Americans are the biggest middle class society today (until China and India catch up at least). Why?
Because most Americans (me included) have good day jobs where they work their tails off all year long, pay their share of taxes and go on to enjoy the weekend culture they have formed around their work-centric lives.
So who are the ones that get ahead of the game and are classified in the upper middle class and the wealthy? The ones that don’t necessarily have to wait for the weekend to take time off and have fun, or the ones who don’t live their lives worrying about job security?
Aside from the retired exception, these folks are either the less than 1% of the working Americans (the C-level suite) or entrepreneurs (full time or part time business men and women). Why? Let’s examine at a 69,000 feet high level:
Let’s take the situation of Gladys, a single lady relatively early in her career. To keep things simple, say Gladys makes $75,000 in total compensation annually. When she files taxes at year end, she gets to deduct the standard deduction, personal exemption and apply the federal, state, city and social security taxes. After spending hours putting her tax return together, she realizes that she is only taking home roughly $49,462. Whoa!
That means she paid more than $25,000 in taxes – an effective tax rate of roughly 34%. 34% is more than one third (1/3 = 33.33%). That means, Gladys worked more than a third of the year just to pay the tax on her earnings. In simpler terms, she worked January, February, March, April and then some of May just to cover her tax burden. How sad?
C-level suites typically make high six figure incomes. So for example, Bob, a company’s CEO might take home $2 Million this year, of which he pays $760,000 in taxes (roughly 38% effective tax rate), and end up with a net income of $1,240,000 for the year. Not bad even after taking it hard in the gut?
Let’s take a smaller caliber officer – say Dole only makes $700,000 a year (a very reasonable C-level payout). When we apply the 38% tax rate, we get a net take home pay of $434,000. Dole, like most of us, can live with that.
Now let’s say Mike is an entrepreneur who owns a small business down the road, or a freelancer who works from home. Pick one – it does not matter. The point here is that he is working for himself in both scenarios. Let’s say his business or freelance consulting engagements generates $75,000 in profits after all his business-related expenses (much like our example above of Good Gladys).
Because entrepreneurs (or the “self-employed”) are entitled to several tax deductions that overlap between their business and personal use, (such as cell phones, part of rent or mortgage, internet, utility bills, gasoline, car expense) let’s examine how much of the $75,000 Mike actually gets to keep.
Let’s just hypothetically say this deduction amount is $7,500 (entrepreneurs are also allowed to deduct business taxes). Assuming that Mike is single just like Gladys, he ends up paying approximately $23,000 following the same tax structure. Mike in our example ended up pocketing approximately $2,000 more than Gladys on the same $75,000 income. Huh – why?
The progressive tax system in the USA (or elsewhere) is a war against the middle class as I often hear it phrased in political context. Without diving into the politics of it, in our example, the corporate employee is penalized more as their income rises. On the other hand, there is a plethora of tax deductions a business owner like Mile is allowed legally under Internal Revenue Service (IRS – or The Tax Man) guidelines.
For a more detailed breakdown of how the various taxes impact income, read my blog post titled Why Pursue a Side Business When You Already have a Successful Career? Here you will see what a 1% change in your effective tax rate can do to your wealth (the money you actually get to keep and take home)
So that you can beat the progressive tax system and come out on the higher end. It’s one way to get ahead in life, at least financially. I have always recommended that owning a part time business is one of the best things you can ever do for your finances.
It is the best way in my opinion to proactively build wealth and protect your hard earned income from excessive tax. You end up keeping more of the money you earn, which means more discretionary cash to save, spend and invest. This leads to a positive impact on your net overall financial situation.
Not to mention the fact that most people hate their jobs. If you are in this group, you have more of a reason to start a part time business. If not for the money, look at it more from a satisfaction, contentment and overall fulfillment perspective.
All that said, I would never recommend starting a part time business for the sake of starting one without careful thought and planning. I am a big advocate of spending the appropriate time upfront on due diligence, and to carefully craft out your part time business plan before signing your free time away.
Don’t know where to start? Here are some idea thought starters to consider:
Any of the options listed above can be pursued online or offline. You can build a website or blog to support any of these interests, or you can pursue each option the traditional way of doing part time business face to face. With tools like Craigslist, Elance and the likes today, there is nothing to preclude you from becoming a freelance consultant or service provider overnight.
Note: I do not recommend investing in a brick and mortar establishment unless you are a seasoned entrepreneur and have the capacity (financially, educationally and time commitment) to dedicate to the part time business.
What you decide to do, what channel or medium of doing part time business you choose, how you go about starting up and the time you dedicate to your part time activities will be dictated by your personal situation in life. And while everyone’s situation varies, the bottom line is to get started with do something – however big or small it may be.
“Side Gigging” can really be for everyone, unless you think you really don’t have any time at all (I am willing to bet you are wrong). At the end of the day, you can be perfectly happy even with a middle school teacher’s salary. There is absolutely nothing wrong with that at all. In fact, there is a lot to be said for a simple lifestyle, as long as you are happy and content.
But is that the lifestyle that YOU want? Remember, a teacher faces the same lay off risk that a middle manager making $120,000 in a fortune 100 company faces. Both have to report to work X hours of the day, and both have professional responsibilities and superiors to answer to.
So while you can be perfectly happy on a teacher’s salary, if you want more out of life, whether financially or more freedom and flexibility, you should definitely own your own part time business on the side which someday can give you options to free yourself from the restrictions you face today. Remember, having options in life is a good thing!
Are you convinced? If not, what is holding you back from your own part time business?
Here are my additional thoughts on starting a part time business and its importance to your finances.Previous: Why Pursue a Side Business When You Already Have a Successful Career?