Spring is a time of renewal and freshness. The flowers are beginning to slowly come out of the ground with their shots of green pressing to reach the sun. It is one of my favorite times of year…
Baseball spring training and little league is in the air. My sons had a “Spring Training Day” at our local Minor League baseball clubs field. Our minor league team is the Wilmington Blue Rocks and their ballpark is Frawley Stadium. What an amazing experience for my sons to be able to practice on the same field as future Major League Ball Players.
My youngest son, Nicholas, was scared and nervous. It was a whole new experience on the big baseball field with all these people. He began to cry and wanted to leave…very sad, but his feelings were about to change quickly. My oldest son, Jack, was super excited. He was at the park with some new friends and even got to put on some eye black to fit the part.
Nicholas was first onto the field with his fellow 4 year olds. Does the phrase herding kittens mean anything to you? The first station was batting off of a tee. Hat’s off to the coaches for being able to maintain order of 14…4 year olds. Nicholas’s turn to bat came and he was hesitant and didn’t want to go. After he saw a few kids hit, he wanted in on the action. From that point on…lookout, Nicholas was on fire and having a great time. There are only 2 speeds for him…on and off.
Jack (in the red shirt) took the field for his group in stride…running onto the field and taking the lead. Maybe to show his younger brother how it was done, or just trying to look cool with his 7 year old new friends. For Jack’s batting, the coach was having them practice hitting the ball off the tee. Many were going over the fence…Jack can truthfully say he has hit a ball out of the ballpark!!!
I’m living vicariously through my kids if you couldn’t tell…you can see why this is one of my favorite times of the year.
What else does this time of year bring? The five letter word that is a touchy subject for many… TAXES.
As we all know taxes are an essential part of a modern society. No matter how we fall on the political spectrum or how our money is handled by politicians we have to pay them. This is why this can be a not so favorite time of year…
To reduce the amount of pain in this time of the year so I can enjoy the amazing parts like I just described above I’m always on a quest to learn more about how to reduce my tax burden.
As the former supreme court justice, Billings Learned Hand, so famously stated “…Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” I take this to heart.
A couple of things I have learned is that all taxes are not alike and they are the #1 Hurdle of Wealth Building. Taxes are your number one expense in life. When you take into account federal and state income taxes, property taxes, and the sales tax you pay on purchases–not to mention the $. 30-. 70/ gallon tax you pay at the pump–it’s a surprise that we have much of anything left.
While many of us pay 50% or more, even lower income folks who don’t pay federal income tax can easily spend 25% of their gross cash flow on taxes. Money that you save in taxes will not only improve your lifestyle today; if invested, these savings can accelerate your investment results.
IRS Defines 3 Types of Income
Not all income is created equal. In fact, the IRS categorizes income into three broad types, Earned Income, Portfolio Income, and Passive Income. While portfolio and passive income are generated via investments, earned income is either employment (W2) or self-employment income (1099).
The principles and methods governing the three are very different and, most importantly, the rules relative to taxation are different as well. In my opinion, knowing these distinctions holds the key to financial freedom.
Earned Income, AKA, Active Income
Most people live in the world of Earned Income, which is to say that the vast majority of us generate income in exchange for our labor and/or services. This is what we do as pilots for the most part.
Simply put, earned income is what you get paid by working at a job as either an employee or an independent contractor. If you are an employee, your earned income comes to you in the form of paycheck, usually at regular intervals like weekly or bi-weekly and in set amount. In this arrangement, the majority of taxes have already been taken out of your check by the time you receive it. We trade our time flying airplanes for dollars.
The current tax rate on earned income is as high as 39.6%, just at the federal level, not including state or local taxes
Portfolio income is income resulting from paper investments like capital gains, dividend, and interest income that you might receive from ownership of notes (being the bank), stocks, and bonds.
The highest tax rate for portfolio income is currently as high as 20%. For most it’ll be 15% depending on your tax bracket.
In direct opposition to the idea that you have to be employed in order to earn income, is the notion of passive income.
The concept of earning income without work is quite difficult for most of us to comprehend since we’ve all been conditioned by our parents and teachers that we must “work hard” in order to achieve. What they didn’t tell us is that by working smart, we can greatly diminish the amount of effort required to achieve our goals.
The Internal Revenue Service defines passive income as income from “trade or business activities in which you do not materially participate…” If it seems to you that this definition implies a possibility of earning income without working for it – without your material participation, you are right!
In the Real Estate World this could be buy and hold rentals, etc. The intent is to buy and hold property for long term earnings potential through cash flow and or/appreciation.
An important point to remember though, is no investment, and I mean no investment is completely passive. Whether it be a wall street vehicles, notes or, rental properties, one must monitor their investments. As a good friend of mine says “One must be a ‘Active’ Passive investor.”
As I mentioned previously, the IRS tax code treats the three types of income very differently. Earned income is the highest taxed income of the three. With the current individual tax rates ranging from 10% to 39.6%. The tax bill can really add up quickly. In addition, earned income is subject to other taxes, such as Social Security and Medicare, which add up to 15.3%.
What’s more, while a W2 employee benefits from their employer paying half of these taxes (7.65%), the self-employed earner pays the entire 15.3%.
Portfolio income, at least as it relates to dividends, interest, and capital gains resulting from the sale of investments held for longer than twelve months, is currently taxed at no more than 20%.
Furthermore, this income is not subject to Social Security and Medicare taxes (a 15.3% savings).
Passive income from investment activities such as rental of real property is the least taxed of the three. It offers even more advantages, and it is not uncommon for an investor to pay only a 15% effective tax rate (taking into account depreciation, interest deductions, and no Social Security and Medicare taxes)..
Review your situation with your tax advisor; have them help you pursue a path that maximizes your opportunity to accumulate wealth. Beneficial tax opportunities are one prime reason I’m drawn to real estate.
Where did I learn about the different types of taxes and how they can severely affect your income? I went to events like the Aviator Freedom Summit on April 22 & 23rd in PHL.
At our meeting you will have the chance to meet and talk to my CPA (Chris LaSpada) who has guided my tax journey with Real Estate and Alternative investments.
The question comes down to… are you interested in changing your future, or are you committed? I believe you are committed…
Make the commitment to find out more and save your spot.
Seating is limited.
Till next time,
P.S. Have you had a chance to get your free copy of “Capital Assets – The key to financial freedom.” Download it today!