For the past 10 years, I’ve been a buffoon. Ever since I was 25, I paid more than $100,000 a year in taxes. Even though I didn’t work for most of last year, I still paid over six figures in taxes. You don’t get a thank you card if you pay over $1 million dollars in taxes in case you’re wondering. Instead, you get the government hooked on your juice with fishing letters from the IRS asking for more!
I didn’t mind paying my fair share of taxes when I was in my 20s because I was excited to progress in my career. I felt lucky to just have a job that allowed me to save like crazy and help others financially through charitable donations. As I grew older, my views on income taxes changed.
Since the turn of the century, we’ve witnessed a devastating war in Iraqistan that by some estimates have taken over 1 million lives. We’ve observed Congress do nothing to pass a balanced budget since 2008 while giving themselves pay raises every single year. During the 2009-2010 financial crisis, the government doled out massive bailouts to institutions such as AIG while allowing executives to pay themselves millions of dollars. AIG even had the audacity to contemplate suing the federal government this year for wrongful terms! What the hell.
I felt sick to my stomach supporting such atrocities by a government who also discriminates against certain citizens while displaying no fiscal discipline. Why can’t we all be treated equally? I don’t know. When it takes 18 months for the city to fix a noisy and dangerous manhole cover, perhaps paying tens of thousands of dollars in state taxes is not worth it anymore. How about $5 bucks instead?
John F. Kennedy once said, “Ask not what your country can do for you, ask what you can do for your country.” Unfortunately, those words were spoken on January 20, 1961. Most of us weren’t alive then since the median age in America is only 35. I’m afraid our society has permanently adopted a one-way take, take, take mentality.
I think I’ve paid my dues. Unless you’ve paid as much in taxes, please don’t criticize me for writing an article on how to help you legally pay less taxes. To build wealth, we must minimize our expenses. Taxes are one of the largest expenses we’ll ever incur.
THE BEST WAY TO PAY LITTLE TO NO TAXES
Besides earning less money, the best way to pay little to no taxes is to make your income equal your itemized deductions. Single filers get a standard deduction of $5,950 while married couples get roughly $12,000. Therefore, make $5,950 a year and voila! No taxes.
The problem is no single person or married couple can live off only $5,950 and $12,000 in income, respectively. Hence, forget about the pitiful standard deduction. Go for the itemized deduction which includes home mortgage interest, property taxes, and charitable givings. Obviously you need a mortgage to be able to pay mortgage interest and property taxes, so consider owning a piece of property already. The government subsidizes your ownership.
As for charity, give as much as you can. It is better to give to causes you are passionate about rather than pay more taxes to the government who ends up wasting your money. The Yakezie Writing Contest is a micro-giving example where we give 100% of proceeds to winning recipients for educational purposes.
The below are three examples with some notes on how to minimize your tax bill.
1) EXAMPLE OF HOW TO PAY ZERO TAXES ON INCOME
|Example Of How To Pay Zero Taxes On Income|
|Passive Income (Replace With Active Income If You Like)|
|CD Interest Income||$35,000|
|Total Passive Income||$60,000|
|Property And State Taxes||$20,000|
|Total Tax on Passive Income||$0|
|Buffer for Other Income||$1,000|
|Copyright 2013 FinancialSamurai.com|
* To generate passive income, you’ve first got to save a lot. You can replace my passive income examples with normal wage income if you like. The effect is the same.
* What is peculiar is that one still has to pay property taxes to the state. At least property and state income taxes are deductible and the money is not going to the federal government. You can choose to move to a different state to lower your tax liability. Changing citizenship on the other hand is much more difficult.
* A $30,000 mortgage interest deduction can be calculated as a 3% mortgage interest rate off of a $1 million dollar loan. If you recall from a previous article, a $1 million mortgage is the ideal mortgage amount if you can afford it. Some may poo poo paying interest, but I say paying interest with other people’s money to build wealth is much better than paying taxes to the government.
* For 2013 and beyond, if you have a modified adjusted gross income (MAGI) of $200,000 as an individual, or $250,000 as a married couple, you’ll also have to pay a 3.8% surcharge tax on all capital gains and dividend income. The government does not have the guts to cut spending, hence more taxes are inevitable.
* You might be wondering how does someone survive if their entire $60,000 in income goes to charity, mortgage interest, and property taxes? The answer lies in living off your savings.
* Important to note: The first $20K income for a couple is tax free as a result of the standard deduction and the personal exemption. If you are in the 10-15% TAX BRACKET you pay zero percent tax on long term capital gains and qualified dividends up to $72K. This was made a permanent rule for 2013 tax returns. So you can earn about $90 K and pay no taxes using those rules.
2) EXAMPLE OF ZERO TAXES ON RENTAL INCOME
|Example Of How To Pay Zero Taxes On Rental Income|
|Tax Shields / Expenses|
|Total Tax On Rental Income||$0|
|Carry Over Loss||$2,000|
|Copyright 2013 FinancialSamurai.com|
* Owning a rental property is like owning a business. All expenses related to running your rental property are deductible from the rental income. Just be careful that deductions start phasing out after you make more than around $166,000 a year.
* A key part of the expense is depreciation. Depreciation is a non-cash expense to provide a fair way for the normal depreciation of your property.
* There’s no escaping property taxes again, but at least it is deductible. It’s important to convince the city your property is worth the least amount possible to pay the least amount of property taxes.
* It’s best to receive no rental income while you are in a higher tax bracket. Once you’ve retired, you’ll probably be in a lower tax bracket and should receive more rental income given your rent will be higher and mortgage intrest and amortization will be lower.
3) EXAMPLE ON HOW TO PAY NO TAXES ON A BUSINESS
|Example Of How To Pay No Taxes On A Business|
|Cost Of Cupcakes||$10,000|
|Traditional IRA For You & Your Spouse||$10,000|
|Total Retirement Deductions||$40,500|
|Operating Income After Retirement Deductions||$24,500|
|Tax Expense At A 30% Rate||$7,350|
|Net Profit After Tax||$17,150|
|Tax Shields At Your Disposal|
|Home mortgage interest||$30,000|
|Student Loan Interest||$2,500|
|HSA Contributions||$3,000 individual, $6,000 family|
|Business Start Up Expenses||up to $10,000|
|Copyright 2013 FinancialSamurai.com|
* Starting your own successful business is difficult, but one of the most gratifying things you can do. A lot of your normal living expenses can be considered business expenses. For example, you can have annual board meetings in Rio de Janeiro if you want. The flights, meals, and accommodations are all expensable. Nobody says your annual board meeting has to be in a place of suffering.
* As an employer and employee, you get to contribute $17,500 to your 401K + 20% of operating profits. In this case, $17,500 + $13,000 = $30,500 that doesn’t get taxed. You can also contribute $5,000 for yourself and for your spouse in a traditional IRA. Eventually you will have to pay taxes on these pre-tax retirement accounts, but not now.
* The business has a net profit after tax of $17,150, however you’ve got so many more tax shields at your disposable which can easily wipe out the tax liability.
* Business taxes are one of the most complex taxes to calculate. The above is just a simple example of how a cupcake owner with $100,000 in revenue might not have to pay any taxes at all. See the WSJ article on “How To Pull A GE” as another example.
DO YOUR OWN TAXES AND TAKE ACTION
Despite a tax code over 70,000 pages in length, it’s important for everybody to understand the basics of taxes. I’ve been using H&R Block at Home Online to do my own taxes for the past 8 years so I can understand the nuances and create pro forma scenarios such as: 1) What if I donated more to charity? 2) What if I accelerated my rental property depreciation? 3) What if I generated more income through dividends? 4) What is the income level I need to make where AMT doesn’t kick in? 5) What is my effective tax rate if I did not have a mortgage? and so forth. You will only be able to understand your own tax situation if you spend the time to do your own taxes.
Nobody cares more about your money than you. Save like mad to develop passive income so you don’t have to pay W2 income tax anymore. Move to a lower tax state or country. Start a business that you care about. Whatever you do, don’t sit around and let the government treat you like a punching bag. If you have the ability to relinquish all assets to a loved one and disappear off the grid, all the better!
Photo: Use your tax savings to visit potential clients in Istanbul, 12/7/2014.