Disclaimer: The statements made in this post are the opinion of the author. They should not be viewed as financial OR tax advice. Please consult with a financial specialist and tax professional before making any financial decisions.
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The American tax system is beyond confusing. In fact, if all of the tax codes were compiled into a book it would be FOUR TIMES THICKER THAN THE BIBLE! (For all of you non-religious folks, think of a book like War and Peace or Les Miserable as another good size comparison). And the majority of those words only take money out of the pocket of average workers without any relief.
How Taxes Work, the Quick and Dirty
I don’t want to bore you with taxes too long, but we need some context. Please note that there are always exceptions when it comes to taxes, I am purposefully over simplifying.
While there are MANY ways we are taxed, most people think of income tax when they think of taxes. Income tax is a very little understood thing, so here is a very simple way to think about it. You aren’t taxed on the first X amount of money you make (this changes every year and it is called the “Standard Deduction”) After that you are taxed a certain percentage of your income within a certain zone or bracket. So the first bracket could be 10%. And if you fill up the “10% bracket” that money is taxed at 10%. Then you spill over into the next bracket. Let’s say that the bracket is 15%. Only the money that is contained within that bracket is taxed at 15%. And so forth.
Let me give you a quick example. You made $50,000 last year. Congratulations! Now, let’s say the standard deduction is $25,000. You don’t pay any taxes on the $25,000. The $25,000.01 to $35,000 range is the 10% bracket. There’s $10,000 (ish) within that bracket so you are charged $1,000 in taxes. The $35,000.01 to $50,000 range is the 15% bracket. So you are charge 15% ONLY on the $15,000 from $35,000.01 to $50,000. That would be $2,250. Total you owe $3,250 in taxes.
That seems straight forward, but it actually hurts the average worker most.
Two Ways That Taxes Take Your Money
As an average worker there are two main ways that you lose when it comes to taxes. The first one is quite obvious, but the second one is where the rich excel and the average fail…miserably.
1 Income tax is what we dread. When you take a job you are told how much you will make each year. If you are like me then you calculate how much that should be in your pocket each month. Then taxes hit and your actual take home pay suddenly feels so small. It sucks doesn’t it? I’ll be honest, as long as you are working there are not many legal solutions that you can use for income tax. The rich also suffer from income tax.
2 Tax breaks are what the rich excel at. Here is why. You, the average worker, go to work, get paid, then pay all of your expenses. The rich on the other hand own businesses. So this is how their money works. They bring money into the business, buy many things that they need for their business, they get paid with what is left over, then they do a tax write off for all of their expenses so they don’t have to pay taxes on that income. They effectively live a rich life and pay the taxes of an average joe at the same time this way.
What to Do About Paying So Much in Income Tax
The first line of defense is to understand taxes. I know I just said they are too confusing, but if you want to make it ahead you need to know how taxes work. This will help you have an intelligent conversation about taxes when tax season comes AND it will help you make wise tax decisions throughout the year.
The second line of defense is to meet with a tax professional EARLY. There are two ways to handle a crisis. One is to prepare for it in advance and go into action when it comes. The other is the wait for the crisis then try to fix all of the problems it causes. I’m sure that you know preparing is the better choice, but the majority of people take the second approach when it comes to tax time.
The third line of defense is to make sure you have a very good tax professional working with you. Your tax professional is one of he most important people you will ever work with. Don’t leave it up to chance and make sure you find the person that can best help you. You can either have your taxes prepared by the high school kid who got certified in a couple of hours to work a booth in Walmart (I literally know someone like that) or you can work with an actual professional. I trust you’ll make the right choice there, but keep in mind this quote by Red Adair, “If you think hiring a professional is expensive, try hiring an amateur”.
The fourth and last line of defense is to start a business (are you tired of me saying that yet?). You have to start a business if you want to harness the tax power of the rich. There is no way around it. While it is possible to become well off with a very good job, it is so much easier to get real wealth with a business.
What ever you decide to do, start today!
If you want to dive more into how to (legally) reduce your tax bill, check out Tax-Free Wealth by Tom Wheelwright (affiliate link) it has some amazing insights.
What are some other ways that average people overpay in taxes? How have you reduced you tax bill? Tell me about it in the comments below.
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