Your biggest expense

Why am I so obsessed with taxes?  I guess I’m wondering why you aren’t.  I’ll bet you know your monthly mortgage or rent payment.  Do you know your monthly tax bill?  If your family is like mine, you pay more in taxes than in housing and transportation expenses combined.  It’s probably your biggest single expense, but chances are you don’t spend much time thinking about it, except once a year when it’s “tax season.”

Contrary to the narrative on TV and in the papers, the US Tax Code does not punish the rich.  The punishment is reserved for people with high-paying jobs, especially two-income couples.   People who earn high salaries are not usually wealthy.  They are people who have chosen high-skill careers (like medicine or engineering), often live in high-cost areas, and are often working to pay off six-figure student loans.  The rich, by contrast, do not generate wealth through wages, they generate it through investments and business ownership.  Because they do not need to live off their paychecks, wealthy families can control the timing and character of their income to defer or eliminate taxes.  The rich can also afford expert advice that is not available to the merely affluent.

The folks left holding the bag are working professionals raising families in urban areas.  Does any of this sound familiar?

  • Your earnings put you in a high tax bracket, but due to the high cost of living in your area, your lifestyle is far from extravagant
  • You and your spouse both work full-time, resulting in a much higher tax rate than you would pay if you were single
  • You have student loans but the IRS says you earn too much to deduct the interest
  • You pay tens of thousands of dollars in childcare costs so you and your spouse can work, and none of it is tax deductible
  • Your income makes you ineligible to contribute to retirement and college savings vehicles that are available to most Americans
  • Your city or county charges high property taxes, but you cannot deduct them due to the Alternative Minimum Tax rules

For many mid-career professionals, reducing taxes can drop more cash to the bottom line than increasing investment returns.  Yet I find most of these individuals devote significantly more time and attention to their investment portfolio than their tax situation.  Most high-earning families could benefit significantly from even basic tax planning.  I’m not talking here about the once a year tax preparation exercise where you give your accountant your shoebox of receipts.  I’m advocating proactively planning and managing your finances in a tax-aware manner:

  • Where possible, managing the timing of compensation income and deductions to minimize total taxes over time
  • Where possible, earning compensation as business profits instead of wages (e.g., joining a partnership, starting a business, opening a practice)
  • Using the tax deferred accounts and savings plans that are available to you
  • Locating capital gain assets (e.g., stocks) in taxable accounts and income generating assets (e.g., bonds) in tax deferred accounts like IRAs
  • Selling stocks that have declined in value and replacing them with similar stocks (tax-loss harvesting)
  • Funding your family’s charitable donations with appreciated stock or, where appropriate, using a private foundation or donor-advised fund
  • Investing in real estate, especially if you or your spouse are a “real estate professional” as defined by the IRS
  • Converting traditional IRAs to Roth IRAs in years with lower-than-normal taxable income
  • Using life insurance and annuities where appropriate

I get it.  Taxes are complicated, frustrating, and boring.  Dealing with the government can be intimidating.  Because taxes are automatically taken out of your paycheck its easy to forget just how much is going out the door.  Given how much is at stake, it’s worth paying attention.  Or, if you can’t or don’t want to spend time thinking about taxes, it’s worth getting some help.

What do you think?  Do you know your monthly tax expense off the top of your head?  What do you do to reduce your tax expenses?  Please leave a comment below.


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