Introduction

Are you fully utilizing your financial strategies to save on taxes? For high-net-worth individuals and their families, not leveraging expert tax advice could mean missing out on significant tax-saving opportunities. Let’s explore how.

For affluent entrepreneurs and business owners, taxes can be a substantial obstacle to preserving and growing wealth. Without effective tax planning, nearly half of their earnings can be consumed by various taxes. This not only hinders immediate wealth accumulation but also impacts long-term financial security and philanthropic goals.

Fortunately, there’s a solution that can mitigate these tax burdens: Management Service Organizations (MSOs). This corporate structure offers a powerful way to unlock significant tax savings and preserve wealth for future generations.

The Problem: High Taxes Draining Wealth

High-net-worth individuals often face substantial tax burdens, which can consume nearly 50% of their earnings when combining federal, state, payroll, and investment taxes. For example, the top federal income tax rate is 37%, and short-term capital gains are taxed at the same rate. Adding state income taxes, self-employment taxes, and other levies, the overall tax rate can approach 50%.

This heavy tax burden restricts how much individuals can reinvest in growth opportunities or set aside for philanthropic efforts. Costly mistakes in tax planning can further exacerbate this issue, draining resources that could have been better managed.

Take the case of Michael, a high-net-worth business owner with an annual income exceeding $10 million. Despite his hard work and success, high taxes limited his ability to reinvest in his business or engage in desired philanthropy. Similarly, Sarah, a multi-millionaire author and real estate investor, found it frustrating to see more of her income going to taxes than she retained. Both faced challenges in growing their wealth sustainably and contributing to causes they cared about.

The Solution: Understanding MSOs

A Management Service Organization (MSO) is a separate corporate entity providing centralized services, resources, and assets to various operating companies under the same parent business. These services can include accounting, legal, human resources, marketing, IT, equipment leasing, and real estate management.

The primary advantage of an MSO lies in structuring it as a C-corporation while keeping the operating companies as pass-through entities like S-corps or LLCs. This setup allows income to be shifted from higher individual tax rates to the lower corporate tax rate of the MSO.

For instance, consider an individual with $1 million in excess income. If taxed at the individual rate of 37% plus the 3.8% Net Investment Income Tax, the total tax would be $408,000. However, if this income is shifted to an MSO taxed at the 21% corporate rate, the tax owed would only be $210,000, resulting in savings of $198,000.

Key Benefits of MSOs

MSOs offer numerous tax benefits, including:

1. **Tax Rate Reduction:** Shifting excess income from high individual rates to lower corporate rates can significantly reduce taxes.
2. **Deducting Medical Expenses:** MSOs can establish plans to deduct medical expenses from corporate revenue at the corporate tax rate, providing additional savings.
3. **Prepaying Long-term Care Costs:** This allows for the acceleration and optimization of deductions for long-term care expenses.
4. **Location Flexibility:** MSOs can domicile in no/low-tax states while keeping operations and deductible expenses in high-tax states.
5. **Deferred Compensation:** Offering deferred compensation plans through an MSO can help retain key executives and reduce taxes.

Flexibility with Tax Law Changes

One of the significant advantages of having multiple entities under an MSO structure is the flexibility to adapt to changing tax laws. By managing various business entities, an MSO can quickly adjust its strategies to comply with new regulations and take advantage of new tax-saving opportunities.

For example, if there are changes in the tax code that affect pass-through entities differently than corporations, an MSO can shift income and expenses between entities to optimize tax outcomes. This flexibility allows businesses to remain compliant while minimizing tax liabilities, ensuring long-term financial stability and growth.

Strategic Employment and Investment Management

MSOs can also provide tax benefits related to employing family members and managing investments. Employing family members through an MSO can convert income taxed at high individual rates to compensation deductible by the corporation at a lower rate. Proper documentation and planning are essential to ensure compliance.

MSOs can also optimize taxes when holding partnership interests, real estate investments, and other assets. By acting as an aggregated entity, an MSO can reduce the tax burden on investment income and capital gains.

Conclusion 

Leveraging an MSO structure can provide high-net-worth individuals and families with substantial tax savings and optimize wealth preservation. Properly established and maintained, MSOs create a tax-advantaged environment for assets, income, deductions, and investments.

If you are a business owner with an annual income over $1 million and retain significant excess income, consider exploring an MSO with the guidance of expert advisors. Connect with your tax advisor to discuss how an MSO structure can benefit your financial strategy.