Is having a good tax strategy all it takes for financial security?
Hello, this is Kelly Coughlin, CEO of EveryDayCPA. “Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.” That was said in the 5th century BC by the famous Sun Tzu. My guest today is a CPA and CEO of a very interesting company called Taxes Mastered, and they have a sub-title Advanced Tax Strategies. My guest, John Brooke, is a seasoned educated, and experienced professional with over 25 years of experience at Big 6 firms, I suspect they were probably Big 8 back then. He got a CPA back in 2007. And what I find interesting about John is he and his firm really focus on tax strategy, and he lets the rest of us focus on tax tactics, and that plays into my Sun Tzu opening, “Strategy without tactics is the slowest route to victory.” So, John, tell us, is your company on the way to a slow route to victory because you know that tactics or do you have something else in mind?
John: Well, thanks, Kelly, first for letting me be on this program. I think our company is on the fast track to victory. And the reason is that, in my opinion, in the tax world victory begins with a good tax strategy. The tax code for the small business owner is actually their friend. Taxes are the enemy. When I started with Peat Marwick and Mitchell in 1975 in their Phoenix office the first thing they taught me is understanding the why of the client, what the client is trying to accomplish; and then once you know that it makes it easier to make good solid decisions. And the tax code wants you to start with your vision, what you are trying to accomplish. And once that is understood then the tax code has a variety of parts that can accomplish that and still be in harmony with your vision. So my answer, Kelly, is strategy is the fast path to victory for the taxpayer.
Kelly: Interesting. So, John, tell us a little bit about John Brooke, where you live, what you are doing and why you have launched your new great enterprise.
John: Kelly, I graduated from Arizona State University in the honors program in accounting in 1975. Upon graduation, I went to work for Peat Marwick and Mitchell in their Phoenix office which was the largest of the Big 8 firms. And I worked for them for 4 years until July 1, 1979, when I opened up my own CPA firm in the Phoenix area. It expanded to a firm in Nogales, Arizona, there on the border with Mexico, and my practice grew to uncover most of the west coast. For a while, I had an office in Washington DC but the logistics for that were not good. When I left Peat Marwick I started in the tax area, and I started building my tax firm predominantly by representing other CPAs and tax attorneys, in appeals, and in tax court. So I was very much involved with defending other people’s tactical execution on the tax return, meaning, how it was prepared. But an interesting question kept coming up from my clients, and that was, John I think we just pay too much in tax. And my common response was, yes, it is hot in Phoenix in the summer and there is nothing you are going to do about it. This is what it is. But I have taken a lot of mathematics classes at the university dealing with the collection of data, large data numbers, and things like that, and so I started to quantify some of our clients and to see if there was a common pattern that I could discover in that quantitative analysis that would explain why people pay too much in tax. And over a period of time a conclusion came up, and by now we are into the mid-80s, and that conclusion was that 85% of all small business people pay too much in income tax, and there was a very clear reason for that or at least a very clear primary reason for that. And the primary reason they pay too much in tax is that their vision, their goals, the things that they were trying to accomplish were not supported by the tax code sections that the tax preparer was using. You know, Kelly, you are a CPA, I have been a CPA since the late 70s, you and I both know that the fun thing to do, in a cruel sense of way, but the fun thing to do is take a set of facts, give them to five CPAs and then watch them try to explain why they all came up with a different set of facts. And the reason that that happens is that the tax code is an exercise in social engineering. It is not primarily written to raise money for the government. If it was, why would a single person, all things being equal, why would a single person pay more tax than a married couple? It was because it was a social engineering purpose pushing people to be married. And that explains also why there are so many answers in the tax code, it is because they are trying to support a large number, actually, of social engineering purposes. So what needs to happen, in my opinion, is that the taxpayer looks to see what social purpose, social engineering best fits what they are trying to accomplish, jump on the path, receive the tax benefits, accelerate the time they reach their goals, reduce their taxes to improve their cash flow and generally achieve their vision, on time, on budget, and with the highest probability of success. Once I began to understand that concept then I began to see why people pay too much in tax.
Kelly: I want to touch on, before you move on, the social engineering concept. You may correct me here, but is not the primary goal of social engineering, I would agree with that, but the primary goal is to redistribute wealth fairly – take from those who have more wealth and income than they need and redistribute it to those that are in need of that? So on your married taxpayer example, it isn’t so much that they are looking to encourage people to get married, it’s they recognize that it is more expensive to be married and have kids, right, than a single person, so single people pay higher taxes, do you agree with that?
John: Kelly, you raised a very important concept. In our political system, we have a wide range of opinions on redistribution of wealth, wherever you want to be you are somewhere within that spectrum. The interesting thing is that a lot of the laws that try to be passed on redistribution of wealth are not proposed to be in the tax code, that’s my first point. The second is that the primary purpose of the tax code is to help taxpayers succeed. And however we feel about wealth redistribution there is a tacit assumption, and pretty much by all people on the spectrum, that we need to have wealth generated. How it is distributed is a secondary question. So the primary focus of the tax code was to help taxpayers, particularly small businesses, to help them generate wealth. Now, the social engineering purpose wants to push us in certain ways. So, for example, they develop section 125, cafeteria fringe benefit plans, provided a business deduction for the owner, and then said, if you will provide health insurance for your employees you get this benefit and they will not be taxed on it. That is a redistribution of wealth concept but it is very beneficial in the long run for the employer to engage in that social engineering because it will actually produce benefits that help them build wealth. And so this idea of the tax code generating wealth, the idea of the tax code being used to redistribute wealth, if I had to put a number to it I would say over 75% of the tax code is helping the taxpayer generate wealth and the rest of that percentage, if I had to put a number to it I would say about 75% of the tax code is helping small business generate wealth. The other approximately 25% of the tax code deals with mechanisms that might result in the redistribution of wealth.
Kelly: That’s an interesting concept because, and I am not 100% sure I agree with it, I have got to give some more thought to that, but it seems like, to me, the more expansive and inclusive economic policy, monetary policy, federal reserve, all of those components are about wealth creation, and tax code is exclusively about wealth redistribution. I suspect you might be right but I have never looked at it that way, and I am not going to say I agree with that but that could be an interesting podcast in and of itself that I would love to have that discussion, frankly.
John: Well, the first thing I’ll say, Kelly, is that my mother thought I was the smartest person that ever walked on the face of the earth. My dad’s concept was I couldn’t find my way out of a box if three sides were down, so I don’t always claim to be right in everything. But here is an interesting point, I write classes for CPAs on their continuing professional education in the area of tax. In my courses, when I am presenting them, I always ask this question, what do you, as CPAs out in the field preparing tax returns engaged in this line of work, what do you as CPAs feel is the primary purpose of the tax code? The predominant answer of well over 80% is that the primary purpose of the tax code is to raise money for the government. It’s a war we are engaged in. The taxes are our enemy. We have got to get it down as low as we can. The odds are not in the taxpayer’s favor. The odds are in the government’s favor because they wrote the rules. And it gets deep into that kind of thought. When I lecture to and write classes for business owners and I ask them, what is the primary purpose of the tax code? They will say, my CPA tells me it is to raise money for the government, I really don’t know, John. And then I’ll go through popular business strategies and they’ll say, yes, that’s a lot of merit. That has a lot of merit, that one too, and then I will point out where those business strategies had their roots, they had their roots in the tax code. And that is a shock to them but what they did recognize before the lecture was over, before the seminar discussion was over, was that a lot of things that they think exist outside of the tax code, that the tax code doesn’t have any bearing on, business strategy as an example, actually has its genesis in the tax code. Every form of financial transaction that is legal in the United States finds its roots and its legality nestled first in the tax code. And a lot of the litigation we have afterward is trying to figure out how that tax code section applies or the rulings, revenue rulings, those kinds of things. A lot of our financial products are first defined in the tax code before they came out. So, my argument to a small business is if you think you are paying too much in tax, which you are about 85% correct, you are, where are you going to go to find a broadly based safe path for success? And it is interesting that it is in the tax code.
Kelly: As I see it, you focus on three elements, when a prospective client comes in to you, you assess – are they paying too much and why, and then you develop a strategy, I think, is your next step, what can be done about that? And then the third step, I suppose, is to execute on that. So, let’s start with the assessment part. Give us the top three reasons taxpayers pay too much in tax that you have seen.
John: Reason number one is that their vision is not properly supported by the tax code sections they used to record their transactions on the tax return. Number two is that they adopted a strategy that flows all income under the form 1040. That’s a very inefficient, ineffective way to do it. And that a significant number of beneficial tax strategies are simply not available on the form 1040 when you are using past through entities bringing that in, and the third is that debt payment is not handled according to the way the tax code wants it to be and, therefore, the payment of long term debt whether it is on a truck, a building, equipment, whatever it is, we end up paying far more in interest in principle than we should. And I know there is a lot of popular programs on debt reduction and, you know, don’t go on vacation, eat beans and rice and sacrifice everything to pay off your debt. That isn’t what the tax code wants, but the end result of what the tax code wants is it doesn’t want you to pay 20, 30 years on a debt, because it realizes that affects the stability of your company, the survival rate of your company. It takes cash flow out from you using that and building up an internal rate of return on it that’s greater than the interest rate, securing your business, all those wonderful things. So, if I had to say it, I would say three things, vision not matching, the selection of the tax code not matching the vision, the structure that people use to organize their business, resulting in a severe reduction of tax strategies and the third is the way they pay their debt.
Kelly: I would imagine you have seen common things with most of your prospects so they all have issue number one and two and perhaps number three, and then you come up with a tax strategy. You have given the assessment, you meet with them, here is the assessment, then you sit down and develop a strategy on what can be done so they only pay their fair share of taxes?
John: Yes sir. If you go to our website, taxesmastered.com, you will see an assessment there and if you take that assessment you will get a good idea of how much you are overpaying your tax. Because the concepts that we just talked about I put it in some mathematical algorithms and based on large data that’s the conclusion. It might be different for a specific client but in a large number survey, it’s a pretty accurate number. What happens then is that at the time that we start to do our strategy, what happens is that our strategy is really divided into two parts, let’s first identify the problems which is what we just talked about, and then the second is, how can we reorganize the status quo to get a different result? Because the tax code does not require us to accept the status quo, we might have filed the tax return a certain way for 20 years. The tax code does not require us to file the 21st year in the same way we file years one through 20. In addition, some of the changes we make to the status quo can be carried back for approximately three years and correct tax returns that have already been filed. So, after we have identified the problem we identify how to change the status quo, how to eliminate them from the group that is overpaying their tax. Then we go through the implementation stage making sure that everything is done, I’s are dotted t’s are crossed. And then we go into the third stage which is the ongoing monitoring to make sure that the design that we put together is still applicable, still occurring, being adjusted to changes in the client’s environment, being adjusted for changes in the tax code or nuances in the tax code so that the client knows it is still being responsive as they move forward and their business hopefully grows and expands.
Kelly: Describe your perfect sweet spot client prospect.
John: Kelly, in answering that question I will tell you that most CPAs disagree with the definition that I am going to give you because it’s not a numeric classification. I don’t care how much they have in revenue. I don’t care how much they have in expenses. I don’t care how much they have in profit. I don’t care about the business they are in and I don’t care about the number of employees. My ideal client is someone that has a reasonably good idea of what they are trying to accomplish so they can articulate their vision, and they want to take responsibility, they want to have ownership over what they do and the performance of their company. And if they have those two mental attitudes then they have a very very good chance of succeeding. They are thinking about their business, they are evaluating options. My job is to educate them on options, balance the pros and cons, explain it in a way that they can then make an intelligent decision because I don’t make the decisions, but they make them, and their business reflects the consequences of those decisions. But that’s my ideal client, they know what they want to do and they take responsibility to get it done. Other than that, the only other requirement we have is that they are in a lawful business and that the business enriches its customers. It’s a good product for the customers.
Kelly: Okay, you want business clients, that’s number one.
John: Number one, we work a lot with business clients but we also work a lot with individuals because we end up working with the employees of the company or we end up with W-2 earners that also pay too much in tax. We talked about the 85% that applies to small business, approximately 65 to 70% of all individuals that file a 1040 and are W-2 employees also pay too much in tax. We talk about businesses but a business is comprised of people and we want to help people regardless of whether they are W-2 or they own their own business.
Kelly: So everybody feels like they pay much in tax, I would say, but I guess when I look at your website and your gateway to a TMI, Taxes Mastered, the best way for people, if you can offer some value to them, is to go to your domain, your website, www.taxesmastered.com/assessment. They should go there, fill out the assessment, and then from that, you can give them a result that will say we can help you or we can’t. Is that fair enough?
John: Yes sir.
Kelly: So that’s what people should do?
John: That’s what people should do.
Kelly: If they want to learn more about you, don’t give you a call, don’t send you a tax return, go to the personal assessment, is that how you move people along the path to helping them?
John: Yes, Kelly, even if they call me on the phone or I meet them casually, the first step of the process is to take the assessment because the first thing to do is find out the vision of the client and their attitudes towards certain things. The only numeric we ask for is a range of how much they pay in tax. But the first place we want to start is understanding our client. The last place we want to start is numbers.
Kelly: Well, that sounds interesting, John. Thanks for all of this valuable information on the importance of marrying a good tax strategy with effective tactics.
John: There are two things I would like to add, first, I would like to thank you for the opportunity of appearing on this podcast. I know you have a lot of listeners, I hope there is something here that will have a lot of merit to them. Second, in your earlier quote about the strategy and tactical, the two fit together, they have to be in balance. Our firm does not do the tactical which is the preparation of tax returns and related activities.
Kelly: Okay, that’s it for me, John, thank you for being our guest. I look forward to talking with you in the future and everybody knows how to get in touch with you. It’s the best way is taxesmastered.com/assessment.
Thank you for listening, goodbye.
Date: August 28, 2019
Attendee and Guest: Kelly Coughlin, CEO, EveryDay CPA – John Brooke, CPA & CEO Taxes Mastered