How the Wealthy Pay Less in Taxes
We’ve all heard that the wealthy pay less in taxes. Sometimes that news even comes with a little stank on it, as if the wealthy are breaking the law somehow. But I’m going to show you how they do it legally, by understanding how the tax law isn’t just a revenue model for the state and federal governments, but more of an incentive program to get business owners to do the things that the government doesn’t want to spend money on.
Welcome back! We're going to talk about taxes, business and how all of that relates to you as a real estate investor. Because I am not an accountant, I highly recommend that you talk to an accountant before you try to apply any of these strategies I'm going to share with you.
As we’ve discussed in previous videos on this channel, the public education system has been set up to teach us how to be employees, not necessarily business owners. Because this is how we were all taught, everything that comes along with being an employee, including how we are taxed, seems perfectly normal. Let’s dive into this and examine why the wealthy generally pay less in tax as a percentage, compared to employees.
In my study that led to the writing of my 4x Amazon #1 Best Selling Book, “Mindset to Millionaire: 7 Keys to Becoming a Real Estate Millionaire”, I found an amazing consistency among the successful people I studied: the wealthy are business owners and real estate investors. And when I first discovered this, I thought, well, sure that's the case, because those activities make a lot of money, right? Well, that's true. But what I found was there's layers to it. One of those layers is taxes. We've all heard that the wealthy pay less in taxes, yes? Did you know that MOST of them do it legally? It's because they understand the tax law. You see, of my 5 Currencies of the Wealthy - Time, Knowledge, Relationships, Credit and Money - that second currency, knowledge, is a very important thing to the wealthy. They have this funny attitude of: “If I'm going to pay into a system, I’m going to understand it!” And what happens when they start to understand it is they find that being a business owner and a real estate investor carry with it more deductions than any other activity. There's nothing else you can do that has more tax deductions to it than being a business owner and real estate investor. The reason for this is the difference between being a creator and a consumer. It’s simple: if you’re creating jobs and housing for people, the government doesn’t have to. So the government provides an incentive to do these things in the form of a tax deduction.
The employee mindset individual was taught all their life to be consumers. To buy liabilities instead of assets. To be scared of finances. They don’t understand it. They don’t want to ask questions about it. And most of them (with the exception of maybe accountants) don’t study the tax law to gain understanding. They trade most of their time for money at a JOB, where they are required to file taxes as a W2. W2 is the most expensive way to pay your taxes! There's not another more expensive way to pay your taxes than the W2 form. The reason being it has the fewest deduction categories. It's also the only way whereby the government gets paid first - you know: that withholdings thing that they do… That's the government getting their money first before you get your check.
W2 Employee Taxation
Okay, let’s set up a hypothetical example to help me illustrate my point. Let's say that you’re a W2 employee who makes $100,000 a year, i don’t know… selling widgets. You work for Widget Manufacturing Incorporated. As a W2 employee, your job is to go out and pick up new customer accounts and sell them widgets. As a W2, the first thing that gets taken out of your check is taxes. On average, we’ll say it's about 30-33% that’s taken out. So, 30 grand immediately goes to the government. You’ve got a house and a cell phone and a car. You’ve got kids so you’ve got to pay for the kids' school and soccer practice and all that stuff. And your expenses total about 70 grand a year. Okay, what's leftover? Nada.
Business Owner Taxation
Let's run the same scenario but this time you’re a business owner. You’ve decided: “You know what, I don't want to work for Widget Manufacturer Incorporated, I want them to be a vendor of mine, I'm going to start my own company. And my company's responsibility is to sell widgets. And we'll contract with widget manufacturing Incorporated, to fulfill the orders that come through. You’ve got the same clientele. You make the same profit margin and commission. In this scenario, you also bring in 100 grand a year. The big difference is, as a business owner, your taxes don't get taken out first. As a business owner, you get to take deductible expenses first.
Business owners get to take advantage of more deduction categories than W2 employees. W2 employees have 15 to 20 deduction categories that they get to take advantage of each year, whereas business owners have more like 250, and real estate investors get another roughly 200.
So, do you think, as a business owner, you might use your cell phone a little bit for business? Yep! Deduction! Do you think, as a business owner, you might do a little bit of work out of your home? Yep! Home office deduction! Alright, maybe you’ll use your car a little bit for work, driving around to service your customers. Yeah, deduction!
What about those kids? How do we write off the kids? You know what, the tax law actually allows for you to hire your kids that are under the age of 18, as long as they are dependents living in your household. You can pay them up to around $12,000 a year each, tax free. So instead of giving your kids allowance, and then also paying for their school supplies, and their soccer practice and their clothes, all with post-tax dollars, pay them 12 grand a year tax free to work in your business. Now, they actually have to do work, and you actually have to pay them for this to be above board. But when it comes time to buy their clothes and their school supplies and pay for their field trips and their soccer practice, HAVE THEM DO IT! THEY HAVE A JOB! Now you’re paying for that stuff with pre-tax dollars, which basically works just like a deduction.
What about groceries? Groceries are not directly deductible, but there is no law that says that your kids can’t contribute to the household. Let them take turns paying for the groceries in the household. Now you’re paying for groceries with pre-tax dollars!
If you have children under the age of 18 living as dependents in your household, think about how useful that could be on so many levels! Teaching them the importance of working for what they get, teaching them solid business strategies at a young age. Not to mention structuring responsibilities for them the help take some of the load off in your business! And that strategy applies PER KID. Up to $12,000 a year tax free PER KID. I mean, I live in Utah. For some of the people I hang out with that could translate to hundreds of 100s of 1000s of dollars each year! [supposed to be funny. Hopefully it lands]
Back to our example. So now, using strategies like the ones I explained, your deductible expenses are about $70,000. And you know what's cool… business owners don’t get taxed on their gross income like W2 employees do. They get taxed on what’s called their Adjusted Gross Income, or AGI. The equation to calculate your AGI is very simple. It’s gross income minus deductible expenses. So in this example of your gross income being $100,000, and subtracting $70,000 in deductible expenses, you’re left with an AGI of $30,000. As a business owner, THAT’s the amount you get taxed on. You’re taxed at 30-33%, so your tax bill for the year is $10,000. What's leftover? 20,000 bucks! You made the same amount of money doing the same things, and spent the same amount of money on the same stuff. You just structured it differently. When knowledge increases, behavior changes.
Anyone want to save $20,000 on taxes this year? Now, I get it. You might be looking at this saying, “well, geez, I don't make 100 Grand, I make like half that.” Well, that's okay. It’s completely scalable. Cut that in half. Want an extra 10 grand this year?
You don’t need to be rich to do this! This is something you can start doing right away, regardless of your income level, as long as you are educated enough to do it correctly, legally and safely.
Again, I’m not advocating that you do anything shady or illegal here. Quite the opposite. I’m suggesting that if you take the time to educate yourself on how the tax law works, and learn to navigate it legally, morally and ethically, you can start to take advantage of some of the same tax strategies that the wealthy do!
Of course, there is still risk in real estate. And I’m not your attorney or your accountant, so I’m not qualified to give you direct advice that would be applicable to your exact situation. These are just some of the things that I’ve picked up along the way and have found success with. There are ALWAYS risks in any of these strategies, so make sure you’re educated before you go out and try any of them on your own!
A great place to start is our weekly live education webinar! Get access to our nation-wide community of real estate investors! We meet on Zoom every Wednesday at 7pm Mountain Time for exclusive trainings, real deal walkthroughs, question and answer, guest speakers and all around real estate investor shenanigans. Beginners, experts and everyone in between is invited. Just go to www.MitchAndMaeliLIVE.com Wednesday at 7pm MST. There is no better place to start getting your investor legs! Best of all - we made it FREE just for you! Can’t wait to talk with you live!
I’m curious what you thought of this Article. If you have any thoughts you’d like to share or if you would have done things differently, please reach out and let me know. I’d love to hear from you! We’ll be bringing you some more amazing content very soon! See you on the flip side!