This is a post from Gary Dek at Gajizmo.com. Enjoy!
Benjamin Franklin said “The only two certainties in life are death and taxes” but with loopholes in the tax code, a little research and planning with your CPA or tax attorney may significantly reduce or altogether eliminate your tax liability. The mega rich know all the ways to avoid income and capital gains taxes, but those with lower incomes can find ways to cut their tax bills, too. Here are a few strategies to teach you how to avoid paying taxes. Not all our tips may apply to you so pick the ones that are feasible and discuss them with your accountant for the coming tax year.
Would you like the government to pay part or all of your tax liability? It can happen if you accumulate enough tax credits. You may qualify for an Earned Income Tax Credit if you have a low to moderate income – $37,870 to $51,567 (depending on the number of dependent children in your household). At these income levels, your refundable tax credit may be larger than the amount of federal taxes you owe, resulting in a sizeable refund. Other tax credits include ones pertaining to energy consumption. You may qualify for an energy tax credit if you upgraded your home insulation, purchased high efficiency appliances or a hybrid car (not all hybrids qualify), installed solar panels, heat pumps or energy-efficient windows. The beauty of these investments is that, while the cost for you is upfront, you will save on your utility bill, earn a tax credit and recoup your expenses when you sell your home in the future. Other popular credits include the Child Care Credit (if you pay for daycare) and the Lifetime Learning Credit (available to part-time adult students who take college courses). Just remember that credits are different than deductions. “Deductions” reduce your taxable income while a tax credit is directly subtracted from the amount of tax you owe the government, therefore making a $1,000 tax credit more valuable than a $1,000 deduction.
Start A Legitimate Home Business
Notice how that title includes the word “legitimate”? This is because tens of thousands of households start illegitimate home businesses each year or expense personal expenditures under their business, opening themselves up to audits, fees and penalties. Legitimate home businesses include offering freelance services such as web development and design, writing and editing, public relations and marketing, becoming a virtual assistant, animal care and training, wedding photography, massage therapy, etc. My personal favorite “home business” would be to start a blog. Many members of the personal finance blogging community are part-time bloggers earning hundreds or thousands of dollars a month in addition to their day jobs. So if you think you have a unique story or special knowledge to offer, why not learn how to start a blog and give it a shot? Domain and hosting costs are tax deductible.
Get Stock Options As Part of Your Compensation
Business executives are often offered stock options as part of a compensation package. Income tax becomes due when the options are exercised but recipients can hold the options and purchase the stock at a later time. Stock options have value when they are held, but there is no income tax on the options themselves. This allows you to exercise your rights when it most benefits you (i.e. a tax-friendly year or when their value has peaked). Taking part of your salary in stock options can save, or at least defer, a bundle on taxes and you don’t have to be an executive to earn them anymore. If you work in financial services or technology, firms are regularly compensating employees using employee stock option plans (ESOPs). Next time you are negotiating a salary increase, consider stock options a point of negotiation.
Benefits of Partnership Agreements
Say you own a piece of real property for which you paid $250,000 dollars and it is now valued at $1 million. You want to sell your investment and pull your profit without paying income or capital gains taxes. Instead of simply selling the property, you form a partnership with the buyer. You place $50,000 in the partnership and your buyer takes out a loan for the remaining $950,000, transferring the proceeds into the partnership. Since the property has not changed ownership and no transaction has taken place, neither party owes capital gains tax. The partnership has no profits because it owes a $950,000 loan. Unfortunately, you have to leave some of your money in the partnership to keep it legal, but you can get most of your original investment and profit out by using this little dodge. Let’s face it, $50,000 is nothing compared to the tax bill you would normally face for this type of transaction.
Whole and Universal Life Insurance Policies
Is life insurance taxable? Whole and universal life insurance policies are financial instruments which offer investment opportunities and tax deferments. Universal variable life policies are invested in stocks and bonds and allow policyholders some control over how the money is invested. Meanwhile, whole life policies offer a guaranteed rate of interest. Returns on life insurance policies are tax-deferred until they are withdrawn and death benefits are non-taxable in most circumstances. Loans that do not require repayment can be taken against the cash value in life policies and do not count as income. There are a number of different types of investment policies to meet different goals, but all offer tax-advantages coupled with low risk. Since all life insurance death benefits are usually non-taxable, coverage offers heirs a shelter from income and estate taxes. However, as a note, we do not recommend whole or universal life insurance for most consumers. A term life policy provides the best combination of affordability, flexibility, and coverage unless you are a high net worth individual looking for a tax-advantaged investment.
Freezing assets is a way to prevent your heirs from paying estate taxes when you die. Since estate taxes are only payable on transferable assets valued over $5.34 million per person (or $10.68M for couples), most American households will not benefit from freezing assets. 99.9% of deaths in the United States do not trigger federal estate taxes. If you anticipate that your estate will be subject to estate taxes, there are methods of freezing the value of your assets by transferring them into a trust many years before your death. These assets are most often stocks and bonds, but may include other investments that are expected to appreciate over time. A certified accountant or tax attorney can help you decide whether freezing the value of assets is a strategy you should employ.
Incorporating A Company or Using A Shell Entity
Income tax law and bankruptcy laws are different for corporations than they are for private individuals. You can take advantage of tax breaks by setting up a company and funneling your money through the business. A shell company does not make any products or offer any services – it exists only on paper. This particular tax dodge allows you to conduct business overseas without paying taxes on profits. On the flip side, if you are an independent contractor or work for a small business that would be willing to pay you through your company instead of as an individual, incorporating may help you reduce your tax bill. Passing your income through a company allows you to claim expenses, investment in property, plant, and equipment, and even pay yourself in stock options. This only works when you have a large income base, otherwise, the cost-benefit isn’t there because self-employed individuals must pay both halves of payroll taxes as well as state filing fees.
Best Ways To Reduce Your Tax Bill
There are methods to help even people with moderate incomes save money on federal taxes, but the best way to find and use these tax-avoidance strategies is to talk to tax professionals – accountants and attorneys. Tax laws are complex and mistakes can be extremely costly when penalties are added to unpaid taxes, so leave it to the experts. While Ben Franklin may have been right about life’s certainties, there are certainly things you can do to avoid or at least minimize taxes. Wish I could have helped you out on the “death” part, though!
Author: Gary Dek is the founder of Gajizmo.com, a site focused on personal finance, career and education advice, and self-improvement tips. He is a former financial services professional turned online entrepreneur, blogger and SEO expert.