Impact of tax shelters on net worth and life quality

From: alexhormozi

The speaker, having paid over $3millionintaxesinthelast5yearsandspentapproximately$1.6 million on legal and accounting fees to structure his finances, shares lessons learned about tax savings strategies [00:00:06], [00:00:12], [00:01:19]. He emphasizes that it’s not about how much you make, but how much you keep [00:00:00].

The discussion covers four core beliefs regarding tax shelters:

1. Tax shelters cost more than they save [00:01:42].
2. Tax shelters decrease your net worth [00:01:48].
3. Tax shelters diminish your life [00:01:54].
4. Tax shelters don’t make you a better person [00:02:01].

Tax Shelters Cost More Than They Save

Tax shelters, while seemingly saving money, often incur greater costs in other resources [00:02:11], [00:02:17]. These can be categorized into three primary costs that people, including the speaker, often fail to account for [00:02:21], [00:05:52]:

Cost of Discovery and Conversion

• Discovery: Approximately 95% of tax solutions are “swampland” (not legitimate), and only 5% are viable [00:02:42], [00:03:00]. The cost of discovery is the time and attention required to sift through illegitimate options to find the legitimate ones [00:03:06], [00:03:10].
• Conversion: Once a legitimate solution is found, there’s a significant cost to convert, involving vetting, creating new entities, transferring assets, reincorporating, and establishing new banking relationships [00:03:33].

Cost of Upkeep

Even with a legitimate structure, ongoing attention and resources are needed for upkeep [00:04:05]. This often means trading valuable attention for less valuable monetary savings [00:04:07].

• Example 1: Travel for Tax Savings: A friend traveled 104 days a year between Puerto Rico and the United States to avoid US taxes [00:04:14]. The speaker questioned if that time could have been used to make 30% more money [00:04:32].
• Example 2: Missed Life Events: Another friend missed their baby’s birth to meet residency requirements for tax purposes [00:05:03].
• Example 3: Captive Insurance: A relative engaged in a captive insurance arrangement, which required constant allocation of attention and funds to remain compliant, adding no value to the business [00:05:17], [00:05:32], [00:05:47].

Cost of Unwinding and Fines

Many “big tips and tricks” are eventually unwound by the IRS, which operates 3 to 5 years behind in closing loopholes [00:06:11], [00:06:16]. If a structure is deemed used for tax evasion rather than its intended purpose, individuals may owe back taxes, fines, and interest [00:06:26], [00:06:37], [00:06:40]. Additionally, there are legal and accounting costs to unwind the structure [00:06:45], [00:06:48]. The tax code is an incentive system designed to move the economy, and using clauses contrary to their intention can lead to penalties [00:07:18], [00:07:20], [00:07:23].

Tax Shelters Do Not Increase Your Net Worth

While seemingly counterintuitive, tax shelters often don’t significantly increase net worth because they focus on minor savings rather than major gains [00:08:14].

The People and Their Thinking Process

• Location of Wealth: Many of the world’s richest individuals live in high-tax areas like California and New York [00:08:39], suggesting that simply moving to a tax-friendly area doesn’t inherently increase net worth [00:09:01].
• Incremental vs. Orders of Magnitude: Surrounding oneself with people obsessed with tax sheltering can lead to thinking in increments (e.g., “how can I save 30%?”) rather than orders of magnitude (e.g., “how can I make 30 times more money?“) [00:09:10], [00:09:21], [00:09:27]. Obsessing over small tax savings diverts attention from big wins that genuinely drive net worth [00:09:47].

How Fortunes Are Actually Made

Fortunes are primarily built from the appreciation of equities, not income [00:11:02], [00:11:04].

• Risk and Maintenance: Fortunes are made by taking significant risk with small amounts of money and maintained by taking small risks with large amounts of money [00:10:51], [00:10:54].
• Appreciation vs. Income: For example, 94% of the Forbes 100’s growth came from appreciation, not income [00:11:12], [00:11:14]. The value of what you build contributes more to net worth than what you earn [00:11:19].
• Business Growth Example: If a business grows its profit (EBITDA) from $10millionto$12 million, its valuation (e.g., 5x EBITDA) increases from $50millionto$60 million [00:12:20], [00:12:21], [00:12:27], [00:12:30]. The $10millionincreaseinbusinessvaluefaroutweighstheafter-taxdividendincreaseof$1.3 million (from $6.3millionto$7.6 million) [00:12:35], [00:12:39], [00:12:41]. This means a significant portion of net worth increase is tax-free due to asset appreciation [00:13:21], [00:13:25], [00:13:28].
• Focus on Building Value: Prioritizing making a business more valuable leads to greater net worth than solely focusing on the income derived from it [00:13:38], [00:13:40]. Letting the value of the business compound is key, regardless of the tax rate in one’s location [00:14:02], [00:14:04].

Tax Shelters Diminish Your Life

Pursuing tax savings can lead to “inverted priorities,” where the means to achieve a goal (money) become more important than the goal itself (a desired life) [00:15:03], [00:15:05].

• Sacrificing Lifestyle: People sacrifice where they want to live and time with loved ones to save on taxes, contradicting their ultimate goal of freedom and increased net worth [00:15:10], [00:15:21].
• Resource Allocation: It makes little sense to sacrifice an irreplaceable resource like time for a replaceable resource like money, especially when money’s marginal utility decreases with abundance [00:16:11].
• The “Enough” Number: For ambitious entrepreneurs, the definition of “enough” money continually changes, making a “temporary” sacrifice for tax savings often permanent [00:17:37], [00:17:38], [00:18:19]. Exposure to higher levels of wealth can shift one’s financial goals from living to thriving, then to “super thriving” [00:18:22], [00:18:30], [00:18:32].
• Personal Example: Intentionally Defective Grantor Trust: The speaker decided against an intentionally defective grantor trust, which could have saved him millions in taxes but would have imposed restrictions on touching the money for three years and carried the risk of IRS scrutiny and audits [00:19:04], [00:19:15], [00:19:21]. The potential headache and stress of an audit, even if won, did not justify the marginal savings [00:20:02], [00:20:06].

Tax Shelters Don’t Make You a Better Person

Focusing excessively on tax avoidance can have negative personal implications [00:20:44].

Reputational Risk

The speaker values his reputation of having “paid his dues and still killed it” over being known for escaping taxes [00:21:31], [00:21:43]. The marginal financial gain from tax saving (e.g., 30% on $10millionis$3 million, resulting in $13 million total) is often not worth the potential reputational cost [00:22:08], [00:22:11], [00:22:14], [00:22:18].

85-Year-Old Self Test

The speaker uses an “85-year-old self test” as a decision-making framework [00:23:03]. He imagines his future self laughing at the idea of sacrificing youth, time, or location for money he wouldn’t need in old age [00:23:14], [00:23:15].

• The Casino Analogy: Life is likened to a casino where individuals amass chips (wealth), but upon death, all chips are left on the table for others to play with [00:32:47], [00:33:00], [00:33:33]. The speaker argues that since everyone is “taxed at 100% upon death” (meaning they don’t get to keep their wealth), obsessing over marginal tax savings during life seems “silly” [00:32:40], [00:32:43], [00:32:45], [00:34:04]. It’s more valuable to prioritize living where one wants and with loved ones [00:34:12].

Rules of Thumb for Tax Savings

For those who still seek tax savings, the speaker offers six rules of thumb [00:24:31], [00:24:56]:

1. Understand Real Tax Savings Scenarios: True tax savings typically arise from:
   • Giving up ownership or control (e.g., charitable giving, trusts) [00:25:02], [00:25:04].
   • Depreciation of assets (e.g., real estate, where the government incentivizes investment) [00:25:33], [00:25:36], [00:25:46].
   • Deferral over elimination (many structures defer taxes rather than eliminate them) [00:26:19], [00:26:21], [00:26:25].
2. Factor in All Costs: When evaluating tax structures, always account for the cost of discovery, conversion, and upkeep, as well as the fee structure [00:26:47], [00:26:50], [00:26:52], [00:26:53]. Consider if this time and attention could yield a higher return by being allocated to your business [00:27:12], [00:27:14], [00:27:17].
3. Ask Questions: Don’t pretend to understand complex structures. Anyone who cannot explain something simply is either trying to confuse you or doesn’t fully understand it themselves [00:27:20], [00:27:24], [00:27:46].
4. Seek Long-Term Proof: Always ask for references of people who have used the strategy for over a decade and ask to speak with them [00:28:20], [00:28:21]. This ensures the strategy has withstood full IRS cycles (3-5 years for unwinding) [00:28:25], [00:28:37].
5. Do Background Checks: Conduct thorough background checks on individuals and entities promoting tax strategies [00:29:04], [00:29:07]. Be wary of new entities or associations with past legal issues, even if acquitted [00:29:28], [00:29:48], [00:29:59].
6. Avoid Unnecessary Spending: Do not spend money solely to expense it or avoid taxes if you wouldn’t have spent it otherwise [00:30:23], [00:30:25]. This is a “silly way of living life” and does not build wealth over time [00:31:14], [00:31:16], [00:31:18]. Spending should aim to build assets that increase company value [00:30:56], [00:30:58], [00:31:02].

Key Beliefs for Financial Success and Well-being

The speaker concludes with personal beliefs that have served him well in his journey [00:31:30], [00:31:33]:

• Attention as the Most Valuable Asset: Prioritize attention above all else and never do anything that detracts from it without a disproportionate return [00:31:36], [00:31:38], [00:31:40].
• Focus on Making, Not Saving: Pay zero attention to tax-saving schemes and instead focus on making money, not saving it [00:31:41], [00:31:43], [00:31:44].
• Think in Orders of Magnitude: Replace “savings” with “orders of magnitude” thinking (e.g., “how can I 10x” instead of “how can I save 10%?“) [00:31:50], [00:31:52], [00:31:53].
• Don’t Regret Past Decisions: Avoid dwelling on “roads untaken” or how much money could have been saved, as this destroys spirit and focuses on the past instead of the future [00:32:01], [00:32:02], [00:32:04].
• Perspective on Death and Wealth: Recognize that ultimately, all wealth will be “taxed at 100% upon death” and not kept [00:32:30], [00:32:34], [00:32:40], [00:32:43]. This perspective encourages prioritizing life quality and relationships over obsessive wealth accumulation [00:34:13], [00:34:20], [00:34:22].
• Money Buys Options, Don’t Trade Optionality: Money should buy options, so avoid trading your optionality (freedom, choices) for it [00:34:30], [00:34:33].

These insights are shared to help others avoid the “pain of consequence” the speaker experienced in his financial mindset of wealthy individuals | entrepreneurial and wealth creation strategies | investment journey [00:34:40], [00:34:42], [00:34:48].