Thursday, June 7, 2012

DIY Tax Savings

Your labor for others is taxed by both the Federal and State government.  But labor you do for yourself is tax-free.  This does add to the potential savings in a DIY project.

As I noted in my Should You Do It Yourself? posting, there are many good reasons NOT to do things yourself.

But one thing I did not consider, was the tax consequences of doing things yourself, whether it is to fix things, or create things.  Your labor is only taxed when you do it for someone else - you sell your services to an employer or a customer for cash.

But if you do those same services for yourself, they are tax-free.

Suppose you hire a plumber to fix your sink.  He charges $200 to drive out and repair the sink.  The net cost to you is $200.  However, you had to go out and earn about $250 to end up with $200 in after-tax money to pay him.

Now, suppose instead, you decide to make $200 less this year, and spend more time doing things yourself, like fixing the sink.  Since you aren't paying taxes on that money not earned, you end up saving that additional $50 or so in Federal taxes, Social Security Taxes, State Taxes, and Medicare taxes.

In fact, if you could be entirely self-sufficient, and generate, using your own hands, $50,000 a year worth of goods and services for your own self-consumption (not for resale) you would pay no taxes at all on that money.  Your own labor, put to your own uses, is not taxable.

In contrast, if you had to buy those same $50,000 a year in goods and services, you'd have to earn $75,000 a year to cover all the State and Federal income taxes, plus pay sales tax on the goods!

Thus, when tax rates soar, people have a greater incentive to DIY.  This may explain why, in places like Central New York, people will spend hundreds of hours of their time, cutting wood and feeding wood stoves and outdoor wood furnaces, instead of just paying NYSEG for gas and electric.

The cost of heating a home may be $3000 to $5000 a year up there, but with the taxes you'd have to pay on the income to do the same thing, you'd have to make $5000 to $7000 up there - perhaps more.

We recently built a studio annex to our house.    The cost of materials for this project was about $10,000.  But to have it built, would have meant a labor cost of $30,000 or so.  By doing it ourselves (with the help of some very good friends) we saved $30,000 in labor costs.  But not only that, if we had to PAY for that labor cost, it would have meant we would have had to make $50,000 or more in income to take home $30,000 to build the building.

Cost cutting is not taxed - so when you cost costs by a dime, it is like saving nearly 15 cents.  And this is one reason why it can be very profitable to be "stingy" in terms of cutting costs and expenses.  But every "little" expense in your life is multiplied by the tax amounts (which are often close to 50% when all is said and done) that you have to pay.

So the fellow who makes $100,000 a year and spends $90,000 of it ends up "making" the same amount of money as the fellow who makes $60,000 a year, but is able to find $20,000 in cost reductions in his life.

And if those types of savings can knock you down a tax bracket, so much the better!

This year, for the first time in many years, we are filing in the 15% bracket.  Sweet!