The Mark Perlberg CPA Podcast
The Mark Perlberg CPA Podcast
EP 109 - The Consumption Tax - The Hidden Cost Making You Broke!
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The consumption tax may be your most expensive hidden tax, created when high earners spend profits on lavish lifestyles instead of tax-advantaged investments that build generational wealth. This concept affects both business owners and W-2 earners, as the tax code rewards those who reinvest rather than consume their profits.
• The consumption tax occurs when you spend all profits on lifestyle expenses, leaving nothing for tax-advantaged investments
• High-income earners who spend excessively on luxury items often struggle to implement effective tax strategies
• The IRS incentivizes business reinvestment, charitable giving, and investments in energy and real estate
• W-2 earners can access similar tax advantages through side businesses, strategic investments, and withholding adjustments
• Creating legitimate business purposes for existing activities can transform personal expenses into deductible business expenses
• Reinvesting profits gives you more control over the timing and rate of taxation
• Capital gains are taxed at lower rates than ordinary income, creating wealth-building advantages
• Consider whether your current lifestyle is financially sustainable when accounting for taxes
• Resources like "Profit First" methodology help prioritize profit before expenses
• Books like "The Millionaire Next Door" reveal that most wealthy people maintain modest lifestyles to build wealth
This is a concept that could be incredibly powerful and instrumental when you look at it in the right way, and it could be one of those dominoes if you look at it the right way that can really build generational wealth and allow you to take control of your finances and, in particular, your taxes. But it's not just about taxes here, and it's my first time talking about it, so I'm excited to riff on this topic of what we are going to call the consumption tax, and this may, for some of you, be the most expensive tax that you have. Now let me explain to you what I mean by a consumption tax. We're not talking about sales tax. Yes, you pay sales tax on your luxury goods and other items. You may pay property taxes on some of your items, but what I really mean here is, when we look at how much money you're paying taxes on, we have our revenue minus expenses, we get our net income, and before we do and consider all these other variables and what our strategies are, that's what your taxable income is, and a lot of high income earners, a lot of W-2s and entrepreneurs, take their taxable income and they spend it on their lifestyles, their lavish lifestyles. They may have nice homes. They may have nice cars or have an expensive lifestyle.
Speaker 1:Now, if you are going to take the profits out of your company, or even your W-2 earnings because this conversation will be applicable to W-2 folks if you are taking your earnings and you are spending it on your own general living expenses, on your own general living expenses, you are indirectly creating what we call a consumption tax. Why is that? Well, let's just look at the numbers here. Let's say you have a million dollars of profit and you spend all million dollars of that profit in taxable income on your living situation, on your lifestyle. We take all the cash and we spend it right away on clothing and fancy cars, et cetera, et cetera. Well, this can create a problem. Obviously, we haven't budgeted for taxes, but what we also haven't budgeted for is any tax reduction strategies, strategies. So what we see here is, if we're using all of our profits on our living expenses, it hinders our ability to actually do something with our profits to reduce our taxes and to build our wealth in a tax advantage manner and invest our wealth.
Speaker 1:And I noticed that this is a really important concept to master, and we'll talk about what you guys should do when thinking about this when I had a client who can't afford their tax bill their companies are not really doing so well and when they're selling assets right now and it's just to pay off debt. But they have a beautiful home, multi-million dollar yacht and have a very lavish lifestyle. So of course, it's going to be hard to do tax planning for these folks because when they have capital gain events, we say, okay, where can we put this cash in a way that can further drive down their taxes. We'll say, hey, you know what we're actually. We're just going to pay off our debts because we're swimming in debt. Well, that's not going to reduce your taxes. In other instances where we're looking for ideas, hey, we can do this strategy. We could put our money into oil and gas to drive down your taxes. We can defer your taxes. We can buy more real estate. Because they're spending so much money on their lifestyles they're running out of ways to spend money on reducing their taxes.
Speaker 1:Now, this shouldn't be an issue for high-income earners. You should ideally have some sort of control and budgeting process where you have enough to put aside to win the tax game and eventually it'll allow you to accumulate wealth, to spend even more and have even more fun with your personal living expenses when you do it right. But this is also the reason why some people complain about the rich paying no taxes. One of the reasons why the wealthy pay no taxes is because they have more disposable income. If you're making a million dollars in profit in your business and you work with a tax strategist such as ourself, you can now find ways to take your profit and, instead of buying yourself fancy, expensive things, you buy assets and you use leverage to create reductions and you create advanced charitable deduction strategies and you do certain things that are going to give you tax credits. There's a whole world of things available for you when you have a budget for your tax planning and strategy, and what I want you to think about here is look at how the tax law is designed. The IRS wants you to do certain activities. The tax law is designed to encourage you to reinvest into your business right To buy assets that you can write off, to invest into staff, to be charitable, and they love to encourage and incentivize investments into energy, into real estate and reinvestment into your own company. So these are all the things that the IRS wants to see. When you are not doing these things, then we have a tricky time finding ways to offset the income.
Speaker 1:Now, some other things we want to think about here is reinvesting into your company in a way that is smart, or in assets that are going to make sense for your company. Not only reduce your taxes, but they create a brighter future for yourself. They ensure greater success of your company. Not only reduce your taxes, but they create a brighter future for yourself. They ensure greater success of your company, and that's going to be have a larger payout in the end compared to buying a multi-million dollar mansion or buying a, an italian sports car. Sure, those things can. Now you can counter argue those things will eventually grow and appreciate it over time and sell at a profit. But you get what I'm saying. Designer fur coat, designer jackets, or you know a lot of these cars. You know they decline in value significantly as soon as you take them off the lot.
Speaker 1:When we think about this and we think, okay, how does this apply to meat? Well, we have so many ways that we can be resourceful here. And if you're concerned about your consumption budget, maybe you have an expensive lifestyle and you have lots of family members and children you want to take out and take around the world and have fun activities with. One of our initial thoughts here is why can't we find ways to create legitimate business purposes around the activities we're already conducting? You know, before we go into all this advanced and somewhat sexy and sophisticated ideas that are these high ticket items that involve additional structures and alternative investments, sometimes you may find that you have the opportunity to create write-offs that you don't even know about. Just being resourceful and understanding of the law and how can we potentially create business purposes and I mean legitimate business purposes around our activities and relationships? And we've had plenty of conversations on writing off your travel, while there may be some vacation related elements into it, and having business related relationships with your family members and colleagues and conducting activities where these become legitimate transactions. So now we are taking our profits and we may find that we enjoy these business trips, but we're also writing them off at the same time and getting to travel as we already intended to do.
Speaker 1:Some other things I want you to think about here is when you reinvest, it gives you more control over the taxation. So even if you're a W-2 and you're putting some money into a traditional IRA or a Roth IRA. We are now or let's say we're putting our money into our company's 401k in excess of the match. We are now having more control over the taxation. Even if we're putting our money into the stock market, it's still tax advantage. So, while it won't reduce your taxes, we now are creating future income, future wealth, future cash is going to hit our account and we are not going to pay the same taxes on that as we would pay taxes on our W-2. The capital gains rate is always going to be lower than our W-2 or ordinary income tax bracket. And then, obviously, we see even greater opportunities and tax incentives when we're investing in things like real estate under the right circumstances, and oil and gas. Even if the real estate doesn't reduce your taxes, the rent revenue is likely to be offset by the depreciation and we're going to see growth over time and equity and all sorts of advantages on capital gains planning, on capital gains planning. So just by taking your money and reinvesting it into stuff that's going to grow and build you wealth, you're going to see some tax advantages here. But we can take this further.
Speaker 1:Now, for some of our W2 folks listening, you may be thinking to yourself well, this all sounds great, but the taxes are already coming out of my paycheck. What can I do? I get it. If you're an entrepreneur, instead of making your quarterly payments, you can buy assets, you can buy solar panel rentals, you can buy more equipment or you can do all these funky things. But what about me as a W-2? I can't write off business meals. Well, hang in there. There are strategies for W-2 folks as well, like we, and you can look I have plenty of videos on this for as a w-2 earner, you can still create businesses and we have assisted our clients to create side businesses that have created ordinary losses to offset the w-2s, like asset rentals, like solar panel rentals, like oil and gas investments. And also we've helped our clients offset their W income with real estate losses. And guess what? You can actually go to your company and change the withholdings from your W-2. So once we know what your actual tax liabilities are going to be, net of our strategies, we can reduce the W-2 withholdings, have more liquidity to reinvest into these wealth building vehicles and see some of the privileges that are granted to entrepreneurs as a W-2.
Speaker 1:So here's some things I want you to think about here. I think one of the first steps here so we can conquer this. Consumption tax is one we want to think about. What are we doing with our cash? Right? So for some of you, before we even think about tax planning and what we're going to do for taxes, maybe you should be thinking about what are you doing with your general expenditures, like, can you afford your lifestyle? Because if you can't, you're going to have an even harder time affording your taxes. Or let's say the taxes are coming out of your W-2. You're missing out on opportunities to really drive down your taxes. So, can you afford your lifestyle? Are you spending too much on your day-to-day?
Speaker 1:And then look at your business. If you're a business owner, are you spending excessive amounts on different areas? What's your profit margin? What's the cash in the business? Another thing I've thought about here is, let's say we're paying a lot of taxes and we have one client who just has a lot of personal expenses that he kind of can't get out of, and so you may find that using debt to acquire assets or for other reasons, or just to invest into some charitable structures, may make a lot of sense, because the tax savings we can create are more that using debt. If we can't outpace our consumption tax if we need more liquidity which results in an overall reduction in taxes and wealth creation, maybe debt is a good thing here.
Speaker 1:Some other things to think about here. When it comes to looking at money and just some resources, I like we have the cash flow quadrant that talks a lot about the different quadrants and moving into that I quadrant where you see, in many instances the investor has some incredible tax incentives. Same with a business owner and as an employee it's a little trickier. But we have some ways, especially if you're a high income earner the profit first methodology and I'll probably bring in a guest or two to talk about profit first and paying yourself first and securing profit. And essentially what we do with profit first or not me, we don't offer it, but other consultants will is you back into the profit that you need to make. So instead of looking at revenue minus expense equals profit, they say revenue minus profit equals expenses. So you look at your revenue, you set aside a certain amount that is going to go for you as profit and then you back out your expenses to meet what your profit has to be. So it's a really interesting way of looking at your business and your finances. And when we do this, not only do we determine how much we're going to pay ourselves, but I would like to add an additional layer to this that we look at how much we are going to then take what we pay ourselves and invest into some sort of tax reduction strategy. Now, this may skew the numbers a little bit. So let's say you buy an asset and you actually wind up operating at a loss on paper. So for the profit first enthusiasts out there, when you look at the income statement and factor in the depreciation, it may have your numbers all out of whack and show a loss on your books. But really you probably just have to modify how you look at your income statement to ensure that profit first methodology is effective. Some of the things we can think about here in resources Looking at the Richest man in Babylon that's an interesting book by George S Classen talking about just some very foundational concepts of how much of your earnings should go into different buckets and some should go to yourself and some should go into your savings and investments.
Speaker 1:I really enjoyed the book I Will Teach you to Be Rich by Ramit Sethi Talks about budgeting for your personal finances as well. The Millionaire Next Door is another great book talking about how our lifestyles impact our net worth and a lot of the times, the millionaires and people who have very high net worths don't live lavish lifestyles. In that book, I remember them citing that the most commonly drived car by a millionaire was a Jeep Not the sexiest thing out there, although I do think that these new Jeep Rubicons are freaking cool and they're also really expensive. But this is right before the Rubicon. Some other things to think about. Here is just what I want you to do. It.