Chapter 24 The Sophisticated Investor The sophisticated investor knows as much as the qualified in- vestor but has also studied the advantages available through the legal system. Rich dad defined the sophisticated investor as an investor who knows what the qualified investor knows and who is familiar with the following specialties of law: 1. Tax law 2. Corporate law 3. Securities law While not a lawyer, the sophisticated investor may base as much of his or her investment strategy on the law as well as the investment product and potential returns. The sophisti- cated investor often gains higher returns with very low risk by using the different disciplines of law. Knowing the E-T-C By knowing the basics of the law, the sophisticated in- vestor is able to use the advantages of E-T-C, which stand for entity, timing, and characteristic: Rich dad would describe the E-T-C as follows: "The E 266 Rich Dad's Guide to Investing stands for control over the entity, which means the choice of business structure." If you are an employee, this is not usually in your control. A person from the S quadrant usually can choose from the following entities: a sole proprietorship, partnership (which is the worst structure because you are en- titled to your share of income but are responsible for all the risk), an S Corporation, an LLC (limited liability corporation), an LLP (limited liability partnership), or a C-Corporation. Today, if you are an attorney, doctor, architect, dentist, etc., and choose the C-Corporation as your entity of choice in the United States, your minimum tax rate is 35% versus 15% for someone like me because my business is a non-licensed pro- fessional services business. That additional 20% tax rate differential adds up to a lot of money, especially when measured over years. It means a non- professional would have a 20% financial head start over a pro- fessional at the start of each year within a C-Corporation. Rich dad would say to me, "But just think about people in the E quadrant who cannot elect their choice of entity. For them, regardless of how hard they work and how much they make, the government always gets paid first through income tax withholding. And the harder you work to make more money, the more the government takes. That's because the people in the E quadrant have virtually no control over entity, expenses, and taxes. Again, people in the E quadrant cannot pay themselves first because of the Current Tax Payment Act of 1943, which started withholding of income taxes from em- ployees. After the passage of that act, the government always got paid first." Sharon's Notes In America, partnerships, S Corporations, LLPs, and LLCs are often called "pass-through" entities because the in- The Sophisticated Investor 267 come passes through the entities' returns and shows up on the owner's return.