Any expense that does not have a tax deductible feature to it has an inherent higher after tax cost. Let’s break this down slowly.
Any expense that does not have a tax deductible feature to it…
Your mortgage interest IS a deduction, your rent isn’t. Your car payment isn’t a deduction unless you own your own business, or are an outside sales person. The clothes you buy, unless a uniform for work, is not a deduction. The dining out, the vacations the DVD surround sound…. all not tax deductible; unless of course you are a rock star who needs to sample other peoples music while traveling to exotic locales, while paying for your band manager and fans dinner. Even then, you can only write off a portion of your travel and meals expenses. Let’s look at the next part of the sentence:… “has an inherent higher after tax cost.”
Remember last week, we looked at the cost of rent. We concluded that in order to pay a monthly rent of $2,000 per month, we needed to have gross earnings (before taxes) of $3,125 per month. Therefore, the true cost of the rent was $3,125. Likewise, if you purchase an automobile that costs you $500 per month, you will need to earn, on average, $833 gross income to net the $500 for your car payment. How about the latest Plasma TV catching your attention as you walk through Best Buy? It only costs $1,999 right? Wrong… with sales tax, the total would be $2,158 and you would have to earn $3,598 in gross income to net the $2,000. I get a quesy feeling in my stomach when I think about having to earn taxable income to pay for sales tax; seems redundant. For the reasons explained above, many people start small businesses. Although, the small business allows more deductions than normal, it’s not foolproof and expenses can be audited, so contact your accountant for the details.
Now that you’re aware of the tax implications of buying goods and services, what can you do? Simply put, you want to minimize taxes. For every dollar you can deduct, you get a 40% return on your money. (Using a combined state and federal tax rate of 40% you would save 40% on your money by not having to pay taxes). First, if you have a 401k you should be contributing as much as allowable, at the very minimum; you should be contributing as much as your employer will match. If you are eligible you should contribute to an IRA and if you don’t have the money this year… start saving for next year. If you have some consumer debt from credit cards or auto loans, consider taking out a 2nd mortgage equity line of credit and paying these off. At the very least you will convert non-deductible interest into deductible interest. If you vacation to the same location frequently consider buying a vacation home. Tax laws allow you to write off interest on up to 1 million dollars of mortgage debt. If you have a child in college that you are assisting in their rent, possibly buying a small condominium as a rental property instead would add some deductibility to an otherwise draining expense. Think legally, but think creatively.
Am I implying you should only buy tax-deductible girl scout cookies or other goods and services, which are tax deductible?… No… I’m only trying to make you aware of the REAL costs of what you are buying. Remember, there are only two things that are for certain in this life: Death and Taxes!
I welcome your comments below!