Cost analysis of tax shelters

From: alexhormozi

Alex Hormozi, having paid over $3millionintaxesand$500,000 in tax preparation services over five years [00:00:06], shares his insights on tax savings strategies. He spent roughly $1.6 million in legal and accounting fees to establish his current financial structure as a U.S. citizen [00:01:19].

A core belief from his experience is that tax shelters often cost more than they save [00:01:42]. While they might save money, they incur significant costs in other resources [00:02:17].

Primary Unaccounted Costs of Tax Shelters

There are three primary costs that individuals often fail to consider when pursuing tax shelters:

1. Cost of Discovery and Conversion [00:02:30]
2. Cost of Upkeep [00:02:32]
3. Cost of Unwinding [00:02:34]

1. Cost of Discovery and Conversion

The discovery phase involves sifting through numerous potential solutions, as approximately 95% of proposed tax solutions are “swampland” (not legitimate), and only 5% are genuinely viable [00:02:42]. This means 19 out of 20 schemes are likely to cause trouble [00:03:00].

The cost of discovery is the time and attention required to find the rare legitimate options [00:03:06]. Even if a legitimate solution is found, the conversion cost is substantial. It involves vetting the scheme, creating new entities, transferring assets, reincorporating, re-creating client contracts, and establishing new banking relationships [00:03:33].

2. Cost of Upkeep

Once a tax shelter is established, it requires ongoing maintenance, demanding valuable attention that could otherwise be used for more productive activities [00:04:07].

Consider these examples of upkeep costs:

• A friend traveled 104 days a year between Puerto Rico and the United States to avoid U.S. taxes. This time spent traveling could have been used to generate 30% more income [00:04:14].
• Another friend meticulously counted days in New York City to comply with tax rules [00:04:51].
• Someone missed their baby’s birth to fulfill residency requirements for tax purposes [00:05:04].
• A relative pursuing a “captive insurance” scheme had to constantly allocate funds and attention to the insurance vehicle to ensure it remained legitimate for tax purposes, without providing actual business value [00:05:13].

These examples illustrate how valuable time and attention are traded for marginal tax savings [00:04:45].

3. Cost of Unwinding and Fines

The most overlooked cost is the expense of unwinding a tax shelter and potential fines [00:05:57]. Many “tips and tricks” are eventually unwound by the IRS, which operates 3-5 years behind in closing loopholes [00:06:11].

If a structure is deemed to have been used improperly, individuals can be fined, charged interest, and owe back taxes from prior years [00:06:26]. This also incurs additional legal and accounting fees to unwind the structure [00:06:45]. The fundamental issue is that the tax code is an incentive system; using clauses solely to save taxes, rather than for their intended purpose, can lead to penalties [00:06:50].

“The thing is is is like everyone has to understand this they write the rules and so what matters most is what your intention is when you use these structures that are complex like the tax code is an incentive system you have to think about it like that they are putting penalties and incentives so that they can move the economy in the way that they believe is right.” [00:07:05]

For instance, real estate has tax incentives because the government wants people to reinvest in infrastructure and maintain buildings [00:07:27].

Example of Unwinding Cost

A relative who used a captive insurance structure faced an audit. Even if they win, it’s a significant headache for a marginal saving of 4% [00:19:57]. If they lose, they will have wasted all the discovery, upkeep, and conversion time and effort, in addition to paying fines, unwinding costs, and back taxes [00:20:15]. This attention could have been spent on increasing the value of their business, which compounds tax-free [00:20:28].

Hormozi decided against an “intentionally defective grantor trust” that could have saved him approximately $6 million in taxes. He chose to simply pay the taxes to avoid needless worry, stipulations, and potential audits [00:19:01].

Impact on Net Worth and Life Quality

Tax shelters do not necessarily increase net worth or improve life quality [00:01:48].

People and Thinking Process

The wealthiest individuals often reside in high-tax areas like California and New York [00:08:39]. This suggests that simply moving to a tax-friendly area does not inherently increase net worth [00:09:01].

Surrounding oneself with people solely focused on tax sheltering can lead to thinking in increments rather than orders of magnitude [00:09:10]. This is “majoring in the minors,” obsessing over saving 30% when the focus should be on making 30 times more money [00:09:27]. Big wins, not minor tax savings, are the primary drivers of net worth [00:09:47].

How Fortunes are Actually Made

Wealth is primarily built from the appreciation of equities, not income [00:11:04]. For example, 94% of Fortune 100 growth came from appreciation, not income [00:11:12]. What one builds contributes more to net worth than what one makes [00:11:19].

Consider a business making $10millioninEBITDA,valuedat5x($50 million) [00:11:33]. If it grows to $12millionEBITDA(20$60 million [00:12:20]. The net worth increase is $10million(fromappreciation)plus$7.6 million (after-tax dividends from income) for a total of $17.6 million [00:12:41]. In this scenario, 56% of the net worth increase was tax-free appreciation [00:13:21].

Focusing on increasing business value allows for compounding on something owned, which has a massive multiplier on equities [00:13:51]. Decisions about where to live, driven by tax savings, are insignificant compared to the wealth created by business appreciation [00:14:41].

Inverted Priorities

Tax shelters can lead to “inverted priorities,” where saving money hurts other aspects of life [00:15:03]. For example, sacrificing the ability to live where one wants or spend time with loved ones, solely to save taxes and increase net worth, contradicts the ultimate goal of freedom [00:15:10]. It places the means (money) above the goal (freedom) [00:15:32].

Sacrificing finite resources like time for a resource (money) that can be generated at will and has decreasing marginal utility (the more you have, the less valuable it is) makes little sense [00:16:12].

Entrepreneurs often set temporary goals (e.g., stacking enough cash to come back from a low-tax area), but the “enough” number constantly changes [00:17:31]. It becomes emotionally difficult to transition from paying 0% tax to a third or half of income [00:17:40]. This constant shifting of goalposts creates dissatisfaction [00:18:19].

Reputational Risk and Long-Term Perspective

Engaging in complex tax schemes can carry reputational risk. Hormozi prefers to be known as someone who paid his dues and still succeeded, rather than someone who “escaped taxes” [00:21:29]. A 30% tax saving on a $10millionnetworthonlyincreasesitto$13 million; it’s not a transformative gain [00:22:08].

Using an “85-year-old self test,” Hormozi reflects on whether his future self would regret sacrificing youth and enjoyment for more money he wouldn’t need. He believes his future self would prioritize living life where and with whom he wanted, rather than obsessing over marginal financial gains [00:23:03]. Everyone is “taxed at 100%” upon death, meaning all wealth is left behind [00:32:40].

Rules of Thumb for Taxes

If one chooses not to simply pay taxes, here are six rules of thumb:

1. Real tax savings typically come from:
   • Giving up ownership or control (e.g., charitable giving, trusts, if done correctly, remove ownership and thus tax liability) [00:25:02].
   • Depreciation (e.g., the government incentivizes investment in assets like real estate by allowing depreciation, which functions as losses to offset income) [00:25:33].
   • Deferral over elimination (many structures defer taxes until later, often death, rather than eliminating them) [00:26:19].
2. Always find the “hair”: Most structures have complications. Factor in the cost of discovery, conversion, upkeep, and the fees involved. Consider if this time and attention could generate a higher return invested in your business [00:26:47].
3. Don’t pretend to know things you don’t: Ask simple questions. If an expert cannot explain something simply and visually, they either don’t fully understand it or are trying to confuse you [00:27:21].
4. Seek long-term proof: Always ask for references from people who have been using the strategy for over a decade and speak with them. This ensures the strategy has withstood the IRS’s 3-5 year cycle of unwinding loopholes [00:28:20].
5. Do background checks: Research the individuals and entities involved. Be wary of new entities or owners with past tax evasion indictments, even if acquitted, due to reputational risk [00:29:04].
6. Don’t spend just to expense: Avoid spending money solely to get a tax deduction if you wouldn’t have spent it otherwise. This “cutting off your nose despite your face” approach is financially unsound unless the expense is an asset that builds value in the company [00:30:23].

Guiding Beliefs

Alex Hormozi shares seven beliefs that have served him well:

1. Attention is my most valuable asset: Never engage in anything that consumes attention without a disproportionate return [00:31:36].
2. Focus on making, not saving: Pay zero attention to tax-saving schemes; instead, focus on generating income [00:31:41].
3. Replace savings with orders of magnitude: Instead of incremental thinking (e.g., saving 10%), think about how to 10x your efforts to transcend tax concerns [00:31:50].
4. Don’t count pennies on roads untaken: Once a decision is made (e.g., where to live), don’t dwell on hypothetical past savings, as it destroys morale and focuses on the past [00:31:59].
5. Mortality’s perspective: Remember that at death, everyone’s wealth is taxed at 100% (nothing is kept). Obsessing over minor savings seems silly in this context [00:32:30].
6. Casino analogy: Life is like a casino where you accumulate chips (wealth) but eventually have to leave them at the table for others to play with. The emphasis should be on playing the game well and enjoying the experience, not on trying to “keep a higher percentage” of chips that must ultimately be relinquished [00:32:47].
7. Money buys options, don’t trade optionality for it: Money is a means to gain freedom and options. Do not sacrifice that optionality for the sake of accumulating more money [00:34:30].