Just for further disclosure, taxes are extremely complex, especially in America. This post is not supposed to be used as professional advice, but is supposed to provide general education. I do not recommend using any way to avoid taxes that would hide money from the government. For professional advice, you should consult a CPA. CPAs know how to use these tactics successfully and understand the tax code far better than I do.
There are two guarantees in life: death, and taxes. You cannot do too much about the former, but there is much you can do about the latter. Most people see taxes as necessary because they help to pay for roads, schools, and security. While this is true, every government has an agenda, and that is for the general well-being. One of the harshest lessons you will learn in life is that general well-being and personal well-being are not very correlated. Just to illustrate a few good examples, which is better: building a new road to improve traffic for a city, or repairing current roads so tires are not consumed by potholes? What about providing money to improve higher education for many people, or providing money for secondary education?
If you ask these questions in public, they are all but certain to spark some debates. Imagine how that goes in Congress or any other political field. The sad fact of the matter is that government cannot provide the answers for all of these. What is a better solution? How about providing people ways to avoid taxes so they have better opportunities to provide for their own personal well-being?
Reservations About Ways To Avoid Taxes
Some people hate to avoid taxes because they feel like they are taking money away from the government to spend on the people. That is a funny mindset, because it is not you taking money from the government, it is the government taking money from you. Also, the government will certainly spend some of your money on something you do not want.
The Delusion Of General Well-Being
Some people believe that the government does what is best for the general well-being. Even the most democratic governments are at most groups of thousands of people determining the best laws and policies for a larger group of people. This group cannot determine what is best for the people alone. Governments may ignore or even victimize entire demographics for the “general well-being.” Also, the government officials’ personal well-beings provide at least some (many times more) bias to government laws and policies. Sorry, the government is not the best at determining what is best for the people and where the people’s money should go to improve their well-being. You should first look to provide for your personal well-being. That is where tax benefits come in. You can use them to keep more of your income to invest in your personal well-being.
How Tax Benefits Work
Generally speaking, there are two ways to lower what you owe on taxes: tax deductions and tax credits. Tax deductions lower your taxable income. For instance, if you have a salary of $50,000 and a tax deduction of $30,000, your taxable income is only $20,000. That may put you at a lower tax bracket and you may pay less in taxes. Tax credits are more direct and generally more desired. A tax credit does not lower your taxable income, but instead lowers how much you owe in taxes. For instance, if you have a tax credit of $2,000 and you owe $5,000 in taxes, the IRS applies the $2,000 tax credit to your tax bill so you only owe $3,000 in taxes.
Retirement, Retirement, Retirement
If you are a citizen of the United States, you probably feel like the government is required to provide financial security for your retirement. Read this previous post to learn that the government is not required to provide you anything during retirement (they do not always do what is best for your personal well-being). Regardless, the government has set up programs including Social Security because they do desire people to have at least stable retirements.
That is why the government established tax benefits for people who save for retirement. There are many retirement funds to choose from. Each have their own tax advantages that beat almost every other way to avoid taxes legally. Traditional IRAs and 401ks provide tax deductions on contributions. Roth IRAs (my favorite) prevent any taxes on retirement withdrawals.
In addition to tax avoidance and deductions, low and middle-income savers could receive a tax credit for their contributions. My CPA has advised me to continually contribute money to my Roth IRA to receive this credit. Generally speaking, you must have an adjusted gross income of less than $32,000 if filing single/separately, or have an income of less than $64,000 if filing jointly. There are other qualifications so make sure to consult a CPA. Otherwise, this is one of the most overlooked tax credits.
An HSA is a health savings account, also referred by Michael Kitces of the Pinnacle Advisory Group as “the most tax-preferred account available.” There are three benefits to a HSA.
- Contributions are tax deductible and will lower your taxable income.
- Growth of money is usually tax-free on the federal level.
- Withdrawals for qualified medical expenses are tax-free and with no penalties.
There is some red tape though. You need to have a high-deductible health plan, which may make medical expenses higher when you have them. Flexible savings accounts (FSAs) cannot be used with HSAs. Furthermore, non-medical withdrawals can start when you are 65 instead of 59.5 like every IRA. However, the tax benefits of an HSA may be worth the red tape.
Speaking of FSAs, these accounts are commonly used similar to HSAs. They are employer provided accounts in which can be withdrawn for healthcare purchases.
There are some major differences between an FSA and an HSA.
1) Employees can use FSAs for almost any healthcare purchase including hospitaliziation cost, first aid supplies, and some OTC pharmaceuticals. HSAs can only be used on qualified healthcare purchases.
2) Contributions to FSAs are immediately taken from income. They are not used as tax deductibles because your income was already lowered by the contribution. HSAs require the tax deductible.
3) FSAs do not require a high deductible health plan, HSAs do.
4) HSA balances last for years. FSA balances usually expire within a year.
Since FSA balances expire in a year, you should not contribute as much to an FSA as a retirement plan nor an HSA. It may be wise to only contribute to these plans if you expect some healthcare costs in a year. Otherwise, FSA contributions can be wise ways lower the taxes you owe. The withdrawals could be tax-free (not guaranteed) if used on qualified medical expenses.
Each qualifying dependent you file gives you a tax credit of $500. Altogether you can receive a credit of up to $2,000.
Furthermore, you can receive tax benefits by contributing to your child’s education. 529 plans offer amazing ways to avoid taxes to savers. A typical 529 plan is much like a Roth IRA. Your contributions will grow tax-free on the federal level and there may be other benefits on the state level. Much like an HSA, a 529 plan is very tax advantaged. Even K-12 education can be saved/invested for to provide tax benefits.
Standard & Itemized Deduction
My accountant has informed me that I should file my taxes jointly with my wife. I never quite understood why that would be advantageous until recently. Anyone and everyone can receive the standard deduction. However, by taking the standard deduction, you lose the potential to itemize your taxes. This could prevent you from using mortgage interest, medical costs, or faced a casualty as tax deductions. A standard deduction if filing as single/filed separately is $12,400 or $24,800 if filed jointly. It would not be desirable for these to be higher than your standard deduction.
People debate over which method of deductions is better. You should have an accountant look at your income and expenses to determine which is better. There are many X factors that may determine whether you should use a standard or itemized deduction or whether you should file as single or married. If you do not file jointly, you will miss out on many deductions and credits, many of which have already been addressed.
Ways To Avoid Taxes With Real Estate
Investors consider real estate as one of, if not even the best investment. The returns of investment help, but the tax advantages are definitely a plus. Real estate has tax benefits including deducting interest, cost of repairs, utilities, heck even depreciation of real estate prices are tax deductions. That’s right, real estate treats losses in investments count as loss in taxable income. If you lose $20,000 in real estate value in a year, your taxable income could be $20,000 less than your total taxable income.
Furthermore, you would have access to amazing tax credits depending on your real estate. There are many credits, such as a rehabilitation credit and low-income housing credit, that are complex and require jumping through many hoops. You should consult experts to ensure your property fits the criteria for these credits. Probably the most easily accessible tax credit for real estate is the energy credit. These can come as tax credits that provide partial or even full costs of energy improvements including solar panels, geothermal pumps, windmills, and central air conditioning units. Make sure you consult tax and real estate experts before trying any of these.
Set Up Your Business
Most business expenses are tax-deductible. These can include supplies, salaries, and even your home office. Furthermore, the SECURE act provides new tax benefits for businesses to set up retirement accounts. This will remove the income you invest into your business to give the world a product/service and even potentially provide some jobs.
Pay Off Bad Debt
If you acquire any debt that has no value and it seems unlikely the lender will pay it off, the IRS may deduce the debt from your taxes. This can be used for many business debts and personal debts. For instance, if you are a business who made a loan to a client, but the client has stepped out and you cannot reach them, you can deduce the bad debt from taxes. You can use the bad debt to deduce your taxes.
Make sure to ask an expert about how these tax deductions work and what counts as bad debt to this.
The Devil Is In The Details
My cousin, an accountant, and I once watched “The Accountant,” an action-crime movie starring Ben Affleck, Anna Kendrick, and, J.K. Simmons. The perfect setting to talk about taxes (partially sarcastic). I remember watching the scene when struggling farmers talked to Christian Wolff, the accountant, Christian Wolff pointed out many ways that the farmers could have their taxes lowered. My cousin cringed. He pointed out everything wrong with that scene including but not limited to the fact you need a designated home office, accurate measurements of said office, and a designated company vehicle that you do not use for anything outside of the company. He even pointed out that if your “home office” has a TV, it is not a home office and the IRS will see it that way.
Apparently (but not surprisingly), many people try to take advantage of these tax deductions without knowing, understanding, nor following the details required to take these tax deductions. If you do not follow these details, you may not be legally able to take advantage of many tax deductions. Even worse, you could be taking advantage of illegal ways to avoid taxes. Then the IRS may take action for these crimes. Sometimes these actions may just result in paying off what you owe later, but imprisonment is not off the table.
This post is meant to educate you on ways to legally avoid taxes. Much of it is simple, but you could easily stumble upon an illegal tax avoidance tactic. Make sure to consult with experts, they will make sure you pay what you should in taxes including not only avoiding taxes you do not need to pay, but make sure you pay what you owe.
Taxes are necessary for any civilization, but you never need to pay more than you should. Some say paying off your taxes is patriotic. But a country cannot exist without the people, the people need to be able to take care of themselves before they can take care of their country. Furthermore, no government can take care of everyone no matter how hard they try.
The ways to avoid taxes I have gone over do not just allow you to keep some of your money, but are incentives towards certain behaviors. If the government wants more businesses and investors, they will provide tax incentives to business owners and investors. If the government wants more children, they will provide tax incentives to parents. Tax advantages can be used to help you forge your wealth.