Why I Owe The IRS $1.5 Million Dollars
What's up here, guys? It's Upgram, and I gotta say, I was actually pretty blown away by how many people enjoyed my Joe Biden tax plan video and wanted to hear more. No joke, when I made the video, I was worried that no one would want to hear about the topic of taxes and that it would be a total flop of something that I spent so long to research and create. But when I see people asking for more tax videos, explaining exactly how it works, what you could do to save more money at the end of the year, and some legal life hacks that you could do on your taxes to save more money, I'll listen, and I'll make that exact video right here.
Because honestly, when it comes to this, not only is the topic of taxes so complex, and sometimes it makes no sense whatsoever, but it's also never taught anywhere, which is absolutely mind-boggling. Just think about it for a second. The average American family spends about 25 percent of their income towards taxes, and the average single American spends about 30 percent of their income towards taxes. So consider this video your introduction to a topic you really need to understand, and it's probably one of the most important things that you could learn, besides smashing the like button for the YouTube algorithm, because that greatly helps out my channel. And that, by the way, is really easy to do: just take your finger or your mouse, place it over that thumbs-up button, and then just destroy it.
So anyway, if you want to save more money and see me attempt to make taxes as entertaining as possible, keep watching. And also, just to spice things up a little bit, I'll be going over my own taxes and why I owe the IRS about one and a half million dollars. Yeah, that's real, so stay tuned for that, and we'll start over here.
All right, so here's your taxes 101 breakdown explained in a few minutes. This is basically going to summarize how 90 percent of the US tax system works on a really basic level, so enjoy. First, if you're in the United States, which according to my analytics about 80 percent of you are, you first start off with what's called your federal tax bracket. This is how much you owe the IRS on the income you make, and how much money you pay is determined by how much income you make. Generally, the more money you make, the higher the tax bracket you're going to be paying.
And right now, in 2020, here's how it's broken down: if you're single, meaning you're not married, all the income you make under $9,875 is going to be taxed at a rate of 10 percent. After that, you'll pay a 12 percent tax on all income earned between that and $40,125. Then you'll pay a 22 percent tax on all income earned above that to $85,525, and that continues until all income earned $518,401 is taxed at a rate of 37 percent.
Now, this is really important for me to clarify, but this does not mean that if you earn one dollar above a certain threshold, that now all of your income is going to be taxed at a higher rate. Like, for example, if you make $9,876, that's not gonna mean that all of your income is now taxed at 12 percent. I've seen this as a common misconception, as a reason not to make more money because all of a sudden it's gonna bump them into the higher tax bracket. And that's not how this works. When it comes to higher taxes like this, you only pay the higher tax rate at the income earned above that threshold, not the entire amount.
Even for me, no matter how much money I make, I still pay the same 10 percent tax on the first $9,875 of income, the same 12 percent tax up to $40,125, and so on. It's just that the more money you make, the more tax you owe based on those higher tiers. And no, I'm not talking about these tiers, even though it may as well be, I'm talking about these tiers.
So now, if you made it this far in the video, then congratulations! You officially know more about the tax system than a lot of people. But then after that, taxes are not over. This is just the beginning. In addition to your federal income taxes, you also have what's known as payroll taxes on your wage income. That means if you're working a job or maybe you're self-employed, you have to pay separate social security and medicare taxes that could be as high as 15.3 percent.
Now, unlike the other tax brackets, this one is not a tiered system, and everyone pays the exact same percentage up to the first $142,000 worth of income. But typically, if you're an employee, this 15.3 percent tax is split evenly between yourself paying 7.6 percent and your employer paying the other half. But if you're self-employed as a 1099 contractor, well, lucky you, you are responsible for paying that full 15.3 percent, because technically you are your own boss.
But wait, there's more! We also have what's known as the state income tax. Now, this one depends on where you live, but if you don't live in one of the nine states that doesn't have any state income taxes, then you're gonna have to pay something extra here too. These tax brackets work the exact same way as the federal tax brackets, in that you will have a tier that you'll owe depending on how much money you make.
So generally, if you do live in a state that imposes state income taxes, you'll have to pay a minimum of one to four percent all the way up to a maximum of 13.3 percent, depending on where you live. For example, in California, people earning between $57,000 and $295,000 will pay 9.3 percent in their highest tax bracket, in addition to what they would pay at the federal level, which would be another 32 to 35 percent on the top end of that income, and in addition to their payroll taxes, which could be another 7.65 to 15.3 percent.
So between all that, about half of your income is going to be going to the government, depending on how much money you make. Now, obviously, this could be a little less than this depending on where you live, but I'm not going to bore you with all the details. If you're curious about your own state income tax, just go to Google and type in your state income tax bracket, and that will give you all the information you need to know.
So after that, if you want me to be all technical here, you aren't done paying taxes quite yet. Because then if you want to spend any money you have left over after paying taxes, then you also have to pay what's called sales tax. This is that little bit that's tacked onto your sales receipt every time you make a purchase. It's usually something that we don't think about doing, but we all pay it, no matter how much money we make.
Now again, this one depends on where you live, but unless you live in one of the five states that doesn't have any sales tax— which is Alaska, Delaware, Montana, New Hampshire, and Oregon for anyone wondering— you’ll probably pay anywhere from five to ten percent in sales tax, depending on where you live. Then on top of that, if you own property, then you also have property taxes, and this is very specific to where you live.
But generally speaking, you're gonna have to pay anywhere from half a percent to two percent of the property's assessed value every single year. And of course, if you want me to be really nuanced here, there are usually other local and city taxes thrown in on top of this. There could be special use taxes, business taxes, gas taxes, and other little miscellaneous charges that get added on without us thinking much about it.
So between the federal income tax, payroll income tax, state income tax, sales tax, property tax, and special use tax, you could very well be spending anywhere from 30 to 70 percent of your income on taxes, depending on where you live, how much you make, and how much you spend. Now take a step back here, because I understand I'm framing all of this in a really negative light, and that's not exactly fair.
Because our tax revenue does help support our school systems, social services, government military spending, roads, infrastructure, and so on. So there's definitely some very worthy programs and services that we are lucky to be able to pay into. Like $16 muffins for the Justice Department. Okay, that was just a playful joke, but seriously, they paid $16 for muffins, $5 for sodas, and $8 for coffee. But I'm gonna save that for another time.
Anyway, now that you know generally how the tax system works, here's what you need to know to make sure you pay the correct amount of taxes and don't leave any money on the table, because the tax system is written to encourage you to pay less if you know what to look for. Now, quick disclaimer here: I am not a tax expert, and I'm just a random guy on YouTube, just making videos from a spare bedroom.
So don't listen to me and always consult a qualified tax expert for your own situation. So anyway, the first most straightforward way of lowering your taxes is just by using what's called the standard deduction. This is by far the most common tax strategy out there, and it's almost always going to be automatically applied anytime you file your taxes.
See, anytime you go and make money, you're left over with an amount at the end of the year that you're going to have to pay tax on. But you have the option to bring that number down through the use of tax write-offs and deductions, and the more you lower that amount, the less tax you're gonna owe. Now, the standard deduction gives people the option to reduce their taxable income by $12,400 if they're single or $24,800 if they're married without doing anything.
So most likely, if you're single and you made $60,000 a year from your job, you just take the standard deduction, and now you're only going to be taxed as though you made $47,600. But you also have the option to itemize your deductions, like mortgage interest, investment interest, state and local taxes up to $10,000, charitable contributions, and so on.
The rule of thumb when it comes to this is that if your itemized deductions exceed $12,400, then you just go and itemize those deductions. But if they're less than $12,400, then you just take the standard deduction to get a bigger tax write-off.
So after that, we have another really popular one called the traditional 401k retirement plan. Now, this is an employer-sponsored retirement plan that allows you to invest pre-tax money, and then you're taxed on all the money you begin withdrawing from the account after the age of 59 and a half. For example, if you contribute $100 a week to a 401k, you are taxed as though you've made $100 a week less on your paycheck.
That saves you money up front by lowering your tax bill, thereby giving you more money left over to invest into the markets instead of spending that money on taxes. Now in 2020, you are able to contribute $19,500 a year into a 401k, and by doing so, you're going to be able to reduce your taxable income by that very same $19,500.
Now, the catch with this is that you have to pay taxes on the money you take out of the account after the age of 59 and a half. And if I were to guess, I would say that taxes in the future are probably going to be higher than they are today. But still, this one is always worth doing if your employer offers what's called a 401k match. This is when they will match your contribution dollar for dollar up to a certain amount.
Essentially, this means you're doubling your money immediately with no risk whatsoever. So the rule of thumb when it comes to this is just always do it: don't even question it. If your employer offers an employer 401k match, just say yes. The second to 401k also makes a lot of sense if you're in a really high tax bracket right now and you expect to retire in a much lower tax bracket. Again, this really depends on your own situation.
But for most people watching, I would only recommend doing a 401k if your employer offers the employer 401k match, and then carefully consider anything else. Because, like I said, I just think taxes are going to be going up in the future.
But once we go beyond the basics, where the tax code really shines is for business owners. The reality is here in the United States, self-employed business owners have a lot of write-offs and deductions available to them to bring down their taxable income. Now, whether or not you agree with the tax system, this is how it works and how it's set up for people to follow.
This encourages business owners to not only reinvest back into their business to lower their tax bill, but also gives them more profit left over that will hopefully circulate back into the economy through their investments, real estate purchases, spending money on Weeble to get four free stocks by using the link down below in the description, and so on.
I think it also encourages people to go and start their own businesses because it means they could fully utilize the tax code as it's meant to be used. The first of which is something I mentioned in the previous video, and that would be running your business through an S corporation. This is a legal entity that you could start up, and then your S corp becomes your employer, which you just happen to own 100 percent of.
The advantage of this is that you could designate yourself a salary that the S corp will pay you, and then the rest of those profits are going to be given to you as a distribution, which is not subject to payroll tax. So for example, if you're self-employed and you're making $140,000 a year, then typically you would be subject to $21,420 with the payroll tax.
But if you created an S corporation and pay yourself a salary of $50,000, then you will only have to pay $7,650 of payroll tax. And then, like I said, the remaining $90,000 is a distribution, which is taxed slightly differently than wage income. Now, of course, when it comes to this, there's also going to be extra accounting fees and S corp taxes that will be due, but overall, if you're self-employed, this is a really good option to look into if you haven't done this already.
Now, on top of that, if you own a business, whatever you spend on that business is generally a write-off against your income. So for example, if you make $100,000 but then at the end of the year you spend $20,000 on a new office space, $10,000 in new equipment, and another $10,000 hiring somebody, well, that's a $40,000 write-off, and now you're only taxed as though you've made $60,000.
Now, the reality is that the more money you make, the more valuable these tax write-offs become, because all these write-offs are reduced by your highest tax bracket first. So for somebody making a million dollars a year, if they spend $100,000 as a tax write-off, that's a lot more money back in their pockets when they file their tax return than somebody who makes $90,000 per year. That's why I typically wait until the end of the year to make my business purchases, because at that point, I could estimate how much tax I would owe and what expenses are best spent for the next year that I could pay up front today.
This is really just the reality and benefits of being self-employed and running your own business here in the United States and how the tax code is designed. All of this is perfectly legal; there's nothing breaking the law, there's no evading taxes. It's all about following the tax code, doing exactly what's required, and keeping proper documentation of everything.
Lastly, without overwhelming everyone with super specific tax codes, I do want to mention this one that helps a lot of people in real estate and it's a term called cost segregation analysis. This allows real estate investors to write off depreciation on certain aspects of the property. For example, the carpet is not going to last forever; it's got a lifespan of a few years, same with wall coverings, cabinets, appliances, fans, and so on.
So in a cost segregation analysis, each item is determined to have a certain lifespan, and when something has a lifespan of less than 20 years, it could be 100 percent depreciated up front in the first year. So for example, let's say you buy a million dollar building for $200,000 down, and 30 percent of that building has a lifespan of 20 years or less. That means $300,000 could be a write-off in the first year on a $200,000 down payment, and this works especially well on apartment buildings, office buildings, and commercial real estate.
And this is what a lot of people do if they make a lot of money and invest a lot of money. Now, obviously, I'm simplifying things a lot here because this analysis is something that experts will charge $5,000 to $15,000 to do, but that's the gist of it for anybody wondering. And this is how some really wealthy people can make a lot of money and then get away with paying no tax whatsoever.
All right, so now as for myself, why I owe the IRS about one and a half million dollars, I'm not gonna beat around the bush, but so far this year, my taxable income is going to probably exceed about four million dollars. And that means by the time January comes around, I'm gonna have to pay the IRS about one and a half million dollars in taxes, depending on my expenses and deductions towards the end of the year.
Typically, with something like this, when you're self-employed, you're supposed to be paying what's called estimated taxes. This is when you would pay what you would owe based on last year's income in four equal payments throughout the year. Doing this prevents one big tax bill from becoming due, like what I'm about to pay, and this year, I did not pay the estimated taxes.
Now here's the thing: when you don't make your estimated taxes on time to the IRS, they will charge you anywhere from three to five percent annually as a penalty for not paying. And for me, I'll be honest, I just found it more profitable to pay the penalty and then have more money available to me to reinvest back into the markets at a time where everything dropped.
And remember, the three to five percent penalty is annualized, which means that as they're owed every quarter, the effective interest rate I'm really paying is more like two percent by the time I pay it off in full by the end of the year. Doing that's allowed me to have more cash on hand to negotiate lower interest rates on mortgages. It's allowed me to use some of that money to reinvest back into the stock market, and overall, I've had a lot more mobility with my money than paying the estimated taxes.
Or really, in other words, it's like I paid the IRS two percent to get a loan from them to then go and reinvest all my money. And when the markets are up substantially for March and April, paying a two percent fee for something like this is invaluable. So really, come January, I'm gonna have a pretty substantial tax bill that I am fully prepared for, but it's still a lot of money and it's something I've been factoring in since the very beginning.
But anyway, I think I've rambled enough about how the tax system works and I hope this is what people wanted to hear. But overall, the more you understand how this works, the more you're going to be able to make sure you get everything back that you're entitled to. And anytime you're not sure, I recommend you hire a CPA, and sometimes this is the best money ever spent. I hired the best CPA that I could afford, and I learn a lot every single year as new things change. It's definitely worth it, and hopefully now you know way more about taxes than you did like 20 minutes ago.
So if you found this helpful in any way, just make sure to hit the like button for the YouTube algorithm. It really helps me out a lot, and with that said, thank you so much for watching. I really appreciate it. As always, make sure to subscribe and hit the notification bell. Also, feel free to add me on Instagram; my posts are pretty much daily. So if you want to be a part of it there, feel free to add me there as my second channel, The Graham Stefan Show. I post there every single day I'm not posting here, so if you want to see a brand new video from me every single day, make sure to add yourself to that.
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