How to Gain Financial Freedom through Tax Planning and Investing
Colorado Business CPA, LLC
July 20, 2016
We all want to be financially secure and financially independent. How can we achieve it? I believe it all starts with the mindset. What we are intentionally doing and what we desire to work on. What are results we are getting? Taxes are the biggest expense for any person’s budget, so why some of us are planning our tax liability and others fell in traps of maximum tax rates? Let’s discuss the ways and strategies that perhaps can at least slightly have a positive effect on financial part of your life.
Create a mindset of an investor and a business owner. These are the categories of people who are more or less in control of their income tax rates, vs. employees receiving W-2 forms. I believe the entire tax code is built on promoting business and investments in the US. There are very few things employee can do to decrease their tax liability. Let’s discuss that category of people first.
Employees have limited options regarding tax savings plans, such as contributions into company’s retirement accounts, Traditional or Roth IRAs ( if income limit allows), flexible spending plans, as well as reimbursement of dependent care expenses, which also prevents them from taking despond’s care credits. Their entire earning capacity depends on earned income and they are in the ordinary income tax bracket. When they purchase a house and pay the mortgage, the interest expense is deductible along with other itemized deductions, such as real estate taxes, personal property taxes, income taxes and charitable contributions. Please keep in mind that the government gives taxpayers an option of using standard deductions if your itemized deductions are less than your standard deduction. Therefore, in order to have higher itemized deductions, you normally have to have a large expense in mortgage interest. Why would you want to pay the bank thousands of dollars in interest to "save "only a small fraction of it on taxes?
People who invest into passive activity of wealth building get the most favorable tax rates. Sometimes it can be a zero tax rate. One of my clients who sold a real estate investment property she held for more than one year and was confused why her tax liability was so immaterial. I explained to her she was subject to a long-term capital gain rate. She thought I made a mistake. If your’ earned income in 10-15 % of tax bracket, your long term capital gain is taxed at 0.00 % up to a certain dollar amount. People who invest money into real estate or the sale of real estate would qualify for a long -term capital gain rate if the property sold after one year and one day. Make a decision to purchase real estate, bringing you a positive cash flow on a regular basis and keep your properties for at least one year and one day to qualify for a long-term capital gain.
Now, let’s talk about my other favorite category of people, business owners. I believe small business owners are one of the most influential people in US economy. They provide jobs and opportunities as well as support to their local communities. Most of the business owners are self-employed individuals and therefore their income is not only taxed at their ordinary income tax rate but they are also responsible for self-employment taxes. Those taxes are a 7.65% FICA tax as employee of its company and a 7.65% as an employer of the company, thus subjecting oneself to self-employment tax of 15.5%, in addition to ordinary income tax rate. Therefore tax rates can be up to 40% -50% with the State tax liability included!
If you are a business owner, this is where your tax planning opportunities begin. Investing in a valuable relationship with proactive CPA is a must. How one reports your income and how much you make, can save money on taxes by restructuring your business into an S-corporation. Create retirement account strategies, pay health insurance and other ordinary/ necessary expenses paid before your tax bill. Partially deduct your family vacation with careful planning, pay your children and save money on taxes, pay for their education, and pay for your and your employed spouse medical expenses and deduct it as an ordinary and necessary business expenses. This is the area where tax planning opportunities are endless!
Create a shift in your mindset and plan your investment strategies. Build your three legged stool of wealth - investing into real estate, building a business and contributing money into retirement account. One more tip, do not forget to invest in a good relationship with proactive CPA! We are here to help! 1-800-5040-CPA (272)
Colorado Business CPA, LLC