recording is for informational purposes only, should not be relied on solely for investment, tax, or legal decisions. And it's in no way intended to communicate or guarantee specific performance or suitability of any security instrument or product as we may have discussed. Investment advisory and financial planning services offered through Advisory Alpha LLC, a registered investment advisor. Insurances— insurance products are provided by Ideas by Mike, a licensed agency located in Norfolk, Virginia, and licensed to do business in all 50 states. While tax and legal issues may be discussed in the general course of financial and investment planning, Advisory Alpha does not provide tax or legal services. Please consult with your tax or legal professional prior to making decisions related to these issues. If you want an appointment with Ideas by Mike or One Oak Financial, please reach out via our website. This podcast is produced in conjunction with Mike Milligan, LLC.