Today, I’m going to let you guys in on a little (big) secret (it’s really not that secret…).
Here goes: The secret to becoming (or staying) wealthy, is to stop paying your taxes…
But Nick, If you don’t pay your taxes, you’ll go to jail!
Precisely! And what do you get in prison? Free accommodation, free meals 3 times per day, free education – and even a free membership to the gym! Granted, you might have to share the dumb bells with a real badass mofo, but beggars can’t really be choosers, can they?…
All kidding a side, I don’t mean you should stop paying your taxes altogether. – I just mean you shouldn’t pay more than the law requires…
Most of you probably already know this, but which form of income is taxed the highest (in most western countries)?
That’s right. The money your earn by trading in your valuable time, going to work every day, is taxed the highest of all the possible income streams you can imagine. Your main (for most of us) income stream is thus the one, where you have to share the most with Uncle Sam (the tax-man).
The marginal tax in Denmark is among one of the highest tax rates in the world. I pay 42% tax on my personal income and then an additional 8% (the so called labor market contribution – if I don’t work, I don’t pay this tax! – Makes sense, right?!…). Before these taxes are applied, there’s a few deductibles though, so my effective tax rate on my personal income currently amounts to about 45%. Note that this number will go up, the more money I earn (because of the extra “top-tax” applied to amounts earned over a certain limit). The limit for the top-tax is currently DKK 513.400 (€68.450 / $80.000). Anything I earn (as personal income) above this limit is taxed with an extra 15%.
The marginal tax can vary slightly, depending on which part of the country you live in (which commune). There’s actually a difference of more than 5% from the lowest taxed to the highest taxed commune in Denmark. The price of land also varies significantly though, so the house taxes will (typically) even out this difference. I live in an area, where there’s a pretty even balance between the commune tax and the land taxes, so if I were to move to a “cheaper” part of the country (where land is cheap), I would pay a “penalty” in added income tax, so over time (depending on my income of course), this could prove to be a bad idea. Anyway, I’m not planning to move, so let’s leave that out of the equation for now 😉
So, the lowest possible income tax bracket that I could currently squeeze myself into, would be just about 40% (this is including the labor market contribution and my current deductibles). This would require me to earn below the top-tax limit though. If I “removed” the income that I currently earn above the top-tax limit, I would suddenly be missing quite a decent chunk of the money that I put into my FIRE pot every month, so that would kind of suck!
But what if we look at other income streams, besides personal income?
Good idea! Let’s look at some of my new found passive income streams for example:
In Denmark there’s a distinction between income coming from stocks (or dividends) and income coming from other sources (like crowdlending for example). I’m not really sure why that is, but that’s just the way it is 😛
So we can divide my current passive income, into two different categories; interests and dividends (this is just to simplify things, bare with me here!). The interests that I get from crowdlending is taxed by a different rule set, than the (small) income I currently get from stocks (my REIT).
The interest tax
The first tax type is the interest tax. This is a bit tricky to work out, because the actual tax percentage that you pay on earned interests, can vary a lot, because it’s actually taxed as part of your personal income – however, you can deduct the interests that you PAY (on your loans) in that equation, so you can earn tax-free interests – technically! If your earned interests (from eg. Crowdlending) match up with your payable interests, then Bob’s your uncle (as they say over there). However, to make matters worse (or more complicated at least), there’s a so called “bottom deductible” limit that will grant you the right, to earn a certain amount of interests before they are slapped with the top-tax (remember, the interest tax follow your personal income tax). The current limit is DKK 44.800/year (€6000 / €6.900) if you’re unmarried, and double that if you’re married (WHAT?! This is the ONLY time, where marriage is actually going to grant you an advantage! 😛 of course this is only if your spouse has 0 interest income…). To simplify it, I usually just use 40% as my interest tax level. That’s my simplified version of it, anyway. And I don’t really earn enough interests for it to actually go higher at this point in time – but it can potentially go as high as 56% (yikes!).
The stock tax
The stock tax (as I call it) applies to capital gains and dividends from stocks. This is a bit more stringent and a lot easier to calculate, because it’s flat, and does not depend on any other variables of your personal finances. It has two levels though. Income from stocks up to DKK 54.000/year (€7.200 / $8.300) (again, twice that if you’re married! WHAT?!) is taxed at 27%. Anything you earn above that (the so-called progression limit) is taxed at 42%. So, there’s a pretty clear advantage for the stock tax (over both the interest tax and the personal income tax), if you stay below the progression limit! We’re of course in it to win it, so DKK 108.000 (2x 54.000, cause we’re married -YAY!) is not really going to cut it in the long run, now is it?! That’d be DKK 78.840 after tax. That’s DKK 6.570/month. A student living in a very tiny room somewhere might be able to live off of that, but a family of 3 with a tendency to a little everyday luxury, spends more than that on food alone on a monthly basis (guilty as charged!).
So, the stock tax is pretty decent, provided that you don’t make more than DKK 108.000/year via that stream…I plan to make substantially more than that.
The Company tax
Here’s the thing: Have you EVER met/talked to/known/seen a wealthy person that did not own/invest via some sort of company structure?…
No, you have not (I haven’t). WHY do you think that is?!
Because company taxes are substantially lower than personal taxes! (tadaaa).
In Denmark the company tax is 22%. This means that if I were to put all my money into a company, and bought stocks, properties and crowd loans, ANY income that were to come in from those investments, are only taxed at 22%. BAM! (Bob’s your uncle!).
Whoa, whoa, whoa. Hold on a minute there sparky – money invested within a company wouldn’t technically be yours. You’d be in control of it, yes – but you wouldn’t be able to spend it on food, clothes, rent, vacations and/or cars now, would you?!
That is absolutely correct. – But that is not really important at this stage in my FIRE project now, is it? My main goal right now, is to accumulate wealth. It’s not until 10-15 years in the future, before I actually need that money to live off of.
There’s a bunch of different company “types” that you can create in Denmark, and the one that I’m particularly interested in, is called the VSO (short for VirksomhedsSkatteOrdning – the Company Tax Scheme). Just the name of it should tell you that something really fishy is going on 😛
It’s a special form of company that bridges your personal finances with a “company shell”. How it works is not really important (you need an accountant anyway!), all you need to know is that it’s a way for you to put your money inside of a “company” and only pay 22% of the income that the “company” has. WHAT!? What’s the catch!?
Yes, well – of course there’s a catch. The first part of it is that you DO need an accountant, because the rules are so intricate and complicated that it takes days to even grasp the basics of it, and I still haven’t understood beyond the basics at this point 😛 (I will try to write a detailed post about it, once I get beyond the basics). The second part is that the day you withdraw money from your “company shell” to your personal account, you will get taxed with a regular income tax – but the first 22% that you already paid will be deducted. So, given that I plan to stop working at that point (and thus not having any personal taxable income + not having to pay the extra 8% in labor market contribution), and hopefully don’t really need to add anymore money to my FIRE pot, I can withdraw the exact amount of funds that will allow me to stay beneath the top-tax limit, and thus end up paying only a total of ~40% of my income (now coming from investments via my company).
This has been a long post so far (I apologize, but tax is always complicated!), so I will try to sum it up with this simple table (where would you rather earn €80.000/year?):
|Year||Income Tax||Interest tax||Stock tax||Company tax|
|2019||€ 44.000,00||€ 48.000,00||€ 50.400,00||€ 62.400,00|
|2020||€ 88.000,00||€ 96.000,00||€ 100.800,00||€ 124.800,00|
|2021||€ 132.000,00||€ 144.000,00||€ 151.200,00||€ 187.200,00|
|2022||€ 176.000,00||€ 192.000,00||€ 201.600,00||€ 249.600,00|
|2023||€ 220.000,00||€ 240.000,00||€ 252.000,00||€ 312.000,00|
|2024||€ 264.000,00||€ 288.000,00||€ 302.400,00||€ 374.400,00|
|2025||€ 308.000,00||€ 336.000,00||€ 352.800,00||€ 436.800,00|
|2026||€ 352.000,00||€ 384.000,00||€ 403.200,00||€ 499.200,00|
|2027||€ 396.000,00||€ 432.000,00||€ 453.600,00||€ 561.600,00|
|2028||€ 440.000,00||€ 480.000,00||€ 504.000,00||€ 624.000,00|
|2029||€ 484.000,00||€ 528.000,00||€ 554.400,00||€ 686.400,00|
The table illustrates the accumulated earnings in each of the above mentioned categories (it corresponds to a yearly income of €80.000). When it comes to accumulating wealth (which all of us FIRE guys/girls are trying to do), there’s really no place to do it, like (with)in a company 😉
So there you have it, folks! Tell your friends – the secret is out! 😛
Are you investing/planning to invest via a company?