You work hard for your money. Perhaps your investments work harder for you. Either way, you probably want to use as much of what you earn as wisely as possible. Losing it unnecessarily to frivolous spending and taxes you find out later you didn’t need to pay can feel worse than overeating. Never mind the shame and guilt — you’ve set your financial goals back, and you may not be able to recover.
This is the real cost of not having a tax strategy. Missing out on achieving financial freedom, failing to reach an aspirational milestone, and not saving your business (a.k.a., life’s dream) from going under are possible examples. A tax strategy directly impacts your cash flow.
Informed approaches can increase it, while mediocre or absent ones will likely diminish it. A good strategy is part of smart cash flow investing. Let’s look at why you can’t optimize your cash flow without one.
You Lose Potential Passive Income
Any investor worth their salt knows that the financial security that comes from investing isn’t limited to owning a certain number of assets. It’s also the passive income those assets can generate. This is money you work for once, but it keeps earning more year after year. Perhaps even enough to fund your lifestyle so you have the freedom to work as much or as little as you want.
Without a tax strategy, you could be keeping less of what you make. Retaining less of what you make means you have fewer funds to invest or reinvest. So, investments can dwindle and yield less interest and dividends.
When you’re talking about a couple of thousand dollars parked in CDs at 3%, lost interest may not seem like a big deal. But when you have million-dollar portfolios that could be in trusts and dividend-paying assets, the impact is significant.
Lifestyle Investing expert, Justin Donald, talks about cashflow investing as “It’s not about what you make; it’s about what you keep. That’s why, in my opinion, a world-class tax strategy is the most important skill you can have. Often, a sophisticated tax move can save you more than any single investment.”
You Pay More Than You Owe
Tax forms aren’t pretty. They’re complex, sometimes taking hours to sort through all the nuances and deductions you can take. Yet, if you’re not taking advantage of deductions and credits, you’ll end up paying more taxes than you should. For example, if you run a home-based business, there’s the home office deduction. You’ll want to look at this deduction carefully, as the government takes its share when you sell your home.
No, W-2 employees who work from home can’t deduct those expenses on their federal taxes, but several states allow employees to deduct specific unreimbursed work expenses. But freelancers, independent contractors, and small business owners can take the federal deduction. A percentage of your home-related expenses, such as utilities, maintenance, and mortgage interest, can reduce your self-employment tax. While you do have to understand the rules and limitations, choosing to bypass a deduction like this increases your taxable income.
Not only do you not get to keep as much of your earnings, but a higher tax bill could also spell trouble for your bottom line. In other words, it might be the difference between a sustainable profit and being in the red. For small business owners and independent contractors, every penny literally does count. By overpaying, you’re essentially lending the government interest-free money.
You Hand Down Less Wealth
After years of building wealth, most people want to transfer their assets to family members or loved ones. Yes, there are times when someone wishes to transfer wealth to charities and other non-profit entities. But either way, not having a tax strategy can result in substantial wealth loss during asset transfers.
Capital gains, gifting, and estate tax bills can be higher than necessary. These hefty taxes eat into the wealth transferred from the original owner to the new owner. Knowing the different types of taxes and the rules behind them can help you plan for the transfer of your assets when you pass.
For example, capital gains tax doesn’t just apply to real estate. It applies to stocks, bonds, and jewelry. If you plan to divvy up what remains of your retirement portfolio among your heirs, this wealth could diminish. Your heirs could pay a larger tax bill on the profits from those investments once they liquidate them. Knowing about exemptions for certain types of bonds, such as municipal securities, and holding periods, can help your heirs avoid the tax.
Your Tax Liabilities Can Increase
Uncle Sam isn’t the only one knocking at your door. Individuals, businesses, and estates also have state and city tax obligations. Some states levy capital gains tax on specific types of earnings and assets. Others don’t. Similarly, certain locations can be more favorable for business tax exemptions and credits than others.
A comprehensive tax strategy considers the implications of selling across state lines. It looks at where it makes the most sense to locate a company’s headquarters and where to hire. In addition to leveraging tax credits and exemptions, a good strategy helps avoid penalties and audits.
Penalties can be more expensive than paying what you owe upfront. These fines often stem from a lack of understanding of the intricacies of federal, state, and local tax laws. For small business owners in particular, partnering with an expert can be invaluable. You have enough to tackle. Let those with tax expertise help guide your approach to adhering to the rules.
Developing a Tax Strategy That Works
Each tax strategy will differ based on goals and circumstances. What works wonders for another small business owner in a neighboring city may not be the most astute move for you. Taking a thorough look at the types of assets you have, applicable government tax laws, and financial goals is where the right approach begins.
During the planning process, you may also want to get your heirs on board. Consider their current and future ambitions, as well as what might affect them. Skipping these steps can cost you and future generations time, money, and emotional stress. If your business employs others, not having a tax strategy can impact livelihoods for years. When you approach taxes with calculation, you can ensure you’re not losing more wealth than you should.
