Are You Paying a Sucker Tax?

It may surprise you that most taxes and fees people pay are voluntary.

By Brad Beckstrom.

Did you know the sales tax rate in the city of Chicago as of Jan 2017 is 10.25%. The 10.25 percent rate includes sales taxes assessed by the state, county, city, and local transit agency.

I felt like that was high compared to taxes where I live, until I took a closer look. The state of Virginia has a 5.63% sales tax, then Arlington County adds an additional 1.07%. Not too bad until you look at the personal property tax of up to 5% that you pay every year on personal vehicles including cars, trucks, boats, RVs etc. for as long as you own them. You pay the tax even if you’re leasing them, based on assessed value determined by the state. This is separate from property tax on real estate which in my county in Virginia is about 1% of home value annually.

I’ve always thought that kind of sucked until I took it look at the total tax burden by state. The folks over at Wallethub put together this cool sortable chart, with tax burden by state based on personal taxes, property taxes, sales, and excise taxes as a percentage of income. That’s where things really get interesting. As it turns out, Virginia is ranked 40th in total tax burden. That means people in 39 states may have it worse than we do when it comes to state tax burdens. See how your state ranks.

See the sortable list on WalletHub

The point here is that every state has its zingers. Even states with no state income taxes have to pay for those schools, roads, law-enforcement somehow. You may think you’re killin’ it by paying no state income tax in Texas, but when you look at the total tax burden, there are 16 states lower than Texas. Just by crossing the border from Virginia to North Carolina I would get zinged. Jumping from the state with the 40th highest tax rate to a state that ranks 28th. It’s even worse if I go north to Maryland, a state that ranks 12th in total tax burden. You also need to consider what you’re paying for. You may be where you are just for the schools, family or work. Alabama, South Dakota and Oklahoma may be great places, but I’m not going to move there just to lower my taxes.

There’s a better way.

So what to do if you live in one of these heavily taxed states? Many people believe they can lower their taxes by moving to a state with a lower tax burden. Moving, especially moving frequently, you open yourself up to a whole bunch of other sneaky taxes and fees. Local governments love when houses change hands. There’s all kinds of transfer taxes and things like title insurance where both the buyer and the seller get a bill. Don’t forget the realtor fees, other closing costs, property taxes and insurance at your new location, which the mortgage company will be glad to roll up for you in a high escrow payment.  Banks also love it when folks move a lot, or frequently refinance their home. These all add up to (transaction taxes), all the fees and costs and taxes that go along with anything you buy or finance whether it be a new house, a new car, or just a few rooms of new furniture.

The one thing all of these taxes and fees have in common is that they are optional. Yes, when you think about it, even income taxes and state taxes are optional and are driven by the decisions you make every day.

For example, let’s say you decided to forgo replacing your car for 10 more years and instead put that additional $500 a month you’ll save in principal and interest, taxes, and insurance into a 401(k), IRA, HSA or other tax-advantaged account. By making that choice, you’ve lowered taxes and transaction fees across the board. More importantly, those tax-advantaged accounts generate income that is also tax-free, versus a new car that loses nearly 30% of its value in the first few years. Let’s compare that car to putting $500 away pre-tax for 10 years. If this money was invested in a low cost total market index fund like VTSAX and achieved a 7% return rate after 10 years, you’d have $70,000 put away. If your employer offers a 401(k) match, you could be looking at double that, and if you’re about 30 years old, that money will be funding a large part of your retirement. Those dollars will continue working for you, growing tax-free until you retire, even if you don’t add another cent after 10 years.

What’s that new car worth after 10 years and how much of you spent on down payments, principal interest, fees and taxes over those 10 years?  What do you have left?  What would you have saved on insurance, gas, and related taxes by owning an older, smaller vehicle?  

So, the short answer is, one of the easiest ways to save over a million for retirement is simply avoid buying new cars. When people ask me how I saved money towards financial independence, a big part of my answer is cars. Cars that were paid for by the company, cars that were paid off, and used infrequently, and fancy cars we didn’t buy.

You can apply this saving versus buying philosophy to many things, especially anything you buy on credit. RVs, Boats, high end appliances. When you buy that furniture or those appliances on credit, you’re paying even higher interest rates on those small and midsize purchases. Instead, if you buy quality used goods and wear them out, you can invest your savings in tax advantaged accounts that will reduce your total taxes, avoid sales taxes, and earn income. I like to think of every dollar I save as an employee that works for me every day, all day, earning income.

When you get exceptionally good at this, you can earn six figures a year and pay zero taxes. Our friends Jeremy and Winnie over at Go Curry Cracker have this down. You can even take a look at their tax returns. This will give you a glimpse of what financial independence and freedom from sucker taxes looks like.

I found the actual tax returns extremely helpful when discussing tax-free investments and returns with my CPA.  It’s always a good idea to have a tax professional review your returns to make sure your low tax lifestyle meets IRS guidelines.

 

The Frug

Follow me on Twitter Facebook Flickr Instagram

Leave a Comment