Everybody wants to pay less taxes, but not everybody knows how. This article comes up with a logical solution to pay less taxes so you can be more free. Taxes serve as a drag on your time to achieve financial independence. As a result, it's up to all of us to try and legally minimize our tax liability as much as possible.
By now you've probably heard that Donald Trump supposedly only paid $750 in federal income taxes in the year he ran for president and in his first year in the White House, according to a report in The New York Times. Whether this is true or not, nobody can be sure since Trump said the information is fake news given his tax filings are still under audit.
The president’s financial disclosures indicated he generated at least $434.9 million in income 2018, but his tax filings reported a $47.4 million loss. Therefore, it's a little mind-boggling to normal people like you and me as to what is exactly going on here.
At least Trump has employed thousands of people and his company has paid tens of millions in FICA tax each year as a result.
Even though roughly 45% of Americans pay no income taxes (mostly due to low income), in 2017 the average tax filer paid roughly $12,200, or about 16 times more than what the president paid. Therefore, if we are to be honest, I'm sure the 55% of Americans who do pay income taxes would love to pay less.
Instead of getting mad at a supposed billionaire for not paying a lot of federal income taxes, we should take this opportunity to learn how to minimize our tax liabilities as well. So long as we can legally minimize our tax liability, we should.
After all, financially savvy people are always looking to minimize expenses and maximize earnings.
How Regular People Can Pay Less Tax
You and I are regular people. We aren't billionaires nor do we wield positions of great power. Therefore, a lot of the tax avoidance strategies available to the rich and powerful are not as readily available to us. That said, I'm going to first come up with a framework so that all of us can pay less taxes and not feel guilty.
To start, the easiest way that regular people can pay less taxes is by making less income. Single filers get a standard deduction of $14,600 while married couples get $29,200 in 2024.
Therefore, if you want to pay no income taxes, then make up to $14,600 a year as an individual or up to $29,200 a year as a couple after deductions and voila! You won't pay any income taxes.
The problem with this low-income strategy is that it's hard to live off only the standard deduction amounts a year for most people. Some families food budgets, alone, are greater than $14,600 – $29,200 a year.
Unfortunately, no single person or married couple can comfortably live off only the standard deduction limits. Hence, focus on itemized deductions if you can.
Further, regular people can max out their 401(k) and IRA contributions and thereby reduce their taxable income. After decades of contributing, I expect all of us to at least become 401(k) millionaires.
Regular people can buy a primary residence and take advantage of mortgage interest and property tax deductions. When it's time to sell, regular people can pay no capital gains tax on up to $250,000 in profits if single or $500,000 in profits if married.
Finally, we can all donate more to charity to reduce our taxable income. It is better to give to causes we are passionate about rather than to pay more in taxes to a wasteful government.
How Financially Savvy People Can Pay Less Taxes
Now that we know how all of us regular people can pay less taxes, let's take things up a notch. Here's how financially savvy people can pay less taxes. Financially savvy people are those of you who want to achieve financial freedom sooner, rather than later.
1) Learn The Tax Rates By Income Levels
The key to paying less taxes is understanding the tax rates for various types of income and what type of items can be deducted from income.
Unfortunately, most people make most of their money through a day job. Day job, or W2 income, is taxed at the highest rate.
The goal is to make the most amount of income that is taxed the least. Therefore, people need to get into the mindset of building as much passive investment income as possible in order to pay the least amount of taxes.
The easiest way to approach tax rates by income is to divide the tax rates between short-term capital gains tax rates and long-term capital gains tax rates. Short-term capital gains tax rates are also equivalent to regular federal income tax rates.
If income tax rates change in the future, we must know each tax rate as soon as it comes out. Below are the 2023 short-term and long-term cap gains tax rates for singles.
2) Earn Income Where The Tax Rate Differential Is Greatest
The income level where the difference between the short-term and longer-term capital gains tax rates is greatest is between $170,051 – $539,900. Once you get between $215,951 – $539,900 you experience the largest tax rate differential of 20%.
The 20% tax differential is one of the reasons why I had a goal of generating at least $200,000 a year in investment income before I had children. Back in 2012, I thought $200,000 was the ideal income for maximum happiness as an individual. I didn't just pick a number out of thin air.
Now that I have two children and a wife to support, my passive investment income goal is $300,000 – $350,000 a year, which is still in the maximum tax differential range. I could aim for a lofty $539,900 in investment income, but with a declining safe withdrawal rate, the amount of capital required to generate such a passive income figure is too much for me.
By paying a 15% marginal income tax rate versus a 35% marginal income tax rate, a person can make about 22.4% less on the marginal income and still end up with the same amount after tax.
For example, at a 15% marginal income tax rate, $100,000 of the income above $215,951 becomes $85,000 after taxes. To end up with $85,000 after taxes at a 35% marginal income tax rate, you would need to earn $130,769 in income above $215,951.
3) Earn the lowest-taxed income from investment income
At this stage, you've gotten into the mindset of earning more passive income and achieving a certain passive income target. You're no longer making fun of people like me for trying to live a middle-class lifestyle off $300,000 a year because you understand tax optimization. You also understand that the cost of living is different throughout the country.
It's time to earn the best-of-the-best type of income to pay the least amount of taxes. The two best types of income to earn are rental property income and business income. Earning income through these two sources are tax-efficient due to deductions and flexibility.
You can also invest in tax-free municipal bond income as well. However, with interest rates so low and municipal bonds having performed so well, the future returns likely won't be as attractive.
Let me demonstrate how to legally pay less in taxes through rental property income and business income.
How To Pay Zero Taxes on Rental Property Income
Thanks to loose monetary policy, strong demographics, and a growing desire to own hard assets, owning rental properties is one of the best ways to build wealth and generate relatively stable passive income.
Below is a simple chart that shows how to pay zero income taxes with rental property. The key lies in all the available deductions.
Owning a rental property is like owning a business. Almost all expenses related to running your rental property are deductible from the rental income.
Some common rental property expenses not included in the chart are advertising, transportation, supplies, cleaning, phone, and tolls.
A key part of the expense is depreciation of the building value (not land). Depreciation is a non-cash expense to provide a fair way for the normal depreciation of your property. In the example above, we have a rental property building valued at $633,308 taking a $23,000 annual depreciation expense for the next 27.5 years.
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.
If you have a high W2 income, owning rental property is a tax-efficient way to generate cash flow. Imagine amassing 10 rental properties, all generating $23,000 a year in tax-free rental income a year thanks to depreciation. That's $230,000 a year in tax-free income!
The Downside Of Rental Property
The biggest downside to owning rental property is the time it takes to find good tenants and maintain the property. If you get unlucky and end up with tenants who don't pay on time or pay at all, your returns will really suffer.
Further, your property is also subject to natural disasters. Hopefully, you will have a strong enough homeowners insurance policy to not only cover your property's damages, but to also make up for lost rental income.
The older and richer you get, the less you want to deal with maintenance and tenants. This is where owning REITs and participating in real estate syndication deals become relatively more attractive.
Platforms like Fundrise, which has private real estate for investors, has really grown in popularity thanks to its more stable passive income source. It's free to sign up and explore.
How To Pay Less Taxes With A Simple Business
Creating a portfolio of rental properties is like creating a business. You can create an LLC and inject all your rental properties into your LLC for liability protection.
You can also create many other traditional types of businesses to earn tax-efficient income. Below is an example of a cupcake business with net revenue of $90,000 and taxable income of $65,000 at most. In reality, after retirement contributions and other deductions, the taxable income will be closer to $0.
Starting your own successful business is harder than just working a day job, but it's one of the most gratifying things you can do. A lot of your normal living expenses, such as your mobile phone and internet bill, can be considered business expenses.
For example, you can have annual board meetings in Hawaii if you want. There's no requirement to have one in your windowless basement. The to and from Hawaii air tickets, meals, and accommodations are all deductible. If you want to do a team-building event on a luxury catamaran, that's probably deductible as well.
As an employer and employee, you get to contribute up to $20,500 to your Solo 401K + 20% of operating profits. If you have the operating profit, the maximum 401(k) contribution is $61,000 for 2022. In this case, the person contributes $20,500 + $13,000 = $33,500 that doesn't get taxed.
You can also contribute a maximum of $6,000 for yourself and another $6,000 for your spouse in a traditional IRA. Eventually you will have to pay taxes on these pre-tax retirement accounts, but not now.
After the Tax Cut And Jobs Act was passed in 2017, a Qualified Business Income (QBI) deduction was introduced for sole proprietors, partnerships, S corps, and some trusts and estates. The deduction is equivalent to 20% of QBI. Therefore, in this cupcake business's case, it could reduce its taxable income by potentially another ~$8,000 – $13,000.
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.
How To Pay Less Taxes With A Complicated Business
Now that we've mastered the cupcake business, let's look at a very interesting business case study: Gawker Global, an online media company.
Before Gawker Global went bankrupt, partially due to Hulk Hogan's lawsuit, it had one of the most fascinating business structures ever to pay less taxes.
Take a look below at how Gawker Global was able to pay a 4.5% effective tax rate on $1,000,000 in advertising revenue.
The bottom line is that Gawker Global set up a subsidiary in Hungary, which has much lower corporate tax rates than in the U.S. In other words, Gawker Global ended up paying itself and arbitraging the tax rate differential.
If you want to learn more about Gawker Global's business structure, I wrote a more in-depth post about it. I can't believe it was legal, but the IRS allowed it for many years.
Running an online business is my favorite type of business to run in the internet age. There are over three billion people online today. The scale and potential profitability of an online business is massive.
Unfortunately, from a tax perspective, due to the low-cost nature of running an online business, the tax bill could also be outsized.
Business Flexibility Is Huge
Flexibility is one of the main reasons why businesses are able to pay less taxes. W2 income earners hardly have any flexibility in comparison. Here are some examples of business flexibility:
- Delay income and expenses. If the beginning of the year is going strong, a business might front-load capital expenditure or backload revenue to the next year. One easy example is depositing client checks received in November and December to January of the next year.
- Decide on the level of business expense. A business can always spend more of its operating profits and retained earnings to try and generate more business down the road. However, not all expenses have the same return on investment. For example, let's say business is going really well. Instead of taking your staff to the Motel 8 in town, you decide to fly your staff to Aspen and pay for five nights at The Ritz Carlton. Instead of buying a $20,000 Honda Fit as a company car, you can buy a $220,000 Lamborghini Urus instead.
- Where to direct business expenditure. If you own a business, you can decide to hire relatives you care about who are in a lower tax bracket. For example, let's say your son, whom you love dearly, is down on his luck after graduating from college. He's living at home with you, but you don't want to just crush his ego by giving him money. Instead, you can pay him $12,000 to do some work for your business. He gets to earn $12,000 tax-free and you get to deduct $12,000 from your business income. A win-win! Of course, you could always pay him more.
Pay Less Taxes By Being A Bad Business Person
Finally, just like how you can strive to earn less money as a laborer to pay no taxes, you can also strive to be a terrible business person to pay no taxes.
Money-losing businesses don't pay income taxes. However, if you can grow your money-losing business to massive scale, you could end up becoming extremely wealthy. Uber is a great example of a money-losing business that made its founders multi-billionaires.
Just beware that after about three years of not making money, the IRS might come knocking. The IRS is not stupid, and knows that some individuals will create a business for the main purpose of sheltering income with questionable expenses.
From the IRS's perspective, the primary purpose for starting a business is to make money.
Rental Property + Business Income = Best Combination
Hopefully, this article provides a simple framework for how regular folks can legally pay less income taxes. U.S. tax laws are very complicated. There are a plethora of things one can do to minimize tax liability. As a result, many people don't even try.
After over 21 years of earning multiple types of income, I recommend focusing mainly on earning rental property income and business income if you want to pay less taxes and build the most wealth.
Earning stock dividend income is also great and is a recommended passive income source. However, it's much harder to shield dividend income. Earning municipal bond income is also a wonderful source of tax-free income. However, returns are now very low.
Eventually, the lion's share of your income will come from tax-efficient sources. When it does, you will no longer feel as bitter or as burned out by a wasteful government that progressively taxes you the more you make.
If you can buy one rental property every 2-5 years and work on your online business, over a 20-year period, you'll be set for the rest of your life.
I can't guarantee you'll be able to pay only $750 a year in federal income taxes without deducting $70,000 worth of hair expenses. However, if you build rental property and business income, I'm sure you will pay much less in taxes than a typical W2 laborer with the same income.
Related:
Ranking The Best Passive Income Investments
Why I Regret Selling My Business For Millions Of Dollars
The Rich Pay More Than Their Fair Share In Income Taxes
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Hi there!
I am a CPA owner and a fan of your personal finance blog.
I can’t entirely agree with your recommendation that high-income taxpayers should prepare their tax returns using Turbo Tax and H&R Block Tax Software instead of hiring a CPA tax professional to save several hundred dollars. Or hiring a CPA tax professional for a few years, then switching to self-prepared—lousy advice.
Two brilliant brains are better than one. I am a CPA with a Masters’s Degree in Taxation and a decade of experience advising and preparing tax returns using professional tax software daily.
Why DIY???
In my opinion, Turbo Tax is a simple software designed to prepare simple returns. High-income taxpayers with complicated tax issues and paying high taxes should not be following your recommendation. They will potentially be at increased risk of making common errors on the return, overwhelmed and confused with the tax forms, and missing tax savings opportunities.
I am confident that if you allow me to have the opportunity to review your last three years’ tax returns on a nominal fee. There is a very high chance of finding missing tax savings opportunities that you may overlook or finding errors on your filed tax return.
Remember: The IRS permits taxpayers to amend the prior three years’ return for a refund due.
All the best,
AZ
You are probably right!
Hi Sam,
New subscriber here :). I was doing research on LLC tax as S Corp to save capital gain tax. I’m single from SF, CA.
I have a long term and short Unrealized capital gain from my crypto investment. My question is as follow:
Will I save all my capital gain tax by forming a LLC S Corp and keep it in S Corp (Understanding S Corp is a pass through – doesn’t have to pay any profit at the corporation level rather in personal level)?
Once I harvest the gain in the S Corp then I’m planning WD and reinvest in Real estate i.e. crowd funding real estate portfolio (I’m inspire how you generate passive income from those investment).
Will I be paying any tax at all – using the gain from crypto and reinvest into the passive income investments from the S Corp?
When is a right time to register to S Corp since I don’t have any cash flow and sitting on unrealized gain? I understand that I will have to pay myself as an employee (reasonable salary) plus the employees taxes, SSI, medical, etc through the pay check.
Do I have to pay/owe to IRS those pre taxes quarterly basis even though I didn’t earn/have realized gain yet, once I formed a LLC with selection of S Corp?
I’m looking to earn $100,000 – $250,000 a year passive incomes (inspire by you and I have the same outlook in term of investment for financial freedom) – what is the tax rate on those on my personal income tax? Are they consider as dividend income distribution?
I’m looking to buy a physical property from my passive incomes.
Any advise/suggestion or recommendation of tax accountant/lawyer would be greatly appreciated.
Thanks
Ken
With regard to Sam’s real estate example, your passive activity loss may be limited unless you are a real estate processional. https://www.thetaxadviser.com/issues/2014/jul/skarbnik-july2014.html
In my case, my wife is a W-2 wage earner and I was a part-time management consultant while investing in real estate. I decided to close up my consulting business to focus on real estate so that I can claim to be a “real estate professional” which allows me to take full advantage of my losses which are about to get bigger.
I have dealt with fires, dog bites, shootings, bed bugs, evictions, etc. as a housing provider. What came out of the blue was the global pandemic. There is not another business where the government has declared consumers are allowed to continue to enjoy good and services without paying. To some extent in every state right now, tenants cannot be evicted for non-payment of rent. In California, that extends until at least January 31, 2021 with very limited ability to collect rents owed or evict. Likely I will never be able to collect most of the lost rents from March 1, 2020 to January 31, 2021 nor will I be able to evict the tenants for those amounts. The owed rents are being reclassified by law as “consumer debt” which means they will be settled in small claims court, not eviction court.
Excellent article Sam! This is why I am trying to get my second rental in 2021. I need the real estate depreciation tactic soon. The income tax check I sent Uncle Sam for 2019 was quite painful. I am thinking of starting a non-profit to donate, do some good and lower my taxes. As one friend once told me, “When you are paying a lot in taxes and finding ways to pay less, in means you are doing something good”
Thanks for sharing great info Financial Samurai!
Economy Chief
Mike,
Great point about the 403b & 457 for public employees. This is one of the most under utilized tax avoidance strategies, for public employees who can afford it. This year if your under 50 you can defer $19,000 in 403b & $19,000 in 457, $38,000 total. Even my CPA had to look up the rule.
This was a great article. Another geat thing about a solo-401(k) is that you can invest in literally anything with the money, such as another rental property on a mortgage funded by your yearly contributions. All the income in there is tax deferred until you draw down the account in retirement.
Love your articles. Do you have any experience on Family Limited Partnerships v Trust for handling Estate Planning. We are trying to keep it simple and stay away from any complex Estate Planning. Ex, Generation Skipping Trust..
Marshall Murphey
If I own a property I am living in, but also renting out individual rooms (house hacking), am I eligible for tax breaks. Thank you!
Also curious about this. It sounds like you can only depreciate the portion of the home used to generate income but not totally sure what that calculation looks like or the downstream effects.
No, Just the standard owner deductions as it’s not considered a rental. You are living in it, it’s owner occupied.
I enjoy board games and computer games, it’s past time for me to look at my taxes and see what the rules really allow, granted that I am not about to start creating any shell companies (or bank accounts) overseas.
Last years it was 25k to Uncle Sam, 12k to our state, another 8.375% in sales tax so less than 8k, probably, but it all adds up, 12k in property tax on what would be a very modest home anywhere else, capital gains tax, unemployment tax (it’s really employees that it costs). Use tax, alcohol taxes, gas taxes, driver’s licenses, car licenses (for ten year old cars), electricity and natural gas taxes, water tax, cable and internet service tax, cell phone tax, bridge tolls, hotel room tax, nature trail permits, and a slug of others that we pay directly or indirectly.
And I’m not even counting medicare and social security since we theoretically get something back from them someday. Or mandated health insurance for that matter.
This is easily total over a third of all taxable income from wages. If I really knew all of the taxes involved (amazing the way government’s first instinct is to hide as many of them from us as they can) it might easily be over 50%.
Teachers can contribute to BOTH 403b and 457 accounts.
For those with significant W2 income and minimal deductions, taxes are horrendous. At this point, I try not even to add up the total income tax, but last year, we ended up at:
37% Taxes
22% Spending
40% Savings
We are very fortunate to make a great wage, but a 37% effective rate seems like quite the subsidy.
Time to start buying rentals…as soon as the market does it’s thing.
37% effective tax rate is huge! Are you pulling in over $1 million a year? I think the highest effective rate I got was 34-35%, which includes California State tax and FICA tax. At that point, I was so tired from working that I really wanted to take things down a notch, and I did.
I rather expect most people (that are paying taxes) are paying over half of their W-2 Box 1 wages in taxes of one form or another, directly or indirectly. Our politicians and bureaucrats work hard at making this very difficult for us to figure out.
A good tax system would eliminate taxes on income, be consumption based (with large offsets for poorer folks, but ensuring everyone has an interest in keeping them down), eliminate all hidden taxes and put them right out where we can see them in every transaction, and force the breakup of society destabilizing fortunes at death with an inheritance tax (not an estate tax) that encourages spreading it out among more inheritors.
2 questions:
What are all the hidden or indirect taxes you are alluding too? Most states require sales and use tax to itemized on invoices. And income taxes are pretty basic if you ignore complex deductions/credits.
It isn’t confusing as much as it is people ignore them because they aren’t optional. Governments have required transparency for most taxes via laws, so I’m curious where you think all the effort is to hide them?
But you’re right, most people don’t know if they pay 37% or 42% of their gross income in total tax because it doesn’t really matter. Taxes may not be optional, but they aren’t sneaky.
And curious on how today’s fortunes are destabilizing the global economy? Greater fortunes and similar concentrations of extreme wealth have existed for over 150 years.
Hidden taxes are everywhere. Optional or not. This forum is not really the place for a dissertation. All you have to do it google it. You will get lots of hits and probably have to dig a bit because of that. Like anything else these days, try to weigh each source for potential bias.
I didn’t say global economy. Also, a little over 150 years ago is right smack in the age of poorhouses, Check Wikipedia on what these were. most folks don’t really know anymore, even though they were around right up to 1950 or so. The England they were called workhouses, which is also in Wikipedia. People have seen portrayals of one in Oliver Twist, but they existed for men and women, too.
If a person earns a truly vast fortune during their lifetime, that’s fine, kudos to them.
The problem with INHERITED fortunes getting too large is that, past a certain point, money if more about power than anything else.
But let’s say you’ve been a pillar of your community for decades. You drive to Washington DC and call any senator or congressman to have lunch with you that day. Unless you have some very serious connections, good luck.
Now a former juvenile delinquent that just turned 18 and got access to his 30 billion dollar inheritance does the same thing. Odds are he is having lunch with whoever he called if he is insistent enough. In other words, he just inherited your political representation. Are you really okay with that?
The US was not intended to have an entrenched hereditary aristocracy and it causes . . . problems. Problems the Constitution wasn’t really set up to handle. I am not advocating socialism in the slightest; that way lies a dystopia. Like most of us reading this site, I probably lean considerably further the other way. But letting things go too extreme in the opposite direction is probably just as dystopian.
Hell, we should probably replace the estate tax with an inheritance tax, give a massive exclusion, perhaps 50 million, but then implement a steep graduated tax after about 100 million (exact starting numbers are negotiable but need to be tied to something).
Because it would be an inheritance tax (paid by the recipient, not the estate), there might not be any taxes due at all if it was spread around to enough beneficiaries, but that would be entirely up to the person writing the will. A lot of billionaires have signed Warren Buffet’s giving pledge, but not nearly enough, and it isn’t really tracked or enforced, in any case.
Totally agree. But consider when under exection it’s much harder for IRS to tax inheritance rather then income so as for now the majority portion for tax would still be income tax.
Thanks for the suggestion to browse Google and Wikipedia for answers to my questions.
And am I really concerned about some delinquent with a $30B inheritance serving as my political representation? Quite the far-reaching example, but I get where you are going with it.
Regardless, I haven’t registered to vote in the past 20 years I was able, so that should tell you how much I am concerned with my own political representation.
Not $1M, but enough with only a standard deduction to feel the sting. And 37% is inclusive of all Income tax including CA.
Fortunately, I am young, healthy and love my job. I enjoy the work, people I get to work with, the challenge it brings and I have flexibility to do what I want/need with my family anytime. So I can definitely put a lot more years in.
And unless I could develop something like you have here or other avenue for mental stimulation, I’m not sure I’d make it not being where I am.
I am very much inspired and in awe by the work/life balance successful bloggers like yourself can eventually create with enough hard work and time.
Young, healthy, and LOVE your job. What more can you ask for? Seriously, I wouldn’t have left finance in 2012 if I loved it. But, I started to bore with the same old routine and the office politics wasn’t great. I knew i was capped working out of a satellite office, so I moved on. Progress is happiness!
With blogging, I’m doing my best to keep it to 3-4 hours a day. But with shelter-in-place, the time has extended and slowly, it’s feeling more like work. I’ve gotta dial it back. I think you’ll enjoy some future posts about online entrepreneurship and stuff.
The only major issue I have with this post is the information under point 2 of the article about earning income with the greatest marginal difference.
It is a common misconception that when you hit a higher tax bracket your entire salary gets taxed at that rate. In fact it is only the dollars that are in that tax bracket that get hit with the tax rate assessed. So go the first 100k of salary in your example both people come out with 85k take home when they hit $100k. The person making $135k does not take home the same as someone making $100k because the higher marginal tax bracket does not apply to every dollar.
I’m in the 37% tax bracket so the last dollars I make in the year are the ones that get hit the hardest and are thus my least favorite dollars (I actually wrote a post about this and why I took advantage of it by now paying someone 1 day a week to cover my radiology practice for me). The net effect of that person’s salary is a much smaller hit because the dollars I lost in income were the least valuable to me.
Thanks. Do you think most people confuse marginal tax bracket with effective? I do write “marginal income tax rate” in my passage.
“By paying a 15% marginal income tax rate versus a 35% marginal income tax rate, a person can make about 22.4% less on the marginal income and still end up with the same amount after tax.”
But to your point, to increase clarity, I’ve added “income above $200,001” to clarify. This may be my blindspot, assuming that everyone knows the difference between effective and marginal.
“For example, at a 15% marginal income tax rate, $100,000 of the income above $200,001 becomes $85,000 after taxes. To end up with $85,000 after taxes at a 35% marginal income tax rate, you would need to earn $130,769 in income above $200,001.”
I do think marginal and effect income tax are incredibly confusing for the lay person. I know more than a few people that thought once they hit a higher tax bracket, ALL of their money got taxed at that rate.
I think the clarification added to the post will be helpful to end the confusion. Essentially every $100k earned ABOVE the comparison individual making $100k has a diminishing return. For example in the highest tax bracket that $100k only brings in an extra $63k (compared to the $85k of the control subject (and that’s only considering federal taxes, some progressive states like California take even a bigger chunk for the high earners)).
That is why I quickly realized why am I killing myself working all those extra hours when it doesn’t move the needle as much. I started taking more vacations and having days off than I used to because of this realization.
Go it. You are the first person to say there is confusion with the effective vs marginal tax rate on this post, yet you are not confused about the two. So I’m not sure if anybody is really confused. :)
Yes, everything is at the margin. There is a declining marginal utility and return for every extra dollar we make. I truly do believe $200-250K per person and $300-350K per family of 4 is the ideal income for Max happiness and returns and effort.
It’s definitely confusing. I know and you know and he knows what you meant. But I guarantee my mom, wife , sister, and 75% of the rest of world will not.
I’m surprised you left out the Muni category. I’m currently building a muni portfolio which is like a printing press for tax free dollars, every month.
Yes, muni bonds is a good one and a good reminder. Thanks. I have a pretty sizeable municipal bond portfolio that I started aggressively building after I sold a property in 2017. However, with interest rates so low and municipal bonds having performed so well, the future returns likely won’t be as attractive.
I feel it’s hard to get rich investing in municipal bonds. If one is already in a high tax bracket, then investing in muni bonds is more attractive. But if you’re regular people facing a federal income tax rate at 24% or less, I’m not sure investing in munis now is worth it. I’m not and would much rather look for rental property or online business deals.
Related:
The Case For Bonds: Living For Free And Other Benefits
The Allure Of Zero Coupon Municipal Bonds
Sam,
Great article. What advice do you have for a guy making low 80’s from a w-2 job to pay less in taxes? Start an easy side hustle? I’m currently renting, and don’t have anything under my name besides my truck, no debt.
Property, Income and sales taxes vary wildly and over a career can literally save millions by living in a lower tax state, county and city. Given many now can work away from the office, more should consider moving. The rich afford homes in various locations and claim residency in lower taxed locates assuming thy can meet requirements (I would never suggest not following the law). It is the single biggest choice a person can make. Putting half of the tax savings into retirement accounts, real estate and other investments will significantly boost living standards now and in the future.
Ironically, I had an appointment with my CPA today and asked how I can pay just $750 in taxes for the year.
His answer, don’t show income, which is illegal and/or borrow 700 millions and loose it.
Unfortunately I can’t do either, so I’ll continue to pay my fair/un fair share.
As Sam stated, it’s all about income AND expenses. It’s very possible (and perfectly legal) for a large business to pay little to no taxes in a given year. I manage a 10 person small business. Last year, we brought in over 10 million in revenue, but our expenses (including payroll) were just shy of 10 million as well. And guess what, we paid like $100 in taxes. Breaking even in business isn’t such a bad thing. So you you’re CPA was being a bit dramatic, and it’s not necessarily a sign of fraud or mismanagement.
I don’t own a business, hence his reply. I have Llc’s for my rentals and other investments but they don’t generate enough income for a lot of deductions. I also have a hubby in a high paying job.
Sam, I think you left out QBI deduction (Section 199A). So in your example, that is another $8,000 or so that you do not have to pay tax on with your cupcake business.
Right now I am struggling to figure out how much to contribute to my Solo DB plan vs. maximizing taxable income to get largest QBI deduction (by staying just under the $326K taxable). Current 24% marginal is relatively attractive given likelihood of future increases.
In any case, some great advice in your post today.
Good point. I’ll update the chart as I used an older example before QBI. Thanks
Can one put rental property and a business under the same LLC?
You hit on it at a higher level I suppose with the Gawker Global example, but there are similar options for smaller entities as well. Where you set up your business, and/or your personal residency contribute to limiting tax implications. Especially in the case of W2 earners living in states with reciprocity… Work in the highest paying, and live in the lowest taxing if possible.
Also federal employees working in the capital are exempt from DC taxes, can can pay their home taxes – large benefit for those living in the 7 (kind of 9) states with no income tax.
Another option is to work out of country. The exclusion on foreign income earnings for 2020 is $107,600. Not bad for tax free earnings. Lots of exemption potential for expats.
I’m sure are those who are crafty enough to blend the various lines in their favor to receive some of these benefits in addition to all the depreciation models and advantages you listed above.
OK, I have two basic questions, but I’m asking you because you seem kind and would never laugh at those of us still learning.
1) Is my research correct that it only makes sense to start an LLC for an individual if you’ve generated thousands in income? Anything less than $30,000 would just complicate your taxes?
2) When does it make sense to hire a tax preparation service? I’m lazy and always had someone else take care of this, but I want to get smart about filing my own. If I can avoid robo-advisors and their .25 fee, surely I can save money by filing my own. I only hesitate because of the freelance business I generate outside of my full-time job.
It depends on your business’ growth as well.
Also your time and intellectual curiosity. I really like learning about and staying on top of the tax laws.
You claim 23k on $633,308 property value. You do know you can’t depreciate the land portion of your appraised value. If you deduct 23k over 27.5 years that puts you at 632k and change. I doubt the land value of your property is 1k
Speaking of deducting traveling expenses for rental properties, Sam, can you comment on your Tahoe vacation home? Can you deduct the trips you take there? I.e. – for doing repairs or inspections?
Yes. There’s no free way yet to drive 200 miles away.
Sam, it’s obvious that you are strongly against taxes. You write about it all the time. As a challenge to you, what if you wrote a followup article about how taxes are good? As I’m sure you’re aware, the country would not be able to function if people didn’t pay taxes. We get a taste of this every time the government shuts down when Congress fails to pass a budget. And as a bonus, what if you compared life expectancy versus the tax rate for various countries. Thanks! I look forward to this article.
Additionally, there’s a fantastic article by The Guardian titled “How Philanthropy Benefits The Super Rich.” It’s a long read, but it’s seriously one of the best articles I’ve read in a really long time. One of the biggest takeaways for me is how it’s kind of unfair for the ultra rich to donate massive amounts of money to charities because it gives them unfair power to decide policy. This is the job of the government and democratically elected officials, not wealthy people. The article gives several great examples of this on both sides of the political spectrum. I’m not saying charities are bad. I think on a smaller scale, normal people donating to charities is a fantastic thing. The problem arises when the tax-free benefits of charities become abused for reasons of power rather than doing good.
Sounds good to me. I welcome a guest post from you on the subject. Overtime, I have observed that people who pay the least amount of taxes are generally for the largest amount of government and highest tax rates and so forth.
What is your current tax and financial situation?
I think it’s the duty of everybody to help support the country and pay taxes. At the same time, I think it’s the duty of everybody to minimize expenses and maximize cash flow for the sake of their family.
Can you imagine paying more in taxes than you get to save each year? Reality is, that’s exactly what most Americans do given the US personal savings rate is only about 6% in normal times.
Here are a couple of good posts:
https://www.financialsamurai.com/property-taxes-by-state/
https://www.financialsamurai.com/how-higher-taxes-saved-me-a-alot-boatload-of-money/
https://www.financialsamurai.com/a-savings-and-tax-guide-titts-ratio/
Sam, I would absolutely love the opportunity to write a guest post. What is the best way to collaborate on a topic?
For reference, current NW is ~$1.5M. In 2019, I paid almost exactly $100k in taxes. Nothing makes me prouder to say that I paid six figures in taxes because it means that I had a very good year. I haven’t calculate my savings rate, but I would guess that it’s somewhere between 50-60%, and I would ideally love to get that higher.
Great post, Sam.
Robert…a refreshing uncommonly highlighted view.
We live in world we’re most of us mindlessly have no qualms about being tracked by our favorite blogs, brands, etc that in turn actively and efficiently traffick and profiteer off us…but lo and behold big bad inefficient government invade our privacy.
I suppose I occupy that alternate/aspirational universe of wanting us to pay not a damn penny more AND have a fit for purpose government. Blindly subscribing to the frankly inane and banal small govt knows best is simply no less odious than a bloated one.
Few, if any, places strike that balance well.
Sign him up for a guest slot, Sam!
For most of us, taxes are our highest budgetary expense. Some of us look at how much money is wasted every year by the government and we rightfully think that we can do more good for ourselves, our families, and those we choose to give money to than a wasteful bureaucracy. Congress can’t pass budgets because they have a spending problem, not due to a lack of taxes coming in. I believe it is every citizen’s duty to legally pay as little in taxes as humanly possible.
There’s definitely a ton of wasteful spending by the government, but do you have any idea how much money is wasted by corporations? If you think there’s any less, then you don’t have a good idea of how corporations are run. The answer isn’t to cut taxes, but to instead force the government to spend more efficiently by demanding transparency and voting for better candidates. Everyone suffers when the government is under funded.
I’ll leave you with a quote by someone from reddit that sums up how I feel about your argument:
“We were convinced less government was good. Hired people who want less government, so they decided to make it more inefficient. They proceeded to complain government was ineffective and even less government was neccessary. They then proceeded to give contract to their buddies since the private market is better than public market. Private companies overcharged while producing less than the government did. Argued it was bad because it was completely government controlled therefore government needed to be cut back. Then argued taxes need to be cut because private needs more profit to create jobs. Private proceed to use money to increase stock since their manager have stock incentives. Use advertisements and subtle manipulation to convince people to buy more. Use that to create a system in which people only care about material good while ignoring the rest of the issues that may affect them in the long run because 20 to 30 years seems way too distant in the future. Then use patriotism, or freedom as a virtue signaling if someone asks why?”
I agree with the argument; FS has never made a patriotic point about less govt. that I know of. Government is necessary, it isn’t evil, and it’s easily controllable if the money is kept close to home AND the populace is engaged.
We should minimize taxes personally but no one should claim that the more well to do shouldn’t pay more- clearly the system has benefitted them more- great, return the favor.
But engagement is sketchy, at best. Really, bad government (defined here by excessive spendong, but really being non responsive to those it serves) is usually a sign of a lazy population. Folks don’t go to meetings that occur all of once a month, don’t contact their representative, but they love to complain online and at work.
If our government overtaxes, or spends recklessly, then it reflects us in every way. If it sucks, we suck.
So, blame others, deny the lack of involvement, tell me why I’m wrong, anything but spend a few minutes a month caring enough about where 25-50% of your income is spent to do something about it.
Understanding tax laws is very beneficial no matter how much or how little you earn. There are lots of tax credits you can be eligible for and ways to benefit from many different tax deductions as well.
I remember as a high school student dreading the thought of having to file my own taxes as an adult because my parents made it sound so daunting and complex. Yes the tax laws are complex but we can understand them with enough reading and research.
Fortunately we have really good tax software now that makes it so much easier to file than 30 years ago! Great post. Thanks