In the United States, your federal taxes are due… dun dun dunnn… tomorrow! If you haven’t done them yet, I recommend you read this post later. Yes, I’m willing to drive you away from my site, because your taxes are that important. I don’t want you getting a penalty!
Now that we’ve got the urgent issue handled, let’s talk about why it’s not only important to get your taxes done on time, but it’s important to understand how they’re calculated.
I’m not saying everyone needs to be a tax accountant (God knows we don’t need any more of them…), but this is an area where EVERYONE should have a basic understanding. Even if you’re a plumber who hates finances and pays a CPA to do your taxes, here are the reasons you should take the time to understand some basics:
#1 – Save money through tax incentives you didn’t know existed.
There are two sides to every coin. Robert Kiyosaki says that the sign of true intelligence is the ability to recognize the edge of the coin as a third side and to sit on it and see the other two sides at the same time. The two sides to your income statement are 1) Income and 2) Expenses.
While I personally enjoy focusing on income much more than expenses-it’s just more fun to make money than save it-I still recognize that wealth creation and building requires strong focus on my expenses as well. And for most people, there is no larger single expense than TAXES.
If you’re an employee, did you know that IRA (individual retirement account) contributions reduce your current taxable income? Or that Roth IRA contributions are still taxed, but future earnings AND withdrawals are tax free? Not to mention, if your employer provides a “match” (50% is common) this is an IMMEDIATE 50% return on your money. You won’t find that most places…
If you’re an entrepreneur, you may have been pretty upset when you found out that you had to pay self-employment taxes. This additional 7.65% tax can seem overwhelming. Though you still have to pay it… did you know that it’s tax deductible? The portion that you now pay as your own employer can reduce your taxable income.
#2 – Pay as little as you can throughout the year, without getting penalized.
The time value of money says that a dollar today is worth more than a dollar tomorrow. This isn’t just a version of the “bird in the hand” saying: This takes into account the four letter word “inflation.” The purchasing power of the dollar goes down over time, so it’s better to pay as much at the end of the year as possible.
That being said, you don’t want to end up with a penalty. Holding on to an extra $50 and earning 0.5% – 5% interest for a few months isn’t worth paying an additional $50 in penalties at the end of the year. But, it’s worth having that more cash now in general.
If you’re an employee, it’s pretty easy to pay the right amount throughout the year, because the federal government withholds money from each paycheck. In fact, they get their money before you get yours… think about that.
If you’re an entrepreneur, you may be forced to learn a little more about taxes (which is a good thing), because you need to estimate your taxes and pay them on roughly a quarterly basis. You get to hang onto that cash for about 3 months before paying Uncle Sam… just one of the many advantages of owning your own business.
#3 – Learn the game of money.
Don’t hate the player, hate the game. If you still play the game, learn the rules. There is a reason that tax law is insanely complex: People with wealth and power use that wealth and power to maintain wealth and power. This concept is simple and obvious (and you can’t really blame people for this basic survival behavior).
So, even if this kind of makes you hate the game–I feel for ya–if you live in the U.S., you’re already playing the game, so it’s time to learn the rules. One of the big rules is that it pays to be a business owner and investor.
If you’re an employee… I’m sorry, but there’s a reason that my business helps people leap from employee to entrepreneur: The rules are not on your side. Two of the big ones are below:
- Your income is “earned,” and this is taxed at the highest tax rate (which depends on how much you make). Investors receive long-term gains and passive income on various assets that are taxed at lower rates.
- You are taxed on your “gross income.” You have income, you pay tax on it, and then you have all of your normal expenses to pay. Entrepreneurs have income, then they deduct business expenses and only pay tax on the remainder.
We can argue the motives and the morals surrounding the United States tax law until we’re blue in the face. I mean, should someone working for his money really be taxed at a higher rate than someone who’s daddy gave him an apartment building for his 18th birthday?
But complaining isn’t going to change the law, at least not quickly… Instead, put your energy into learning how you can take advantage of the rules to retain and build your wealth. After that, if you have time to lobby for tax reform, mad props to you.
You will spend more money on taxes in your lifetime than… probably anything else. So, if you are serious about building wealth, this is an important area to learn about.
I’m not saying to completely change your life to fit the ideal tax rules perfectly, but you should make some serious considerations to see how you can take advantage of the rules. Even if you delegate your taxes to a CPA, gain a basic understanding of what’s going on, and it may impact your future investments and expenses.
As always, my business is here to help. Even if you’re not ready to quit your job, maybe you’re ready to start a business on the side. That second source of income is the first step to becoming an entrepreneur.