“If you drive a car, I’ll tax the street. If you try to sit, I’ll tax your seat.
If you get too cold I’ll tax the heat. If you take a walk, I’ll tax your feet.
Don’t ask me what I want it for—If you don’t want to pay some more.
‘Cause I’m the taxman, yeah, I’m the taxman!” (George Harrison)
Taking on the Taxman with Tom Wheelwright
If you have ever felt overwhelmed by the 6,000 pages of tax regulations or the checks you write to the IRS, you are not alone. For many Americans, taxes are the biggest bill they pay—sometimes even more than their mortgage. But it’s an area where you might have more control than you know. And with the new tax reform… there are even more ways to benefit!
“The fastest way to put money in your pocket is to reduce your taxes,” says Tom Wheelwright, one of the top tax reduction experts around. I am fortunate to have known and worked with Tom for many years, and his good thinking on taxes has profoundly affected my own approach to tax reduction for my family, business, and clients. Today, we share some of the wisdom we’ve learned from Tom’s advice for reducing your taxes.
First, let me share why I listen to Tom’s tax advice. Author of Tax-Free Wealth, Tom has worked with Ernst and Young and he has worked directly for Fortune 500 corporations and successful entrepreneurs to reduce their taxes. Tom has a bachelor’s degree in accounting, a Masters in Taxation (yes, there is such a thing!) and he spent 14 years as an Adjunct Professor at Arizona State University in their Masters Program teaching CPAs and other tax professionals to help people reduce taxes. He shares stages with Robert Kiyosaki and others, recently presenting for the Cash Flow Wealth Summit to teach business owners how to trim their taxes.
If you’ve ever heard him speak, you know that Tom Wheelwright approaches the tax code with excitement and enthusiasm! He views the tax code as a series of incentives that can help us dramatically lower our taxes—IF we take the cues it offers us.
There are two basic rules of taxes, says Tom. In the eyes of the IRS:
- “All income is taxable unless we say it isn’t.”
- “No expenses are deductible unless we say they are.”
The key to reducing taxes is to act and invest according to the incentives the government offers. Find the exceptions to the rules above and take advantage of as many as you can. After all—that’s what the government wants you to do—act according to the incentives the government gives you.
The government wants you to start a business, own a home, invest in neighborhoods, save money for retirement, donate to charities and teach your children the value of earning money. To incentivize behaviors such as this, the government offers tax incentives in five forms.
5 Ways to Reduce Your Taxes
1. Tax Deductions.
From business expenses to mortgage interest deductions and charitable giving, deductions give you an immediate tax advantage. If you are a business owner, these deductions can be quite substantial, whether it’s a home-based business you do on the side or a major corporation.
Many taxpayers neglect to take all of their deductions, so this is an area where a little knowledge and record keeping go a long way. Common deductions you might miss include:
- Charitable donations
- Business-related mileage or vehicle expenses
- Costs related to a job search or business-related move.
For more ideas see “Tax Deductions You Should Claim (and Five You Can’t!)”
By converting one kind of income, expense or property to another kind, you can lower your tax rate. One great example is how converting income earned as an employee or a self-employed person into business income can reduce taxes. This is more true than ever with the new tax law’s Pass Through Deduction that applies to certain business income. (We’ll cover that more in a future article.)
For now, let’s look at converting income through the lens of Robert Kiyosaki’s Cash Flow Quadrant to understand the “big picture” concept.
The Cashflow Quadrant
Warren Buffet has observed that some of his employees pay a higher tax rate than he does! Obviously, that’s not because they are earning more. It’s because of how different kinds of income are taxed.
There are four main ways to earn income, as illustrated in Kiyosaki’s Cash Flow Quadrant. While you might earn money in more than one way, most people earn the majority of their income in one or perhaps two of the following categories:
Quadrant One: Employee. How much you are taxed as an employee depends on your income. This can range from 10% for those earning less than $9,525 to 37% for income earned over $500,001. The top tax rate for employees has dropped from 39-1/2% to 37% under the new tax regulations.
Tax rates are “laddered” so that you only pay your maximum tax rate on the earnings above the lower amounts. This is your Marginal tax rate, and it is different from your Effective (or average) tax rate. Read how marginal tax rates work.
Quadrant Two: Self-Employed. Taxes for the self-employed can be even higher than for employees. That’s because self-employed folks pay their “employee” share of taxes, plus the portion that would have been paid by the employer, such as social security tax.
Quadrant Three: Business Owner. As a big business owner, your taxes actually go down to 21% under the new tax plan. Before the new tax plan overhaul, corporate tax rates were between 15% and 35%, with all but the tiniest corporations paying at least 25%.
And there are other significant advantages to being a business owner (and to some extent, self-employed). One reason that employees pay a lot in taxes is that employees typically pay taxes first on their income, then they get to keep what is left over. When people move to the right side of the quadrant, as business owners and investors, they reverse this. They take out expenses (deductions) first, then pay taxes on what is left over after their deductions.
Simply put, business owners have a lot more tax incentives! And these deductions apply whether you are an employee with a side business or own a large business.
Quadrant Four: Investors. Capital gains taxes are still at 0%, 15% and 20% and have not changed significantly. However, as a professional investor, it is possible to reduce your taxes down to zero, says Wheelwright. That’s because there are ways to take deductions, depreciation and deferrals against the already favorable capital gains tax rates.
The IRS incentivizes this because the government wants people to invest in businesses and in the economy! If there were no real estate investors… who would rent out houses? If there were no shareholders, it would be much harder for businesses to obtain financing.
3. Tax Credits.
Tax credits are one of the best strategies for taxes because they offer a “dollar-for-dollar” savings. In other words, you’re not just reducing your tax rate or making deductions from your income. Tax credits go directly into your pocket by subtracting directly from the taxes you owe.
Examples of tax credits include:
- The Earned Income Tax Credit, a refundable credit for people—especially parents with children—who work and don’t earn a lot of money.
- The Child and Dependent Care Credit for expenses you paid for the care of a qualifying child, disabled spouse or dependent.
- The Child Tax Credit may apply to you if you have a qualifying child under age 17.
- The Retirement Savings Contributions Credit (Saver’s Credit) helps low-to-moderate income workers save for retirement.
- The American Opportunity Tax Credit helps offset some of the costs of higher education.
4. “Borrow” your childrens’ tax brackets.
Kids have their own tax brackets, and they start low—lower than yours! Under the new tax plan, you can shelter up to $12,000 per child per year income tax free. If your children are under the age of 18 and you set your business up correctly, you won’t even owe social security taxes on that income.
You might be thinking, “Wait a minute, I don’t want to give my kids $12k!” But think about what that can be earmarked for. Your kids may have college tuition to pay—or save for. They may have car and car insurance payments. Chances are, they have expenses that you would be paying for anyways! You can’t use it for food or clothing, but you can put it into real estate or have them save it in a life insurance policy.
What can you pay your kids to do? I’ve paid mine to stuff envelopes, help with mailings, proofread websites, and more. Other appropriate tasks might include filing, cleaning, answering phones, running errands, data entry, or updating your website.
If you own any kind of business, this is a great strategy with multiple benefits. With this strategy, not only can you reduce your taxes, but you help edge your kids towards financial independence.
5. Tax Deferrals.
Deferrals are probably the most COMMON form of tax reduction, and the least preferable. After all, when you defer taxes, you end up paying them later—sometimes at an even higher rate! In spite of the common reasoning that “you’ll be in a lower tax bracket later,” that isn’t necessarily true.
Still, many people choose to defer taxes, most commonly through their 401(k) or an IRA. The advantage of this is that you pay less taxes in the year you make the contributions, because you are reducing your taxable income. The downside comes later—when you withdraw the income. (Actually, it’s “double the pain” if you take dollars out before age 59-1/2 and you pay a penalty as well as taxes.)
The BEST Way to Save on Taxes
Note that the first four strategies above are permanent deductions, which means that you never have to “pay back” the taxes you save. Even better, you don’t have to wait until your next tax return to take advantage of the savings! You can adjust your withholdings as an employee, or adjust your estimated tax payments as a business owner to increase your cash flow today.
Typical financial advice tells you to use a qualified retirement account as your primary tax reduction strategy, but as you can see, there are better ways to save on taxes and enjoy the savings now.
There’s MUCH more to cover about taxes and especially the new tax plan. In a recent presentation, Tom went into more detail on why the new tax code is so advantageous for investors. We’ll be back on the blog soon with some specifics on exactly how you can benefit from the new tax plan if you:
- invest in real estate,
- are self-employed or a business owner,
- own cash value life insurance or life settlements.
Tom Wheelwright’s Podcast with Yours Truly!
I was thrilled to have a chance to be on Tom Wheelwright’s Wealth Ability podcast. We had a great conversation about the tax benefits of whole life insurance, the uses for life insurance, how insurance companies are regulated, and much more! Click the link below to listen to the podcast: