How to Get Your Effective Tax Rate Under 20%

An effective tax rate is total tax divided by total income. For a business owner earning $700,000 with no planning, that number is usually somewhere between 28% and 34% federal, higher with state tax.

Getting it under 20% is not a matter of finding obscure loopholes. It is arithmetic: you need deductions equal to roughly a third of your income, or you need income to arrive in a lower-taxed form. There are five levers that produce that at scale. Everything else is decimal dust.

Lever 1: Depreciation From Real Estate

This is the largest lever, and the only one that reliably produces deductions several times larger than the cash you spend.

Buy a property, commission an engineering-based cost segregation study, and 20% to 40% of the depreciable basis reclassifies into 5, 7, and 15-year MACRS property. Because the One Big Beautiful Bill Act made 100% bonus depreciation permanent under IRC Sec. 168(k), that entire amount is deductible in year one.

A $1,000,000 property with a $250,000 down payment can generate a first-year deduction of $250,000 to $320,000. That is a deduction equal to or exceeding the cash invested, in the year invested.

The constraint is IRC Sec. 469. The deduction offsets your other income only if the loss is non-passive. Three routes: short-term rental treatment with an average stay of seven days or less plus material participation; real estate professional status under Sec. 469(c)(7); or holding the property in a closely held C corporation that can offset passive losses against net active income under Sec. 469(e)(2).

Depreciation is a timing strategy, recaptured on sale under IRC Sec. 1245 and Sec. 1250. Recapture can be deferred with a 1031 exchange or eliminated by the basis step-up at death under IRC Sec. 1014. See the complete cost segregation guide and the STR strategy guide.

Typical contribution: 8 to 15 percentage points off the effective rate in an acquisition year.

Lever 2: Retirement Plan Stacking

The cleanest deduction available, with no audit exposure and no operational complexity beyond administration.

A solo 401(k) with employee deferral and employer contribution is the starting point. A cash balance plan layered on top raises the ceiling dramatically, because defined benefit contributions are actuarially determined by age and target benefit. An owner in their fifties can often push combined pre-tax contributions past $300,000.

Unlike depreciation, this money stays yours. It is deferral rather than avoidance, but deferral into your own account, growing tax-free, with distributions likely taxed at a lower rate later. See cash balance plans for S-Corp owners and solo 401(k) maximum contributions.

Typical contribution: 5 to 12 percentage points.

Lever 3: Entity Structure and Income Character

This lever does not create deductions. It changes the rate applied to income you were going to earn anyway.

S-Corp election. Splits income between payroll-taxed wages and distributions outside the SE tax base.

QBI deduction. Up to 20% of qualified business income under IRC Sec. 199A. Above the thresholds it is limited by W-2 wages and property basis, which means the salary number and the QBI calculation must be solved together.

C-Corp for retained profit. A flat 21% under IRC Sec. 11(b) on income left in the entity. Only helps if you are not withdrawing it, since distributions add a second layer. Often best deployed as a second entity providing management services or benefits rather than a full conversion. See the S-Corp optimization guide and C-Corp income shifting at 21%.

Capital gain versus ordinary. Long-term capital gain is taxed at 0%, 15%, or 20% plus 3.8% NIIT, against ordinary rates reaching 37%. Where you have genuine flexibility in how a transaction is structured, this is a 15-point swing.

Typical contribution: 3 to 8 percentage points.

Lever 4: Owner Benefits and Reimbursements

Individually small. Collectively $30,000 to $70,000 of deductions per year for a typical owner.

• Accountable plan reimbursements for home office, vehicle, phone, internet, and equipment, deductible to the business and tax-free to you under Treas. Reg. 1.62-2
• Augusta Rule under IRC Sec. 280A(g): up to 14 days of home rental income excluded entirely
• MERP through a C-Corp for tax-free medical reimbursement under IRC Sec. 105(b)
• Employing children at defensible wages for genuine work
• Vehicle depreciation on qualifying business-use vehicles

These require documentation, not risk tolerance. Every one is well-established. See the Augusta Rule guide and MERP through a C-Corp.

Typical contribution: 2 to 5 percentage points.

Lever 5: Timing and Charitable Structure

Shifting income between years matters more than most owners realize. Moving $200,000 of income from a 45% marginal year into a 24% year is a permanent $42,000 saving.

On the charitable side, donating appreciated securities held long-term produces a deduction at fair market value while avoiding the capital gain entirely, a double benefit. A donor-advised fund lets you bunch several years of giving into one high-income year, clearing the standard deduction threshold and taking the deduction when your rate is highest.

Typical contribution: 2 to 6 percentage points.

How It Adds Up

A worked example. Business owner, $850,000 of income, currently at a 31% effective federal rate, roughly $263,000 of tax.

Strategy	Deduction / Effect
STR acquisition with cost segregation	$265,000
Cash balance plan plus 401(k)	$185,000
Accountable plan, Augusta Rule, family wages	$48,000
Donor-advised fund contribution	$40,000
Remaining taxable income	~$312,000

Tax on roughly $312,000 for a married couple lands near $60,000 to $68,000 federal. Against $850,000 of income, that is an effective rate near 8%. Even discounting heavily for the excess business loss limitation under IRC Sec. 461(l), which caps how much business loss can offset non-business income and converts the excess into an NOL carryforward, a result in the mid-teens is realistic.

What This Requires

Three things, honestly stated.

Capital. The real estate lever requires a down payment. The retirement lever requires cash you can lock up. If every dollar of income is spent, most of this is unavailable to you.

Participation. The STR route requires genuine, documented involvement. This is not a passive investment dressed up as one.

Sequence and time. These interact. Retirement contributions reduce the income that real estate losses would otherwise offset. Salary affects both QBI and plan capacity. Sec. 461(l) caps the total. Implementing them piecemeal produces a fraction of the result.

Getting under 20% is achievable for most business owners with real estate exposure and retirement capacity. It is not achievable by finding a better preparer in March.

Frequently Asked Questions

Is a sub-20% effective tax rate legal?

Yes, when it is produced by the provisions described here. Accelerated depreciation under IRC Sec. 168, retirement plan deductions under IRC Sec. 404, the QBI deduction under Sec. 199A, and the Sec. 280A(g) rental exclusion are all express provisions of the code. What matters is that the underlying facts are real: the property exists, the participation happened, the plan is funded, and the documentation supports it.

Which single strategy moves the effective rate the most?

Cost segregation on real estate, in an acquisition year. It is the only common strategy that produces a deduction larger than the cash outlay, because bonus depreciation applies to the full basis while you only funded the down payment. Its limitation is that the loss must be non-passive under IRC Sec. 469 to be usable against your other income.

Can I get under 20% without buying real estate?

It is harder but possible for some owners. Maximum retirement plan stacking, entity optimization, owner benefit strategies, and charitable bunching can move a rate meaningfully. Without a depreciation lever, though, most high earners land in the low-to-mid twenties rather than under twenty.

What is the excess business loss limitation and how does it affect this?

IRC Sec. 461(l) caps the amount of net business loss that can offset non-business income in a single year, with the excess carried forward as a net operating loss. It does not eliminate the benefit, it spreads it across years. Large first-year real estate losses frequently run into it, which is why the total plan has to be modeled rather than each strategy considered alone.

Do these strategies increase audit risk?

Properly documented, not materially. The items that draw scrutiny are large rental losses claimed without support for material participation, cost segregation based on rules of thumb rather than engineering analysis, and Augusta Rule deductions with no rate substantiation or meeting records. The strategy is not the risk; thin documentation is.

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