Can Simple Business Processes be Intellectual Property?

TRANSCRIPT

Kevin Schneider: [00:00:00] Welcome to another episode of the Hidden Money Podcast, and today we have for your listening pleasure, Gregory Treat. Greg is a attorney and not all attorneys are bad guys. This is one of the good ones. He's fighting for you. So, Greg is going to tell us all about the cool aspects of intellectual property.

A lot of people have intellectual property in their businesses. You just don't know it and you're not getting the tax benefit for it, but he's going to tell us why it's so important to put a value on your IP and what are the benefits of doing that. So Greg, I'm just so excited for today's episode.

Welcome. Please, take a few minutes, tell the audience who you are, how you got into Law, how you got into this little niche you've built out, and we'll go from there.

Gregory Treat: Awesome. Thank you so much, Kevin. Thank you, Mike, for having me on. I really appreciate it.

I grew up in the People's Republic of California, and my family were fourth generation dairy [00:01:00] farmers, and being a small family agricultural business in the early 90s in California was not a great strategy, you might say,

and so, we wound up- I think, when I was four or five years old, the ,ranch was finally shut down, and then it took almost 10 years for us to sell the property. So, my whole childhood was dominated by this cycle of owning Ag land that we had very great difficulty re-zoning, but we couldn't use it for any Ag purpose that was profitable, given the rules and regulations in California,

and at the end of that process, we actually got assessed. So, we had submitted a zoning request to the California zoning authority to get re-zoned for suburban lots so we could sell it to a developer, and that zoning requests have been denied for a variety of complicated reasons. But after four or five years of that, the California Franchise Tax Board- the state property taxing authority, had decided to assess our property as though, instead of being 300-odd Ag- acres, it was 1,200 and something [00:02:00] suburban lots, which, that's quite a different property tax bill, as you might imagine, and then, my grandfather finally got some lawyers involved, and to their credit, those lawyers really did help our family.

Now, in the situation that we were in they couldn't do much more than get us fifty cents on the dollar, but one of the strategies we used, we helped a city incorporate and they drew us within their zoning authority and one of those, classic gerrymandered, jurisdictional lines that you see in these political, events and and I had this insight as a 17 year old, you've insights when you're 17 and maybe they're true and maybe they're not, but I knew as a 17 year old, if we had had access to those kinds of legal strategies, when I was six, when we first shut down the ranch, then maybe we wouldn't have had to shut down the ranch, and like I said, it was the early nineties.

It was a small family Ag operation, not a good place in time for that kind of business, California being what it was even then, let alone now, with the years of experience that I've had now, I think I'm less optimistic, [00:03:00] but at the time it was like so clear to me that this is what family businesses needed.

They needed adequate representation from someone who could help them navigate the changing legal and tax environment and an increasingly kind of hostile regulatory environment, because, one of the things that I observed was there are still businesses functioning. The big boys have some way

of making these structures work for them, and so, that kind of set me on my path. People sometimes will observe that I'm fairly obsessive about finding these unique strategies and remembering all this information and tracking down where things come from, and it's because it's super important to me.

Kevin Schneider: This is what happened to my family and I love helping other families defend their inheritance, because that's part of what makes good people is businesses being passed down from generation to generation, being those pillars in their communities. I Think that's where our businesses align, and that's why we can make such great partners is we value the generational wealth [00:04:00] aspect. Ours is more short term like on a year by year basis. We do need to take a big picture idea of where your state's going, but there's so many things we could do today, and you as well, to get money away from our government and back into where they can invest it.

They can provide for college, whatever it is they want to spend their money on and get it away from the government, protect it. That's where you come in protecting that generational lineage of building this wealth up, but actually protecting it and sending it on to your children, grandchildren. That's very impactful.

So, I'd love to hear that and I'd love to see us align like

Gregory Treat: Yeah. So, I think one of the things to recognize is you have to document. You have to have a process. The property isn't tangible, but you want to have somebody that can hold something in their hands. The more documents, the more diagrams, the more ways you have of communicating what you have and what you're doing, the better,

and at some point, you can put all of those in a [00:05:00] packet and there are valuation experts out there that can help you assign a value for tax purposes. It's the same kind of people that a lot of them come from a business background.

One of the things that's interesting is, in this transition from real estate and industrial properties to intellectual property, we're now seeing large amounts of businesses where, by far, the most valuable asset in their structure is their intellectual property, and in some ways, if you value that intellectual property in a pure sense, it would almost be more valuable than the other pieces of the business. This is that leveraged kind of concept. I don't know if you saw that the airlines a couple of years ago, had segmented out their business and they had an employee loyalty program that had all these intangible assets in it.

It was somewhere between a bank and a loyalty program, and they valued that loyalty program as being more valuable than all of the rest of the businesses combined. So, their theory was that the rest of, like American [00:06:00] Airlines, was actually a net drag on this amazing loyalty program that they had built,

and that got up a lot of commentary from the general public, and I think, that's an extreme position that they could take because they were willing to defend that in an audit situation, but it is quite common, that situation I'm describing, where the intellectual asset is actually more valuable than the rest of the business in some mysterious way, but it's quite common to have an intellectual asset that is the most valuable piece of property, certainly more valuable.

Computers can be replaced. In many ways, most of the employee group can be replaced. The business owner hopes to be replaced one day. That's called retirement, or at least a vacation. Some of them manage it, some of them don't, but they all hope that they're replaceable.

But the intellectual property, the strategy, the way that they interact with the world, the way that they solve the variety of hard problems that constitute their value proposition, that can't be replaced, or at least, you have to actually replace it with something similar,

and for many people, this is the sum total of their life's [00:07:00] experiences. People get these intellectual property assets from all of the successes and failures they've had in their lives. So, you document that, and you can document that in a number of ways. You can look at it from the perspective of the marketing materials or the training materials, you can look at it from- what are your experiences?

How did you develop this? Going through your life and figuring out how valuable were you in each of these three or four year periods where you were developing a chunk of this? Sometimes, if there's other people doing similar things, you could get a software- this comes from the software world where you could talk to another software development team and say, 'What would you charge us to develop

somethings that does the similar function from the ground up, or maybe in a different programming language? That's an interesting exercise, sometimes, people do. When you get these quotes back, which are very high because it's actually really hard to solve a lot of these problems, and that's the step one, is that documentation and getting the value, and then, you have to put that in front of a valuation expert who is willing to sign on a piece of paper, that the IRS[00:08:00] might come back and discuss with him as to what that valuation is.

The same as you would with any asset. Now, it's an interesting time to be in intellectual property because, for instance, real estate appraisals have a lot of licensing requirements and a lot of regulations on how they can do their comps, and intellectual property doesn't. That's a feature, I think, of the amazing amount of political influence that our top software companies have right now.

It's not in their interest for there to be significant amount of regulation as to how Google can value its algorithm, for instance. No, they certainly don't want that, and in many ways, I think a lot of this stuff is still so new from a economic perspective that no one wants to kill the goose that laid the golden eggs.

We're still not sure which of these ideas are going to pay off, but the valuations can be quite high.

Kevin Schneider: I've always just wondered this about intellectual property- would like name recognition, or your brand have some intellectual property tied to it? And I'm just [00:09:00] thinking of like a celebrity, like if Brad Pitt walks in, and I'm filming a movie and I got a thousand qualified actors, but Brad Pitt walks in- that holds value,

Gregory Treat: Yeah, well in this. This gets into the distinction between goodwill and reputation on the one hand, and the kinds of intellectual property assets that we're now beginning to explore.

So, if you have Brad Pitt as the actor, that's probably going to be classified more as goodwill, which has a lot of restrictions on it.

Elon Musk, on the other hand, is going to have a very strong argument that what he's bringing to the table is technical skill because he has a lot of technical skills. You can put Elon Musk in a room with engineers, and those 10 engineers will produce, sometimes, some people say, 10 or 15 times as much work as they should have because Elon Musk was in the room with them,

which is magical, but that's not based on reputation. The engineers weren't more productive because they liked Elon. They did probably like Elon. A whole bunch of them seem to, [00:10:00] but you can't get that increase in performance from reputation.

Mike Pine: Let's start going down the direction of the hidden money in intellectual property as it pertains to tax. Can't take the tax out of us. We love tax credit, but you do too. Kevin alluded to amortizing intellectual property, but let's say you have some kind of professional consulting firm out.

They have grown this firm. It's grown pretty well. They know they have IP. They've talked to you. They know they have

Gregory Treat: Yep. Yep.

Mike Pine: What are the basics? How do they start mining that hidden money in the intellectual property to make a difference in their taxes?

So, we get clients all the time. They bought a rental house 10 years ago for $100,000. It's worth $500,000. Now, they call up and say, 'How much can I take in depreciation?'

--I was like, 'How much did you pay for it?' --'A hundred, but it's worth 500. Now, can I depreciate the 500?' --And the answer is, unfortunately, 'No.' -- If you'd have bought it, or like you said, had a step-up basis because of a death or something, [00:11:00] yeah. But you only get $100,000 to depreciate, but in the realm of intellectual property, the tax law offers us ways of getting that fair market value step-up so that we can take amortization,

and that's one of the coolest tricks that I've seen in years, that Kevin and I have learned from you on how we do that with this IP stuff.

That's what Kevin and I talk about all the time- the tax code. Yes, there's some pages that deal with the assessment of tax and people having to pay tax, but the majority of it... super majority, is all incentives that we, as a society, have come together and say- This is what we need for economic security, for economic dependence, to lift everyone up.

This is what we need, and this is just another area in that tax code that's beautiful! So, you say a lot of people see just laws and rules and regulations when they look at tax code- not these three people on this podcast! We see hidden money in the internal revenue code, hidden money in tax court cases, there is [00:12:00] hidden money.

Kevin Schneider: Yeah...

We all think alike, and hopefully, we're trying to convince other people to think alongside with us. It's an opinion, but I think everyone should agree it is best for you to have as much money away from the government into your own pockets for your own benefit, investing in wealth growth, and this strategy here,

if I can put some other layman terms on it, because this is a very complex tax strategy, so it's very hard to not dive into details, but from a high level, going back to another podcast we did, I forget what it might've been. Even the first episode we did, we just did some Tax 101- education of your buckets or your classifications of income.

So, you have active income, which is your W2s, and that's going to be your self employed income. You have passive income, which is going to be investments or businesses you invest in that you don't materially participate. Real estate defaults to passive. Then you also have portfolio income, portfolio income being cap gains, dividends, interest, your investments.

Now, when you're self employed, you're earning income in the active bucket, and so diagnosing [00:13:00] where your tax problem is, is always Step 1, because you can't go out and get passive investments and passive losses and offset your business income. Passive losses can't offset your active income, but with this strategy that we're trying to present, is you could classify your self employed earnings away from the active classification to a passive classification.

Mike Pine: We'll make it basic and cleanse the data, but we recently met with one of our shared clients together. He's an attorney. He's got a pretty good business. I mean, he's grown it. It's a second generation law firm and he's helped growing it and growing it bigger, and they're doing pretty well.

They make almost a million a year in profit, and over the last few years, he's started working on the business more than in it. He's got the least amount of billable hours of any other attorney, although he works probably more hours than all the attorneys put together in his firm. We met with them and we went [00:14:00] over basics.

We haven't done the full valuation and everything yet, but we went over the basics and just by restructuring and recognizing this asset, this intellectual property that is earning the company money, and structuring it in a way that meets all the rules, requirements, dots the I's, crosses the T's for the IRS, he's going to save $170,000 a year for at least the next 8 or 10 years, and that's not tax deferral like we do with depreciation. That is complete, non-stop, full-stop $170,000 saved each year that he's always going to have. In his pocket.

Gregory Treat: And without having to invest. There's so many tax strategies where you can save money if you spend money,and many people, what they do when they start recognizing this, is they do start to spend money over in this intellectual property development side,

but there's nothing requiring you to do that. In some ways, we're just recognizing you already spent the time and energy to make this asset go, but it can be an [00:15:00] enormously impactful strategy, for sure.

Mike Pine: And that's what's great about this strategy, and a lot of other tax planning and saving strategies, is you're not changing the way you do your business. You don't want to. Don't let your tax tail wag your business dog. You're running a business. You're learning how to make it profitable, how to keep people employed, how to make it successful.

You don't change any of that. All you're doing is prescribing what the IRS wants you to do, what Congress has incentivized you to do- to take advantage of those incentives and take more money home, which is going to mean, hopefully, more jobs. It's going to mean more affordable housing. It's going to mean so many good things for the world and for our country,

but that's all it is. You're not changing things. You're not reinventing the wheel. You're doing everything that you did, but hopefully having a little more money to reinvest in it by taking advantage of the tax laws.

Gregory Treat: Yeah. And you've already done the work, and that's one of the things that some of the families that I work with that have, like I said, made that generational transfer.[00:16:00]

They have solved the hardest problem in the world. They have figured out how to transfer within a family,

because most businesses, not to put too fine a point on it, are motivated by fear, do this or I will fire you and you will have to go find another job and endure the indignities associated with being between jobs, and go through this competitive process, and all that.

That's how most jobs work, and most incentive structures work. And you can get a certain amount of performance out of people motivating them with the threat of- I'm going to do this... or I'll fire you, but you can't do that with your son.

Kevin Schneider: I want to fire my kids sometimes.

Mike Pine: My wife won't let me.

Gregory Treat: We'll keep that between us, Kevin. We'll keep that between us.

And like you've mentioned a couple of times, working on the business is the most valuable thing you can do. I mean, go reference back. We did a podcast with Ross Patterson from XM Performance, and he always equates it to, in our language and,in attorney world and CPA world, it's billable hours.

Kevin Schneider: Here's my billable rate per hour, and if I'm doing, working in the [00:17:00] business, I have a set billable hour. It could be $400 an hour, $500 an hour, whatever I charge. If I'm working on the business, that could be $1,000 an hour work. That could be $2,000 an hour work because you're providing a lot more value than solving technical problems for clients.

Instead, you're solving bigger problems for the business, which is a lot more valuable, and so working on the business is actually the best way to scale everything. Eventually, you have to stop working in it. Now, everyone starts out there being self employed unless you did inherit an already functioning machine.

If you're building a machine from scratch, you are going to be the mechanic. You are going to be everything in between because you're getting your own business off the ground. You're in that hustle stage, but eventually you want to get out of that. Eventually you want to be working on the business and that's where that intellectual property kicks in and utilizing this strategy,

if we can put a value on that intellectual property, you can basically shift tax brackets from a 37% at the top tier to paying top 20%, and you're not changing anything functional in the business. You're operating the same way. We're just going to tap into that intellectual [00:18:00] property, get you into a lower tax bracket. And it's a no brainer.

That's why Mike and I are so excited that we've found you, Greg, is because it's novel, and the fact that it's not out there, but when you think about it, Mike and I kick ourselves because it's like how did we not even think of this because it's so simple in concept?

It's complicated in acting, but the concept is so simple once you get into it and you just say- I have so much value that I bring as a business owner. How do I even begin to tap into that on the tax side of things? And that's where you come in, and Mike and I will come in and partner with you and make sure that this strategy is handed out.

So, it's just really exciting stuff, and it actually opens the door. I know Mike loves the aspect of actual basis studies and actually tapping into some additional expenses, maybe that you possibly couldn't take unless we have IP out there, and I don't know if we want to get into that.

Gregory Treat: maybe before, I think, one of the things to talk about is- Who is ready for this? [00:19:00] If this is your first business, if this is your first rodeo, if you've been in operating, less than 5 years and you don't have a very big team, this is probably not for you.

For most people, where you develop that, you have a team now and you've solved a bunch of problems and your life is under control in that sense where you're not having to spend insane hours working in the business because you have a team. Now, maybe you choose to spend insane hours because you want to keep growing and, you have goals.

Kevin Schneider: Or a control freak, like me.

Gregory Treat: I wasn't going to say it,

but if you're set up so that you could step away, then that's the moment where you have definitely, people like Robert Kiyosaki talk about having a business system.

It is the level at which you can play in this game, and one of the things is don't be afraid if you got your system from someone else. If you implemented this system and you're making money- money above and beyond whatever they charged you for the royalties, or even in a franchise type of a scenario,

if you've been doing this for a while, and you're [00:20:00] making significant money, then you had to make improvements. That's one of the other things people say what happens- we set the structure up and it's paid at a certain level. What happens when we start making way more money?

And my response is- How is it that you're going to make way more money? You're probably going to make way more money because you improved something.You either stopped making a poor decision or you started making a good decision. It's one of the interesting things about COVID-

there was a bunch of businesses I knew that liquidated several of their ancillary things, or really focused down or made their team smaller, and then two years after COVID with that smaller team, more focused, they were making the same returns, with way less overhead,

and that just happened to a whole bunch of people. And what we say was there was some bad decisions that you stopped making. Did you learn something from this? So, I know that was a tangent from the basis discussion, but I wanted to put that out.

Well, Greg, thank you so Much for this just interesting concept of intellectual property, utilizing it for tax breaks, tax benefits, [00:21:00] and just thinking a little bit outside the box and we just appreciate you being here, sharing your knowledge. And for anyone who wants some more information on getting access to this tax strategy, or just kicking the tires and seeing if it's the best fit for you, please reach out to Mike or I, you can go to www.pinecocpas.com or www.hiddenmoney.com and you can contact us there. You can schedule a free consultation with Mike or I, and we can just lay it out before you and see if it is a good fit, and if it is, we'll bring Greg in and we work together as a team to get this tax strategy implemented. So thank you so much, Greg, for being here today.

Kevin Schneider: Any final closing thoughts?

Gregory Treat: What I would say is that I think there is enormous opportunity in the changes that are happening in our economy. There's a lot of people that are really freaked out about all the changes, and I'm not saying those aren't, sometimes, very valid concerns, but with every shift, there is an enormous opportunity,

and my goal, and I know your [00:22:00] goal is to make sure that our clients are able to take advantage of those opportunities. So thank you so much for having me on.

Mike Pine: Thank you for being here, Greg. It was a sincere treat to have you.

Gregory Treat: Oh, thank you.

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