Taxes: Three Chess Pieces

by Matt Jones, CPA

After years in public accounting it clicked for me. My most successful clients also tended to be the ones who: 

  • worked the least
  • traveled the most
  • had many expenses (car, cellphone, travel, meals, etc.) paid by the company, and 
  • paid a lot less taxes than I expected

That’s not to say they didn’t pay a lot in taxes, they often paid hundreds of thousands or millions of dollars annually, but it seemed like less compared to how much they made. There appeared this pattern of offsetting income and expenses, setting up businesses within companies and leasing real estate from one of those companies to the other. Entire books can be written on this topic and have been,1, and my goal is not to demonize these people (because they’re playing within the rules set up by the IRS) but to learn from them and follow their example to maximize your income and lifestyle. Who wouldn’t want that?

In the years since I first noticed this phenomenon I’ve come up with an analogy: Three chess pieces, each with different options to make moves based on the rules of the game.

The Pawn
You see, if you only have one income stream – say your 9-to-5 job where you work for someone else – you have one move, like a Pawn on the chess board. Your sole move is your W-2 and it’s not a very good one (take it from me, this still makes up a large portion of my income). Other characteristics of the Pawn are:

  • no commission 
  • potential for raises/bonuses each year (but not guaranteed) 
  • increasing responsibility/hours
  • limited emails/calls on your personal time 
  • largest opportunity for earning increases through promotion 
  • Taxes taken out up front, receive the remainder
  • Advance by being more valuable to keep than lose to competition, up through the pyramid – paid enough to not leave, but little more
  • Often less stressful than working for yourself
  • Risk of being let go when you’re at the top – your salary is high and they can pay someone younger less to do the processes you’ve perfected
  • Study: Among adults who were employed full time, full year in a long-term job at ages 51 to 54, 56 percent subsequently experienced an employer-related involuntary job separation 2

“If you don’t design your own life plan, chances are you’ll fall into someone else’s plan. And guess what they have planned for you? Not much.”

Jim Rohn

There are other chess pieces available with more options, and you can thoughtfully move toward them and improve your lifestyle to have better options. They don’t require you taking a class, renting your home or quitting your job.

The Knight
The second option is the Knight. Knights are better positioned than pawns for their earning, but this doesn’t guarantee a better life. This group earns more, might keep more, but often must work more, billing hours, selling, traveling, etc. to maintain this level of income. In addition, some of these roles require advanced degrees (JD, MD, CPA) that can take years of education, training, money (student loans) and most importantly, time.

Aside from higher earnings, the largest advantage is becoming aware of opportunities to invest and having the income to make those investments. Additional Knight characteristics:

  • Working for someone else still, but with control over your income through bonuses for new sales
  • Paid based on how hard/long you work and ability to increase company revenue. Stop working, you stop earning
  • Opportunity to gain ownership through years of service (have to buy in)
  • Still paying taxes up front (higher income brackets and ~40% on bonuses)
  • Potentially move some personal expenses to business – cell phone, travel, meals

The Queen
This is where we want to be. In chess, the queen has the most available moves and freedom. So, too, in our analogy, business owners, real estate owners, or equity partners have the most freedom. There is no requirement to earn a certain degree or continue with additional education to be a business or real estate owner. There’s no playbook and the only real requirement is to succeed.

Those who are the Queen often fall into many income categories, owning real estate as well as a business, and more often than not these businesses service one another. I saw this situation come up time and again while working in public accounting and the reason is that business owners (including rental real estate) pay tax on NET INCOME, as opposed to total income like most people. For an in depth lesson in this concept I recommend the book Rich Dad, Poor Dad. Here are some additional characteristics:

  • Pay tax on remainder of income after expenses
  • Often own business and real estate
    • rent building owned by one business to the other where operations are
  • Move personal expenses to business – cell phone, travel, meals
  • Potentially provide jobs to others 
  • Ability to remove self from the business if desired – “lifestyle business”
  • Ability to sell business
  • More likely to be approached with business/investment opportunities
  • Risk and pressure weighs on your shoulders entirely; if the business fails, you fail

Starting a business and buying real estate can be scary, especially if you’ve never done it before and don’t know anyone who has. Fortunately, who you know can change by building your network. Now that you know the options exist, you can build your plan to get there, starting with tracking your net worth.

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