Blog | Personal Finance

The Two Tax Mindsets

Playing the game of money by the rules of the rich

As the new tax law pushed through by Trump comes into effect, I’m starting to see a number of articles pop up around who it’s benefiting and how.

There is good news for employees, or at least most of them. As FOX News reports, the average middle-income household will get a tax cut of around $930 this year—a 1.6% increase in after-tax income. Reactions have been mixed.

Here are some of the quotes from people on Twitter as listed in the article:

“I just checked my paycheck and I have $100 extra dollars! That money will go to my church and help pay a bill.”

“Looked at my paycheck today, took home $130 more than last paycheck.”

“Everyone is talking about getting more money in their paycheck because of the tax bill and I got $7 more than usual. Reaping the benefits man, totally proportional to the cuts the top 1% got.”

One woman who works as a secretary at a high school was “pleasantly surprised” that her pay went up $1.50 a week. She did the math and realized that equaled $78 a year, which would cover the cost of her Costco membership.

I don’t begrudge these folks for enjoying a little extra money in their pockets, and I’m happy for them, though clearly some are enjoying more after-tax income than others.

But I do think that this shows two mindsets when it comes to taxes—and ultimately money in general.

The employee tax mindset

The reality is employees have little control over their money when it comes to taxes. They are at the full discretion of the law, which gives them very little wiggle room. And what little wiggle room they did have might be gone now with the elimination of a lot of the few deductions they enjoyed. If they’re lucky, however, the raise in standard deduction will help make up for those loses.

So, it’s not surprising to see how the people quoted above responded. Though they were a mix of both positive and negative reactions, there was one theme that was common: I have to take what the government gives me.

The employee mindset might be bitter or it might be glad about their tax situation, but what is shared is a mindset that there is nothing you can do about it. After all, you can’t fight city hall, right?

The rich tax mindset

On the other hand, the rich are excited about the tax cuts. Not because they might make more or less in after-tax income (though the smart ones always will make more), but because they have new incentives built into the law to discover and take advantage of.

The rich understand that tax laws encourage certain behaviors and reward them for taking action. I wrote about this in detail a while back, “Are you doing what the tax code wants?”

I and most of my friends have already been in contact with our tax advisors on the new law, looking for ways to make more money with the tax code, both by moving away from things that increase our tax bill and adopting practices and investments that are incentivized.

This shows a common mindset of the rich when it comes to taxes: I go and take what the government gives me.

An example of taking what the government gives

I shared this example a long time ago in another article called “Think Rich to Lower Your Taxes,” but it’s applicable here and has an added bonus thanks to the new tax law.

2004: My wife, Kim, and I put $100,000 down to purchase 10 condominiums in Scottsdale, Ariz. The developer paid us $20,000 a year to use these 10 units as sales models. So we received a 20 percent cash-on-cash return, on which we paid very little in taxes because the income was offset by the depreciation of the building and the furniture used in the models. It looked like we were losing money when we were in fact making money.

2005: Since the real estate market was so hot, the 380-unit condo project sold out early. Our 10 models were the last to go. We made approximately $100,000 in capital gains per unit. We put the $1 million into a 1031 tax-deferred exchange. We legally paid no taxes on our million dollars of capital gains.

2005: With that money, we purchased a 350-unit apartment house in Tucson, Ariz. The building was poorly managed and filled with bad tenants who had driven out the good tenants. It also needed repairs. We took out a construction loan and shut the building down, which moved the bad tenants out. Once the rehab was complete, we moved good tenants in and raised the rents.

2007: With the increased rents, the property was reappraised and we borrowed against our equity, which was about $1.2 million tax-free, because it was a loan -- a loan which our new tenants pay for. Even with the loan, the property still pays us approximately $100,000 a year in positive cash flow.

Now here’s where a new incentive in the Trump tax plan comes into play. There is now a 20% deduction on pass through income, which rental income can qualify as. And since real estate businesses is an LLC that is not classified as a “service trade or business,” the 20% deduction isn’t phased out even after meeting the high-income limitations. There are limitations to how it can be applied, but that would be my job, or any investors job, to figure out how it applies. This means that I could stand to enjoy even further tax benefits on my cash flow income, if I structure my entities and returns correctly.

Money is a game

Ultimately the difference between an employee and a rich mindset about taxes comes down to how they look at money.

Many people who are in the middle-class are scared of money and don’t understand it. As a result, they don’t even like to talk about it. Most people don’t consider money a vulgar topic because they don’t like it, but rather it’s easier to place a stigma instead of learn. For most people money is a drudgery.

Conversely, my rich friends talk about money all the time. They aren’t bragging about how much they have. Instead, they’re sharing tricks of the trade. For the rich, money is a game—and one they love to play and master. Just like some people love to master the game of golf.

Among the rules of the money game that need to be mastered are the tax laws. And when the rules change, the rich find new ways to adapt their style of play while the rest of the world just takes it.

The reality is that everyone is playing the game of money, whether they like it or not. So, the question becomes: What kind of player do you want to be?