Choose to pay less in taxes
Childhood memories tend to hang with us in the weirdest ways. In my case, I have no idea why I vividly remember a dry conversation about money and income between me and a sixth grade classmate. I recall the exact phrasing he used because it struck me as something his fiscally-conservative dad would say:
“Paychecks are awesome until the government takes half”
At the time, I didn’t understand or care that much about paychecks. My key priorities at the time were video games and electric guitar #NerdAlert. Yet, my brain decided to crystallize on that phrase.
Flash forward to 2018, and here we are: raising two kids, building a business and working a day job. I’ve come to believe that a truly healthy outlook on our financial livelihoods requires that we approach our family/business planning with a balance of seriousness and playful gamesmanship; hence...
Playing “Offense” = expanding our means (e.g. cashflow producing assets, like real estate)
Playing “Defense” = reducing our expenses (e.g. taxes)
The creature lurking in your paycheck
Unless you’ve won the lottery or have access to a trust fund, you likely have to generate income to support your livelihood. In our case, Jennifer and I have supported ourselves for the past 10 years by working full time jobs at companies - companies in a variety of industries, sizes and geographies. I am deeply grateful for the relationships, skills and learnings gained throughout this corporate journey. These experiences have played a big role in shaping my own development and have granted me the opportunity to make positive contributions for others, along the way.
Now, it’s time to address the elephant in the room. It has taken me years to see it clearly and recognize it for what it really is. I’m actually embarrassed about missing it for so long.
It is a lurking, destructive force…
...quietly slipping past detection on every paycheck...
…hiding in plain sight, normalizing its presence…
…employing jargon, misdirection, fear and inertia...
...causing massive damage to our financial livelihoods…
I am, of course, talking about income taxes.
I remember the first paycheck I received at my first full-time job - an inside sales job. It was a paper check in an unmarked envelope. That fateful Friday afternoon, I remember walking out to the office parking lot, hopping in my salvaged old Ford Explorer, opening the check and thinking: “Yes! I did this myself! Wait, w-w-where did the rest of it go? This isn’t fair!”
From that moment on, the normalization process continued. Every couple weeks, the paycheck would come and each time, the numbness became more potent. The unspoken internal conversation, reassuring myself: “This is how this works. This is just the way it is.”
Want to hear something really embarrassing? I have worked for three well-known, successful accounting and tax software companies in a row (Intuit, Xero and Gusto)... and it still took me almost a decade to finally get this big learning through my thick skull:
We have a choice in how much tax we pay.
It doesn’t have to be this way.
Calm down, this is not a manifesto for tax dodging. It is, however, an impassioned plea for you to open your eyes faster and wider than I did.
“It’s not how much money you make, it’s how much you keep” - Robert Kiyosaki
From a tax perspective, there are three types of income. CPA and author Tom Wheelwright explains this elegantly in his book Tax-Free Wealth, with an analogy of “3 types of buckets”:
Bucket #1: Earned Income - the leakiest bucket
Bucket #2: Investment Income - a bucket that sprung a leak, but still holds water
Bucket #3: Passive Income - No leaks. A bucket that does it’s job
Earned Income < Investment Income < Passive Income
If your goal is to fill a financial reservoir for your family, one buckets-worth of wealth at a time… you’d likely want to have a couple extra buckets sitting around, in addition to that one leaky bucket (aka - earned income). To be clear, that leaky bucket still works… it just takes way more time and effort than it should, particularly when compared to the passive income bucket.
Let’s define these more literally…
Earned Income: If you work for someone who pays you or you own/run a business, you are likely generating Earned Income. Most folks receive Earned Income as W2 or 1099 workers (in the form of “wages”). It is the most-taxed type of income in the US. It is the most taxed because there are so many different types of taxes applied to it at the Federal and State levels. Earned income is taxed based on where you fall in Federal tax brackets like these. Example: An hourly or salaried paycheck from your corporate job
Investment Income: interest payments, dividends, capital gains collected upon the sale of a security or other assets (e.g. stocks), and any other profit made through an investment vehicle of any kind. Example: A one-time check you receive from selling a company stock that grew
Passive Income: Earnings derived from a rental property, limited partnership or other enterprise in which a person is not actively involved. Example: Quarterly “mailbox money” checks from a real estate syndication
So, why is passive income so great? Because passive income is taxed far less than earned income. There are also some very cool ways that you can use things like depreciation to massively reduce your taxable income coming from these passive investments (depending on your circumstances and the investments you make). Just as importantly, passive income can be generated passively - meaning, minimal work is required to generate it. Real estate is generating wealth for us while we sleep.
To be clear, most forms of income are a good thing, particularly when changing hands because of value creation (meaning: you added value and are compensated for it). This entire blog is written by a guy who works a salaried day job (and enjoys it). The key message here is: Don’t sleepwalk through your investing life. Take action. Play offense by investing in real estate and generating tax-favorable income. Play defense by reducing your costs. You’d be shocked how quickly you can start changing your financial picture and moving to the right side of this scale.
Buy passive income streams (the “watertight, no-leak bucket”): Invest in real estate. Reach out and we’ll help you do this or point you in the direction to an option that fits your preference and circumstances.
Get a CPA: It costs $50 more than Turbotax, for tens-of-thousands of dollars of upside
Start a business and track everything: This isn’t as hard and daunting as it sounds. Now, more than ever… certain types of small businesses are receiving favorable tax-treatment.
Couples, go all-in on integrating your financial picture, together: Jenn and I have shared a single Mint© account for the better part of a decade. I’m not saying this is “the answer”... this is just something that’s worked well for us. This is a very personal choice and one that you will have to tailor to your own circumstances, but it sure helps if you can learn to have transparent, civil conversations about money with your significant other. There’s a reason “money” shows up as #2 on this unfun list.
Don’t celebrate big tax refunds: We used to get excited about giving the government an interest-free loan. Well now we feel pretty darn silly. We could have used those very same funds to invest in the meantime and put that money to work and help increase our wealth.
Track your net worth: It keeps you focused on a singular, long term goal and helps inform decisions. I’ve found that there are 2 versions of “net worth” that you need to know about:
Version 1: “Typical” net worth - all your assets, minus liabilities (includes the value of your primary residence… your home, minus mortgage debt). This is helpful to track on a monthly basis and ensure the number is moving in the right direction.
Version 2: Accredited investing net worth - to invest in many of the syndications we do at Madison Investing, you must be accredited. 1 of the 2 ways to qualify for this coveted status requires that you have a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
Reach out to chat and sign up for our investor mailing list. It’s a no-pressure way to educate yourself and get exposure to the types of returns that other folks are getting on real estate.