Financial Word of the Day: Tax
Taxes may not be anyone’s favorite financial topic, but understanding them is essential if you want to speak the language of money.
What Is a Tax?
A tax is money collected by a government to pay for public services and programs. Taxes help fund things such as roads, schools, police and fire departments, national defense, government operations, and Social Security and Medicare.
Taxes come in many different forms.
You may pay income tax on money you earn. You pay sales tax when you purchase certain goods and services. Homeowners typically pay property taxes. Employees see payroll taxes deducted from their paychecks. Investors may also owe capital gains taxes when investments are sold for a profit.
In other words, taxes touch almost every part of your financial life.
Why Do Taxes Matter?
Financially successful people don't just focus on how much money they make. They also pay attention to how much of that money they actually get to keep.
Suppose you earn $100,000 per year. That doesn't mean you have $100,000 available to spend or invest. Federal income taxes, state taxes where applicable, payroll taxes, and other deductions can significantly reduce your take-home income.
Understanding taxes helps you make smarter decisions about your salary, investments, retirement accounts, real estate, and business income.
Using the Word "Tax" in Conversation
You might hear someone say: "Before I sell that investment, I want to understand the tax consequences."
That's a financially informed statement.
The person isn't simply asking, "How much money did I make?"
They're asking the more important question: "How much will I actually keep?"
How Taxes Can Affect Your Wealth
Taxes are one reason financial planning matters.
Certain retirement accounts may allow you to reduce taxable income today or potentially receive tax-free withdrawals later. Business owners may have legitimate deductions available to them. Investors may make decisions based partly on capital gains rules. Real estate owners also have tax considerations involving depreciation, expenses, and gains.
The goal isn't to avoid paying taxes you legally owe.
The goal is to understand the rules well enough to avoid paying more than you are required to pay.
There is a big difference between tax evasion and tax planning.
Tax evasion means illegally hiding income or avoiding taxes.
Tax planning means legally arranging your finances in a tax-efficient way.
One can get you into serious trouble. The other is simply smart financial management.
Your Money Move on Taxes
Take a look at your most recent paycheck or tax return.
Identify several different taxes you are currently paying. Then calculate approximately what percentage of your gross income ultimately goes toward taxes.
You may be surprised.
And as your income and wealth grow, consider including tax planning as part of your overall financial strategy. A qualified tax professional or financial adviser may help you identify opportunities that you otherwise wouldn't know existed.
Speak the Language of Taxes
You don't build wealth based solely on what you earn. You build wealth based on what you earn, keep, invest, and grow.
Understanding taxes helps you do all four.
Learn the language. Understand the money. Build the future.
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