Originally Aired: October 14, 2015
Topic: Secrets of a Former IRS Attorney with guest Sandy Botkin, CPA, Esq.
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Guest Introduction: Sandy Botkin
- Starting Your Own Business
- Income Shifting
- Making the Right Choices Regarding Undergraduate Education
- The Health Savings Account
1. Guest Introduction: Sandy Botkin
Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg, along with CPA and attorney Jim Lange. With tax day, April 15th, fast approaching, tonight we’re going to bring you some tips and techniques on how to legally and ethically reduce your income taxes, and we can’t think of a better person to provide you with insider tax-saving secrets than today’s guest: former IRS attorney, syndicated writer and best-selling author, Sandy Botkin. For more than twenty years, Sandy has taught thousands of taxpayers how to save millions on their taxes through his seminars and lectures. Today, he is the chief executive officer and primary lecturer of the Tax Reduction Institute, a tax education company that creates and distributes valuable tax information to independent contractors and small businesses, and his latest book, Lower Your Taxes Big Time!, is brand new for 2015. So, with that, let’s say hello to Jim Lange, and welcome back to the program to Sandy Botkin.
Jim Lange: Welcome, Sandy!
Sandy Botkin: Well, it’s a pleasure to be on!
Jim Lange: And we don’t want to forget your other book that, even if it’s not your newest, is probably relevant, particularly for people who are not in business for themselves, and, just say, investors, is Achieve Financial Freedom,” in addition to Lower Your Taxes Big Time!, by Sandy Botkin, and I will tell you, as a CPA and an attorney, Sandy is right on top of things that sometimes we don’t think about, and frankly, he has, I don’t want to use the word ‘balls’ on the air, but he goes for it, man, and he justifies it and says it with a straight face and it gives people the ability really to deduct a lot of things that they might not otherwise deduct. So, Sandy, one of the things, and very frankly, when I was preparing for this show, I thought, “You know, most of the people, most of our listeners are probably…they have a job, or maybe they’re retired, and we really shouldn’t talk about…we shouldn’t spend a lot of time on being self-employed,” and then your first chapter is called, you know, “You have to be Brain Dead Not to Start Your Own Business.” So, I thought, “How can I skip that?” Can you tell us a little bit about starting your own business, both from an economic standpoint and then also from a tax standpoint?
Sandy Botkin: You know, it’s good that you brought that up because that’s really the genesis behind where people can really save money in taxes. What’s interesting is that most people don’t realize that we have two tax systems in this country, and when I say that, a lot of people think, “Oh sure, one for rich and one for poor,” and that is not true. There’s one to make you rich, and there’s one to make you poor, and I guess it’s a question of which one do you want to be in. The one to make you poor, unfortunately, is designed for the employee and the working stiff, those that don’t have a business, because you are taxed on dollar one. You basically don’t get that many deductions, in spite of what you may think, and if you do get an employee business expense, it’s got to exceed a certain threshold. In fact, even worse, if you take too many employee business expenses, then you get stuck in something called alternative minimum tax, which disallow those things.
However, if you are self-employed, that’s the one to make you rich, and that’s true whether it’s full-time or part-time. It doesn’t matter. You could write off everything that an employee could write off. You could write off part of your house, your spouse, the equivalent of your kids’ education and weddings. I’m not exaggerating when I say that, by the way. You can set up a pension plan that makes any government plan look small by comparison. Like, there’s one plan I’m thinking of, you can put away $210,000 a year, believe it or not. The tax benefits of being in business are enormous. You get your deductions before the government gets one dime to drink. You’re not taxed on dollar one like an employee. You don’t get hit with alternative minimum tax, it doesn’t eliminate your deductions. I mean, it’s just enormous! And even better, let’s say your business generates a loss. As long as you have the right documentation, and that you’re trying to make money (you’re running your business like a business), that loss can be used against any form of income you have. I mean, the government’s probably the biggest bookie in North America because they let you write off any loss from a business against any earnings.
So, let’s say you’re making $50,000 at a job. Instead of working overtime for that boss (which, by the way, spelled backwards is double S.O.B.), you get a part-time business and generates a $10,000 loss, you only pay taxes on the net, which is $40,000, and if that loss exceeds your whole income for the year, you’re a single parent, you get to carry it back two years and offset the last two years of taxes that you paid, or carry it forward twenty years and offset the next twenty years of earnings. Now, you ask me, “Why would a government do this?” And here’s the answer: the U.S. government has learned something that most other countries haven’t learned, and we’re sort of getting away from it, unfortunately. And what we’ve learned is from little acorns come big trees. For example, Apple computer didn’t start with 200,000 employees. It started out of Steve Wozniak and Steve Jobs’ garage. The big internet giant Amazon didn’t start big. It started out of Jeff Bezos’ garage. So, the government passes good tax laws for small business. The key is, you want to take advantage of them because the benefits are enormous, and you can use losses from that business to offset what you’re earning as an employee. So, it’s well worth getting a side business. The key is to try to find something that you think you can make money at.
Jim Lange: Well, let’s say that I’m a listener, and maybe I’m driving to my job or I’m driving to church on Sunday morning, and I’m thinking, “Hey, you know? I have my job, things could be better, but I really don’t want to…you know, I have a mortgage and I have a kid in school,” which we’ll get to later, “I really can’t afford to be without the income of my job.” What do you think about, let’s say, starting something on the side? Which, by the way, is how I got started. I started doing tax returns on the side, and then I went to law school and eventually, I had enough business that I didn’t work for anybody, and I’ve been self-employed ever since. What do you think about somebody starting small, you know, let’s say in a situation where there isn’t a huge amount of risk? Like, you don’t have to buy a building or rent an office and hire twenty employees, do you?
Sandy Botkin: No. You know, you’re absolutely right about this. I mean, there’s no reason why you should actually quit your job. That’s not what I’m saying, and then go, you know, full-risk and go out into business. I mean, that, to me, is very stupid, unless you get a lot of funding from somebody, because you’re going to need funding, not only for the business, but you’ll need funding for your lifestyle while you’re building that business. Everybody forgets about that. No, I would recommend, you know, if you have a job and are making money, I would recommend, on the side, starting that side business, doing exactly what you said. You have much less risk, you’re still providing the money for your lifestyle as well as your business, and just slowly build it up. Eventually, not only do you get some great tax benefits, but eventually, you might make enough money where you can quit that job and do exactly what you did. But it takes drive, and it takes persistence, and it takes time.
Jim Lange: Well, the other thing that I liked is you didn’t say, “Hey, just start a random business about something that you don’t know anything about.” You basically said, “You know, you’re probably better off doing something that you like and that you know.”
Sandy Botkin: Well, that’s exactly right. I mean, you don’t necessarily have to physically know it. You can investigate it. Do some investigation, which is one of the criteria that IRS looks at as to whether you’re running a business like a business. But you can investigate it. There’s a lot of franchises that are very successful, and you can look into those. There’s a guy I know who was an employee for a company selling carpets. He didn’t want to do that anymore, but he went to this one restaurant somewhere where he got the best pancakes he ever had in his life and the best breakfast he ever had in his life and said, “I’m going to open up a franchise.” So, he opened up what is called the Original Pancake House. This place is so busy, he’s opened up two others since then, and the guy doesn’t have to work again for the rest of his life.
You can look into things. There are plenty of franchises out there. There are some very good network marketing opportunities out there. If you have an idea of a hobby that you think you might make money at, that might be a great thing. I’ll give you a good example: there was somebody I know who liked drawing cards. She used to give people personalized postcards, and she’d put a little painting on them, and all of a sudden, her friends were saying, “Gee, I like this. Can I buy some of these from you?” And she said, “Sure.” Then she made more and then the friends would recommend her to other friends, and before she knew it, she had a whole business making postcards for people. You know, take what you like to do, or what you know about, that’s the best way, and try to make that into a profitable endeavor. But even if you don’t know about it, as I said, there are plenty of franchises, there’s network marketing companies, things like this, that will train you on how to do what you need to do.
Jim Lange: Well, by the way, I would love to spend a lot more time on all the tax benefits of a small home-based business, which is, to a large extent, what Lower Your Taxes Big Time! is, again, that’s Lower Your Taxes Big Time! by Sandy Botkin, and his other book, that is probably more for the investors, or people who are not so interested in starting your own business, is Achieve Financial Freedom. But as much as I would like to talk about some of those things, I would like to talk about some of the other things that you talk about, because one of the big ones that really kind of smacked me in the face, because we do it, but we probably don’t do it as often as we should or recommend it as aggressively as we should, and it’s on page forty-six, where you talk about income shifting, because you almost seem like this should be a routine-type transaction, and I’d say not more than a couple people out of a hundred do it. So, can you tell us a little bit about both the gift and shift tax technique and some of the things that investors who are buying and selling stocks and incurring gains, some of the things that they can do to reduce their taxes? And why don’t we assume, for discussion’s sake, that they are in a family where husband trusts wife, who trusts kids?
Sandy Botkin: Okay. First of all, I do want to mention that my other book, Achieve Financial Freedom Big Time!, is not just for investors. It’s for anyone, really, anyone, but it’s very different. Instead of being tax-oriented, it deals with things like estate planning and probate and asset protection and what mortgages to buy, a lot of nitty gritty economic financial issues that people have to deal with. You know, what college did you go to? What kind of debt did you have? Things like that. A lot of little nitty gritty stuff. But anyway, let’s talk about income shifting. You know, when I was at Deloitte-Touche, people used to pay us thousands for the information that I provided in my book, some of which we’ll be mentioning today. Because you’re right. Very few people are doing this, and there’s two essential techniques.
There are a lot of techniques in income shifting, but two of them that I want to mention, for sure, and one is the gift to push tax technique. Now, what is this? Bet you no one has ever heard of it! This really started as a loophole. It was created by the Bush administration, and it was continued by Obama and the current Congress. The way it works is that normally, when you sell stocks, bonds, real estate, mutual funds, things like this, and you get long-term capital gains, you pay, usually, between 15% to as much as 23.8% as a capital gains tax when you sell those things, plus state. That’s in addition to any state tax you might pay. What Congress did is they said, “All right. For someone who’s not in the 15% bracket, something less than that…” and that means if you’re filing a joint return, the net of your taxable income is somewhere under about $72,000, and if you’re a single individual, it’s around $37,000 or so, somewhere in that range. If you’re less than the 15% bracket, and you sell stocks, bonds, real estate, somewhat like that, your capital gains rate will be zero. You actually pay no tax on your long-term capital gains. Now, why is that important? Here’s why: instead of selling the stocks and the bonds and the real estate and all that other stuff and paying capital gains tax at 15% to 23%, you simply give away the stock, or the bond, or the real estate, to relatives that you’re supporting. It could be your children, it could be your grandchildren, nieces, nephews, mothers, brothers, anybody you would support anyway. And then, they sell the stock, or the bond, or the real estate, one day later. Here’s my point: you’re in the 15% to the 23.8% bracket. Your relatives could be in the zero percent bracket if they net under $72,000 joint, or $37,000 single. You could literally wipe out your capital gains taxes by doing that, and that’s called the gift to push tax technique. Now, the rich have been doing this for years. This was the best indoor game in town since Monopoly. However, Congress tried to limit this recently, and the way they tried to limit it was something called the kitty tax. Now, what’s the kitty tax? Children, or anybody for this matter, who are under age twenty-four, and are full-time students and unmarried, can earn up to $2,000 of investment earnings (and that includes capital gains), investment earnings taxed at their bracket, which, by the way, is probably zero. Anything above $2,000 is taxed at the highest bracket of the parents, and that applies to anyone who is under twenty-four, full-time students and unmarried. If they’re not twenty-four, or if they’re not a full-time student, or if they are married, then this age drops to age eighteen. So, if eighteen or older, they’re taxed at their own bracket. And that’s called the gift to push tax technique. So, what do you do if you have three kids and they’re all full-time students and they’re under twenty-four? Well, then you can shift up to $2,000 of earnings to each kid tax-free. So, if you have three kids, you can shift $6,000 that way. So, it still works. It just doesn’t work as well as it did many years ago.
Jim Lange: All right. I don’t know if people are really kind of getting this. This is a way that you can really basically have capital gains-free taxes for your capital gains.
Sandy Botkin: That’s correct. That’s absolutely correct.
Jim Lange: And, you know, particularly, it’s even easier if your kid is older than twenty-four, but Sandy’s actually given us a way to, at least, limit the capital gains even if our kids are less than twenty-four or in college.
Sandy Botkin: I mean, absolutely. Let me give you a good example: I was on a plane with a gentleman who was an attorney, and he makes a lot of money. He’s a labor attorney, and he makes a lot of investments in the stock market that do very well. But, you know, I got the feeling that he gets inside tips. I can’t prove it, but I think he does. But anyway, he has some kids, and I asked him, “What do your kids do?” “Well, they go to the University of Southern California and one goes to UCLA.” And I said, “Well, how do you pay for the tuition?” He said, “I pay by check.” And I looked at him and I said, “You know, that’s a really dumb thing to do.” He goes, “Why?” I said, “Look, give your kids the stock. As long as their net taxable income is under roughly $37,000, all the gain on that stock is capital gains-free. The only thing they’ll have to pay tax on maybe is California,” which is where he’s from. “You’re in the 23.8% capital gains bracket, federal tax bracket. They’ll be in the zero percent capital gains bracket. You’ll be able to shift about $37,000 of capital gains tax-free to them that they can use to pay for their education. You can give them a check for the difference.” He was so excited, he wanted to know how get the rest of my program. He wanted to know about my books. I mean, even wealthy people are not always getting this information.
Jim Lange: Well, see, the other thing that you mentioned earlier, you said people paid thousands of dollars, and I don’t know what the costs of your book are, ten or twenty or even thirty dollars…
Sandy Botkin: It’s not even thirty. It’s about ten or twenty dollars.
Jim Lange: All right. Boy, you know, again, the two books we’re talking about, Lower Your Taxes Big Time! which is probably more for small business owners, and then Achieve Financial Freedom, both by Sandy Botkin. All right, so you mention that there were two income shifting techniques. And you talked about the first one.
Sandy Botkin: Right, that was the first one. That’s called the gift to push tax technique, all right? The second one is actually one of the most popular financial planning strategies among doctors, particularly doctors and movie stars, and it really came out as a result of a Supreme Court decision, and it’s called the sale leaseback technique. Now, what’s the sale leaseback technique, and how’s that different than anything else? Unlike the first technique, where you’re giving away property that has gone up in value, the sale leaseback technique is you give away property that you’ve already depreciated. So, you’ve already written it off. You’re not getting much benefit, or you’ve almost written it off. Now, once it’s written off, just like the gift leaseback technique, you now, with a quick claim deed, give away title to your property, preferably business or investment property, to people you would normally support: parents, brothers, sisters, children, grandchildren, whatever, and lease it back from them. Now, you might not appreciate this, but here’s my point: you have already depreciated the property. You are now deducting the monthly lease payment you’re paying your relative, you’re deducting that equipment twice. And they’re using that lease payment to help support them in their endeavors, whatever it is, for college, and you’re getting a deduction. And even better, that deduction, if you’re self-employed, will reduce your net income for Social Security. So, you could reduce your Social Security that way, whereas rent is not subject to Social Security. So, here, they’re receiving money free of Social Security, and you’re getting a deduction that might reduce your Medicare and Social Security taxes. And that’s called the gift leaseback technique. Now, you will need a trust there because usually, in many states, you have to provide a trust. But it does work quite well, and another advantage of the sale leaseback, or gift leaseback technique, is that if you’re ever involved in a lawsuit after that where somebody sues you for a couple million dollars, they don’t get anything from you because you’ve already transferred your assets out of your name. So, you’ve asset protected yourself very cheaply.
Jim Lange: All right. By the way, I like this, but I want to be fair and talk about some of the downsides of it, too. Number one, all right, so you are going to have to go to somebody, presumably an attorney, to draft a trust on this, and then there’s also going to be, let’s call it, tax preparation complications. How large of a transaction, or how small of a transaction, either way that you want to look at it, do you think that this should be? In other words, you’re not going to do this on a $5,000 piece of equipment.
Sandy Botkin: Well, name your price. I’ll give you an example: the general rule of thumb, from what I’ve seen when I worked at IRS, is a reasonable lease payment is about forty percent of the fair market value of the equipment. So, if you’ve got equipment worth $5,000 if you sell it today, you could lease it back for about forty percent a year. You get a deduction of that for $2,000. A $2,000 deduction goes considerably along with paying any kind of accounting fees for the trust, which isn’t that expensive. Secondly, when they draft up the trust, it’s only a one-time thing. It’s not like they do it every single year.
Jim Lange: Well, this is a really interesting thing that very few people would think about, and this might be particularly appropriate for people that have fully depreciated property, particularly real estate or business property where they’re not getting a deduction, and now they’re actually going to get some, let’s call it, income shifting.
Sandy Botkin: Well, it’s more than that. Think about doctors. The number one concern by every doctor I’ve ever met is liability. By using the sale leaseback technique, or even the gift leaseback technique, all the equipment that’s in their office or in their practice, they get out of their name. So, if somebody sues them for malpractice, they can still use the equipment, and they’ve achieved asset protection here, and it’s a very cheap form of asset protection.
Jim Lange: All right, and then the other thing that I do feel honor bound to mention is it’s not a good idea to do this if you’re about to die, because then, what’s going to happen is you’re going to lose your step up in basis.
Sandy Botkin: That is absolutely correct. But you know what? I can’t speak for you, but I plan on living forever or die trying.
Jim Lange: Well…but, realistically, so I guess my point is…
Sandy Botkin: Yeah, if you know you’re terminal and you don’t have long to live, this may not be a good idea because at least when you pass away, you get a full step up in basis, which means it doesn’t matter what you paid for it, your devalue to your heirs becomes the fair market value as of date of death. But even that, you have to question. Right now, Congress is looking at some tax reform, and one of the things they’re looking at is avoiding the step up in basis upon estate planning.
Jim Lange: Right, but at least for right now…in fact, that’s one of the greatest things about the step up in basis for real estate. So, let’s say dad depreciates the property down to near nothing and then dies, leaving it to kids, and then kids start depreciating it again.
Sandy Botkin: That’s right. They could sell the property and not pay any tax, or start depreciating it again. That is absolutely correct.
Jim Lange: So, the sale leaseback technique, I think, sounds really good for a lot of people. Frankly, you gave me a lower transaction amount than I would have guessed. To me, $5,000 wouldn’t have been enough, but you’re saying a. it’s not that expensive to set it up, and b. the tax complications aren’t that bad, and c. once you do set it up, it’s like a continued tax deduction creditor protection technique that can just go on for years.
Sandy Botkin: That’s correct. I mean, obviously, you want to see a lawyer and get an evaluation on this, or some tax professional, but I think it is well worth it, even for $5,000. And a lot of people, like doctors and other people, have lots of equipment, not just $5,000, and I want to emphasize something here: this works also with real estate. You know, let me give you just a couple of tips with real estate: most real estate…I don’t know if you own any real estate. I own some lodging facilities. And real estate consists of both real estate and personal property. For example, my properties include washers, dryers, refrigerators, stoves, and all that stuff gets depreciated separately from the property, and after you write it off, you can actually give away that property in trust with a quick claim deed, and lease it back from the trust. And now, the money comes out of the trust and goes into your kid’s name or grandkid’s name. Use it for their education. So, this certainly works on real estate.
Another big advantage (which is something I’ll bet you never even thought of, and I’d like to share it with your audience, this is a very sophisticated little bit of tax planning) is that when you buy investment property, I don’t care if it’s commercial property, residential property, any investment property, you make an allocation between the building and the land, because the building is depreciable, the land is not, and you can make the allocation based on the appraiser’s allocation or you can hire your own appraiser to make an allocation, but you make an allocation. Wouldn’t it be great if you could write off the land, which normally is not depreciable? And with this technique, you can, because what you can do is, you can actually divide the title (lawyers usually call it bifurcate the title), you can put the title of the land in the trust and lease the land back from the trust for your kids. And this way, you’re depreciating the building, you’re now deducting the lease payment on the land, you’re writing off a hundred percent of the property. And even better, if IRS audits you and says, “Oh, we don’t like this allocation,” you can always respond, “Well, I’ll take any allocation you want, because then we’ll just increase the lease payment.”
Dan Weinberg: Sandy, we’ve talked a little bit about your books so far. Tell us about Taxbot. We understand you have an app available for Smartphones.
Sandy Botkin: Well, you know, one of the things I’ve realized is that there are a lot of people out there that need to keep track of their expenses and mileage. It’s true for self-employed people, it’s true for corporation that own cars, it’s true for employees that have to submit reimbursements to their employer, and yet, people aren’t doing it. They’re just not keeping their records correctly. They’re not compliant. In many, many cases, I would say certainly over 95% of the people I’ve seen are not compliant, and most of them don’t even know they’re not compliant. That’s the worst part of it. So, we designed something very simple. You know, I don’t like to document. I don’t. I do it because it saves me money, but I don’t like it any more than anybody else. But if it’s simple, easy and fast, I’ll do it. So, I designed something for me with two buttons. It’s called Taxbot. It goes on the iPhone, the Droid (it’s an app), Droid tablets, it could work on the iPad, the web, I mean, it works on all those things, and what it does, it has essentially four things: it has a mileage tracker with a GPS system, so that the minute you start moving over five miles an hour, the mileage tracking automatically goes on, and the minute you stop for more than five minutes, it’ll turn off and automatically give you everything that IRS requires, the beginning address, the ending address, the mileage, the date, it’ll even do a round-trip for you. All you type in is whether it’s business or personal. You just click a box, actually, you don’t even type that in, and put in the reason, and that’s it. And you save everything up on the web and it stores it for you and summarizes it for you. The second thing, it has expense tracking. So, every time you have a lunch or travel or anything like that, all the tax questions that IRS requires for who, what, when, where, why and how much, pop up. So, by filling it out, you avoid procrastination and you avoid any problem with the IRS. And how would that feel, to be bulletproof?
Jim Lange: Well, it sounds good, but Sandy, let’s say that I say, “Hey, I’m a busy guy, and yeah, maybe I missed a couple deductions, but my time is more valuable.” How would you answer somebody like that (and by the way, myself included) who isn’t really historically great about tracking this kind of stuff? Now, not that I want to piss away money, but I don’t want to just spend half my life being a bookkeeper. How would you answer that?
Sandy Botkin: Well, you know, our studies have shown…this is something that really you should bring to mind here. Most people think they save money. They know this. They save money when they document correctly and they keep the government off their back. But they don’t realize how much they save. We’ve done some studies, and we’ve found that for every minute you spend in documenting your expenses correctly, you save approximately…it’s worth about $120 a minute for every minute that you spend documenting. That’s what, $3,600 an hour? I can’t imagine too many people are making more than $3,600 an hour of work. And with Taxbot, by the way, I do want to mention that we also have an integrated camera for receipts, because IRS just announced that they’ll take digital documentation. It doesn’t have to be paper. So, you can get rid of that paper. Just take a picture of it, and then we have a whole library of blogs and videos and all kinds of things on tax and financial topics that I put in Taxbot so people can save thousands, and that’s the reason we did it.
Jim Lange: All right. So, how can people get this?
Sandy Botkin: Taxbot, you can go on the iPhone store or the Droid store and download the app. It’s called Taxbot. It’s only $9.95 a month for all of this, and if you do it for the year, I think it is $99 a year, and save yourself two months. It even comes with a guarantee. I mean, if you don’t generate a minimum of twenty times what you paid in the first month alone (what’s that, 2,000% rate of return?), we’ll give you back all your money. So, you can’t beat that.
Jim Lange: By the way, for whatever it’s worth, I am a buyer of, you know, books and information and other things and tapes and CDs and all types of information things, but I’m not a huge app buyer. This one, I’m going to buy.
Sandy Botkin: Yeah. It’s a good app.
Jim Lange: All right. Anyway, the next area that I want to talk about, and I guess you touch about this in both of your books, again, Lower Your Taxes Big Time!, which is probably more for some self-employed people and people looking for some tax tips, which we touched on earlier, but then also Achieve Financial Freedom, both by Sandy Botkin, but one of the things that you have always been good at is helping people reduce the cost of college, and I don’t necessarily mean by going to a less expensive school, although I know that that’s part of your paradigm also. So, can we talk a little bit about maybe, first, does it make sense to go to an expensive school and have the student incur a hundred, a hundred and fifty thousand dollars’ worth of debt, and then two, whatever school they’re going to go to, if we could talk about what is the best way to pay for it, deduct it, etc.? But why don’t we first start on the very big picture, because this actually might be similar to something that Jim Dahle told us. He is kind of like the finance expert for physicians, and he was saying, “Don’t go to the most expensive medical school. You don’t learn much anyway until you’re a resident. So, you might as well go to a cheap one!” Now, I know Achieving Financial Freedom is a little bit more of an economic book. Also, could you talk about the economics of going to an expensive school?
4. Making the Right Choices Regarding Undergraduate Education
Sandy Botkin: All right. My focus was on undergraduate education.
Jim Lange: Sure, fair enough.
Sandy Botkin: And then, we can talk about whether, you know, you should go to the best medical school or something else, but that’s something else. On undergraduate education, you know, you hear about all this stuff about how you should go to the best school possible. In my high school, the counselors tell people, “Oh, go to the best college you can get into. Cost be damned. And don’t worry about it. If you can’t afford it, they’ll find a way to give you some kind of scholarship, whatever.” And this is true, probably, in 98% of the high schools out there in the United States. Unfortunately, that is horrible advice that they’re giving these students. Horrible! Most people think, “Oh well, if I send my kid to MIT or to Harvard or Cornell or Tufts, oh, aren’t they going to come out ahead? Won’t they get more job opportunities?” There was actually a study done by two Princeton University professors. It was a very quiet study, where they wanted to know over a lifetime of earnings, if somebody goes to a school like Princeton or an ivy league versus going to a state school, assuming there were still bright kids that could’ve gotten in there, what their earnings would’ve been over their lifetime, and, surprisingly, it’s the same thing. Whether they go to a state school or they went to an ivy school, the earnings would’ve been the same for good students. So, the bottom line is if the earnings are the same, why would anybody spend all this money to go to these expensive schools? And this is particularly important for incurring substantial debt. That is a disaster. You know, there’s an old, fun saying: Debt is fun while you’re incurring it, but it’s never fun paying it back.
Jim Lange: And I want to broaden this, too. There’s two potential people, if you do go to an expensive school, or even a state school, for that matter, who are going to end up paying: one is the student and two is the parent. One of the problems that I have with a lot of my clients is that, let’s say that they came from a home where their parents paid for their college, and they always assumed that they were going to pay for their children’s education, and let’s assume that they’re doing okay, but they’re a little light on their own retirement, and they’re spending $60,000, $80,000 a year for their kid to go to school, and they’re going to literally work years longer than they would have otherwise, and this doesn’t sound like a smart strategy to me.
Sandy Botkin: No, you’re absolutely right. I would never, ever recommend compromising a parent’s retirement to send their kids to an expensive school. Never! You know, a lot of these kids, they say, “Oh, I have this dream school” because they see the wonderful ivy and they see the campus. First of all, kids, at that age, they don’t know what a dream school is or what’s important. They can’t really tell. They really don’t! The bottom line, the education is the same, and incurring substantial debt is a disaster. In fact, incurring substantial debt can actually result in a decrease in job opportunities. A good example of that: we met somebody who wanted to go into the movie business. Now, the way you get into the movie business is you have to basically be an intern, probably work for free or low wages, and work your way up and get connections. Well, this person got into NYU, which is one of the top schools for movies in the United States, but they incurred substantial debt. When they came out, their debt was over a hundred thousand dollars. There’s no way that they could work as an intern and then pay off that debt. There’s no way! It actually resulted in a decrease in job opportunities for them. And even worse, which a lot of people don’t realize, student debt can never be discharged. So, before you think about incurring a lot of this debt, make sure you realize that it is very difficult to discharge student indebtedness in bankruptcy unless you are so disabled that you can’t work for the rest of your life, basically. It’s very difficult. And worse than that is you’re only able to deduct $2,500 a year of student loan interest. Now, when you consider that the average student loan debt is somewhere between six and eight percent, that translates to about $35,000 of total debt. Any debt above that, you won’t be able to deduct the interest. Now, you’ve have to spend six to eight percent on interest on debt you can’t deduct, and let me tell you: that’s pretty expensive.
Jim Lange: All right. So, we have two sets of people who shouldn’t necessarily go to expensive schools: one, students who don’t want to incur a lot of debt, and two, parents who might potentially be jeopardizing their own retirement because, as other writers have said, you know, you can’t really borrow your retirement. All right. So, let’s assume, for discussion’s sake, that the college has been chosen, whether it’s a high cost or a state school or whatever. What are some of the tips that you can offer our listeners who might have college-age students for the best way to not just save, because I think we all know about 529 plans (which, by the way, I’m a big fan of), but some of the ways that they can reduce their taxes and some of the techniques that they might not be thinking about right now?
Sandy Botkin: Well, the best planning is not when the kid’s already is school, because once they’re already in school and make that commitment, now you’re more limited. The best planning is before they go to school. That is, by far, the more important, okay?
Jim Lange: Okay, so let’s say the kid’s fifteen, for discussion’s sake, or fourteen.
Sandy Botkin: All right. Let’s take that example.
Jim Lange: All right.
Sandy Botkin: First of all, there are a couple of good ways to save for college, and the first way, which you mentioned, are the prepaid tuition plans, and there’s basically two kinds of those: one is the qualified tuition plans. One is called prepaid tuition, where you actually pay a certain amount of money to the state, and the state guarantees four years of tuition and its required fees, guarantees, and if you don’t go to that state school, depending on the state, you’ll either get your money back, or in Maryland, for example, there are states like Maryland, which will pay to whatever school you go to the amount of tuition that you would’ve had to pay to a Maryland state university. That’s called prepaid tuition.
Jim Lange: Let’s talk about that because I’m going to say, of the 529 plan contributions that I know about…
Sandy Botkin: That’s a different thing.
Jim Lange: Right, I understand that, but what I’m going to ask you to do is to…let’s say that somebody says, “Hey, geez, I’m not sure what school I’m going to go to,” and the parent is contemplating, “Gee should I do the traditional 529 plan,” where they’re actually not buying credits but they’re actually investing money. In Pennsylvania, they have Vanguard, which is a very good set of low-cost index funds, or should they be looking at the prepaid tuition plan, knowing that maybe the kid isn’t going to go to the state school that you buy the credits from.
Sandy Botkin: Well, first of all, a large percentage of people do go to the state school. Let’s be straight about that. But in my opinion, if they can afford it, I would do both. I would put the money away for the state school, especially if you have a state like Maryland that will pay out in tuition what the tuition would have been, because that’s a hell of a good investment. The other option is…
Jim Lange: Well, wait, wait, wait, wait. Hang on a second.
Sandy Botkin: Did you hear what I just said?
Jim Lange: I heard the words, but I don’t…so, let’s say, for discussion’s sake, that the cost of one course is $3,000.
Sandy Botkin: Let’s go one step further. Let’s say to go to a Maryland state university ten years from today, the tuition would be $15,000 a semester.
Jim Lange: Okay.
Sandy Botkin: At that time, they will pay out, let’s say you go to Cornell, they will pay out $15,000 per semester, which, as I said, was what the tuition would have been.
Jim Lange: Okay. Frankly, I wish I knew what Pennsylvania was. I don’t. Maybe…okay. All right, go ahead.
Sandy Botkin: I don’t speak for Pennsylvania.
Jim Lange: Right, sure.
Sandy Botkin: So, I need to understand the state. What will the state do if you don’t go to a state university? Sometimes, they just give you back your money, which is not a good deal. Sometimes, they will pay out, like in Maryland, what the tuition would have been, which would have been a great deal no matter what, all right? So, you’ve got to investigate as to what that rule is. Now, once you do that, then it’s a question…I would maximize the state prepaid tuition if you have a state like Maryland. If you have a state that just gives you back your money, that’s not such a great deal. Then, you’ll want to look at the section 529 plan, which is basically like a mutual fund, and you just put away money every year, and the money is tax-free if used for qualified education, also for required fees, and the 529 can be used for other things, you know, computers, internet fees and things like this, that the prepaid tuition plan is not limited for. So, that’s the second way.
Now, those are called qualified tuition plans, okay? The third way is hiring your kids and having them set up a Roth IRA. I mean, you can hire your kids and you can put away up to $5,500 of earnings, and that money can be used, tax-free, for their qualified education. Now, a lot of people think, “Well, wait a minute. I don’t have a business that I can hire my kids.” You don’t hire them in business. If you hire them in a business, that’s great. You could write off the income. But you could hire them for personal functions. Here’s a great idea I’ll bet you never even thought of: hire them to make their bed, do chores around the house, clean the house, put away the dishes, and you pay them a wage of, let’s say, $5,500 a year. Now, that’s not deductible. But they can take that money, since it is earned income, and it’s probably not taxable to them because they get a standard deduction of $6,300, so they’re not going to pay tax on the money, they’ll take $5,500 of that money, put it into a Roth IRA, and then all that money grows tax-free for their education, and that’s the use of a Roth IRA.
Jim Lange: And even if you don’t use it for their education, because you have some other interesting ways to pay for education, then they’re getting $5,500, and I know you like to talk about the miracle of tax-deferred and, better yet, tax-free compounding interest. So, that’s a great way to get an eighteen-year old, or even a fifteen-year old…
Sandy Botkin: That’s a great way, or you could use it for their retirement, which is always a good thing.
Jim Lange: Yeah, I like that. And Sandy, what was the amount of money that it costs people not to document?
Sandy Botkin: What we’ve found, our surveys show that, roughly, for every minute you put in documenting (I’d like everybody to think about this), it will put about $120 of deductions in your pocket every minute.
Jim Lange: At $120, that’s $3,600 an hour.
Sandy Botkin: An hour in deductions, that’s correct.
Jim Lange: Well now, some people complain about my rate, but I’m nowhere near that, so…
Sandy Botkin: Nowhere near that. That is correct.
Jim Lange: Nowhere near that. Okay, so, anyway, you were talking about an alternative method, you mentioned the idea of hiring your kid, which I really like that idea. In fact, my daughter is actually doing some work for me right now, and I am going to pay her, and then she can take that $5,500 and use it to fund a Roth IRA. But you had another technique that you wanted to talk about before we had to go for break.
Sandy Botkin: Right, well, with hiring, you could also hire them in your business, in which case, then you get a deduction and they get that money tax-free up to $6,300, which they can use for their education and so on. All right. Let’s talk about some other ways to reduce the cost of college. One of the best ways, which is what a lot of people don’t know about, is how do you get in-state tuition for an out-of-state kid? Think about that. And one of the best ways you can do this is to apply to, what I call, the academic common market. A lot of states have programs they set up with each other, so that if your kid has a major that is not available in your state, you can go to a related state and get that major, so that you can study that major, at in-state tuition rates. And there are various things, like the New England Board of Higher Education represents a lot of the New England states. The Midwestern Higher Education Compact represents a lot of Midwestern states. Maryland and some others, like Alabama, are in the Southern Regional Board. So, the point is, if you have a major that is not available by any state university in your state, you can go to these related state universities at in-state rates. So, that’s one way to get in-state tuition.
Jim Lange: Do you have a source for where somebody could find that?
Sandy Botkin: It’s in my book. I got a whole discussion on this in Achieve Financial Freedom Big Time!, page fifty-four, on all the various markets and all the various exchanges that allow you to take courses at in-state rates.
Jim Lange: And by the way, for people listening, if you buy either Lower Your Taxes Big Time! or Achieve Financial Freedom, and you aren’t happy, I will personally refund your money, because it is impossible for you to buy one of these books, spend ten minutes with it and not come out with a hundred times your investment. I believe that. But anyway, go ahead.
Sandy Botkin: You know, I’ll tell you an interesting story: you know, you kind of wonder, with all these great books out there, why don’t we have a lot more people who are rich and aren’t in substantial debt and doing very well? Here’s an interesting statistic: you take all the tax planning and financial planning books sold in the United States, all of them combined, they don’t outsell the lowest-selling Harry Potter book. Think about that.
Jim Lange: Including mine!
Sandy Botkin: Yes.
Jim Lange: And unfortunately, including yours, too.
Sandy Botkin: That’s correct. There’s a reason people are poor, unfortunately, and it’s not due to lack of information available. All right. How else do you get in-state tuition? Here’s a technique that I personally use. So, I’m going to give you a technique that worked for me in person.
Jim Lange: Now, by the way, do you realize how gutsy this is?
Sandy Botkin: Yeah.
Jim Lange: For our listeners, so he’s basically, like, flaunting the IRS, saying “Hey, this is what I did personally, and you can audit me and I feel so confident about it that I’m just going to stand up to the audit.”
Sandy Botkin: I’m not flaunting the IRS, I’m flaunting the universities.
Jim Lange: Okay.
Sandy Botkin: A lot of this depends from school to school on how to get independent status. Different schools have different rules, but most of them will allow you in-state status if you can establish that you’re independent of your parents. Now, what does that mean, ‘independent of your parents?’ What that means is that you’re paying your own rent, you’re paying your own tuition, you’re paying your own room and board, you get the title to your car and voter’s registration to show that you intend to establish residency in that state, and by showing independence and by an attempt to establish residency, many times, you can get in-state tuition for an out-of-state kid, and I did this with my daughter. My daughter went to an Ohio state university. In-state tuition, at that time, was about $9,000 a year, whereas if you go as an out-of-state kid, you’re talking $24,000 a year. Big difference, okay? But what we did is we transferred a bunch of money for my daughter’s education before she went to the college. Now, once she enrolled in college, she paid her own tuition for the first year. She paid her own room and board. She got a driver’s registration in Ohio. She got her voter’s registration in Ohio to show that she wanted to be a domicile. All of her expenses were personal, paid by check. Everything could be shown. At the end of the first year, we applied for in-state tuition. All they asked was to one, make sure that the checks…they wanted to see her checking account to make sure that she paid all of her own expenses, that we didn’t pay for them, and that the money was in her name before she went to the university. They actually looked back a few months before she applied to the university. By meeting those two rules and by also getting domiciled, which means voter’s registration and driver’s license in Ohio, we were able to get in-state tuition for the rest of the years. I saved tens of thousands of dollars.
Jim Lange: Okay, and now, you know, earlier, you said you don’t go to an expensive school, but now you’re giving us a technique to go to an expensive school without even having a high tuition, or the equivalent of a state tuition.
Sandy Botkin: That’s correct. These academic exchanges and establishing independent status, you could get in-state tuition for an out-of-state kid, which is a terrific deal. But again, I want to emphasize: every state, every school has different rules, and you want to look at the schools, see what the requirements are before they go there to make sure you meet the requirements. Some of them are easier than others, like New York is very easy. Some are harder. So, you want to generally check it out.
Jim Lange: All right. So, we are running out of time, but one of the things that I did want to talk about was the health savings account, and I know that you have some opinions for people who are, let’s say, self-employed, but let’s assume, for discussion’s sake, that our listeners now have a job, and let’s even assume that that job has access to a health savings account. Do you think that this would be a good thing for most people to invest in, and even potentially max out in?
Sandy Botkin: Oh, absolutely. The health savings account, first of all, let me emphasize a couple things here. A health savings account, what is it? It’s kind of like a bank account. You put away money every year and you get a full deduction for that contribution, and then when the money comes out, to pay for things that the insurance doesn’t cover like deductibles, eyeglasses, co-insurance, things like that, legal drugs that you get a prescription for, that money is tax-free. It’s a great thing to set up. It could be set up by anybody, as long as you meet certain rules, and that’s the catch with the health savings account. You’ve have to meet certain rules. One of the rules is you have to have a high deductible policy. Now, what’s a high deductible policy? If you’re a single individual, that means for 2015, $1,300. Your insurance has to provide a $1,300 deduction or higher. If you have a family, it could be a couple, it could be a single mom with several kids, that’s what this family is, that you’d have a minimum deductible of $2,600. So, as long as you have a high deductible policy, you can put away $3,350 a year if you’re single, and $6,650 if you have a family, and if you happen to be age fifty-five or older and not subject to Medicare, you can put away an extra thousand dollars or more. And that’s called a health savings account. I like them. They’re very good. But again, you have to have a high deductible policy. Now, one good thing about that is that even if you don’t use it this year, any excess can be carried over to future years, and to be used for future year’s payments. Now, there’s one other exception to the HSA which is very tricky, and people need to understand this. Your deductibles cannot be covered by anything else. So, if you have a flexible spending account at work that covers your deductible, or if you get one of these AFLAC plans that covers injury and sickness, you will not be eligible for a health savings account. You can’t have anything covering…you can’t have a non-qualified medical plan covering your deductibles.
Jim Lange: Well, all right. By the way, I just want to emphasize one thing that you said, and then, unfortunately, we’re going to run out of time, but we are here with Sandy Botkin, author of Lower Your Taxes Big Time!, which, I think, would be great, particularly for people who are either in small business or thinking of starting a small business, and then Achieve Financial Freedom. But the thing that I wanted to re-emphasize with the health savings account (and Jim Dahle said the same thing, by the way, who is kind of the financial guru for physicians) is that you’re getting a tax deduction when you’re putting money into the account, just like a traditional IRA, but it comes out income tax-free, like a Roth IRA. So, it’s really better than a traditional IRA or a Roth IRA.
Sandy Botkin: That is absolutely right. I mean, I like the health savings accounts. There are other options available, which we don’t have time to get into, like the self-insured medical plan where you don’t even have to have a high deductible. But that involves hiring family members and other things that you may not want to do.
Jim Lange: Sandy, this has been a terrific hour. Thank you so much for your time and your wisdom and the resources that you provide people with are Lower Your Taxes Big Time!, Achieve Financial Freedom, and your new app, which is…
Dan Weinberg: Taxbot.
Jim Lange: Okay, thank you again, Sandy.
Sandy Botkin: Yeah, my pleasure. Let’s make everybody’s life less taxing!