Ever since I was 25, I paid more than $100,000 a year 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 has 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? Why is there a marriage penalty tax? How come your Social Security benefits go back to the government if you die without a surviving spouse? 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 $12,000 while married couples get $24,000 for 2019. Therefore, make $12,000 a year as an individual or $24,000 a year as a couple and voila! No taxes.
The problem is no single person or married couple can live off only $12,000 or $24,000 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 below are three examples with some notes on how to minimize your tax bill.
HOW TO PAY ZERO TAXES ON JOB /PASSIVE INCOME
Notes
* 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.
* Starting in 2018, there is a SALT cap limit of $10,000 per person. If you get married, you actually don’t get $20,000 but still only get a $10,000 limit. This is going to be a net negative for many higher income earners who own property in expensive coastal cities.
* A $30,000 mortgage interest deduction can be calculated as a 3% mortgage interest rate off of a $1 million dollar loan. Too bad the mortgage limit is now $750,000 for 2019. 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.
* 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. This is called the Net Interest Income Tax. 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 standard deduction for a couple has risen to $12,000 per individual and $24,000 per couple in 2018. In other words, any income you make up to these levels is tax free. If you are in the 10-12% TAX BRACKET you pay zero percent tax on long term capital gains and qualified dividends up to $77K.
HOW TO PAY ZERO TAXES ON RENTAL INCOME
Notes
* 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 interest and amortization will be lower.
The only thing about owning rental property is that it scores low on the passive investing scale. The older and richer you get, the less you want to deal with maintenance and tenants. This is where investing in real estate crowdfunding platforms like Fundrise and RealtyMogul come in.
Real estate crowdfunding allows you to invest in commercial real estate around the country with potentially higher returns without any grunt work.
For example, there is huge valuation and cap rate differences today between expensive coastal city real estate and heartland real estate. With real estate crowdfunding, an investor can arbitrage the valuation and cap rate differential for potential profits.
There’s no reason employees need to be stuck paying $4,500 a month for a crappy two-bedroom apartment in San Francisco or Manhattan when they can rent a massive house for half the price in Austin, Texas.
HOW TO PAY NO TAXES IN A BUSINESS
Notes
* 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 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. Everybody should at least start their own website today to take advantage of the internet and the 3 billion people online.
* As an employer and employee, you get to contribute $18,000 to your Solo 401K + 20% of operating profits. In this case, $18,000 + $13,000 = $31,000 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.
See: How To Save Over $100,000 Pre-Tax In A SEP-IRA And Solo 401k
* The business has a net profit after tax of $16,800, 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.
HOW TO PAY LESS TAXES IN A BUSINESS PART II
Notes
* After Gawker Global filed for bankruptcy, Fortune Magazine wrote an amazing expose regarding how Gawker Global created a Hungarian subsidiary to transfer revenue to in order to pay only a 5% effective tax rate instead of a 34% effective US tax rate. I’ve put together a sample income statement of the parent company above that reflects a huge tax savings thanks to inter-company dealings.
Recommendations
* Start Your Own Small Business: I encourage everyone to start their own small business. You get a lot more flexibility with deductions as you can see in the example above. The best way to start a business is create a website like mine by signing up for a hosting company like Bluehost, which costs less than $4/month. You get a free domain name for one year too. Once you’ve got your simple website up and running, you help legitimize your business. There’s no need to incorporate as an LLC. Just be a sole proprietor, report your income on your schedule C, deduct all your expenses, and pay taxes on your operating profit.
Whenever I spend money on travel, it is largely a business expense because I’m always prospecting for potential clients. I expense a portion of my car lease payment given I drive down to the Peninsula to work at my consulting clients. Many of my meals are also expensed due to client luncheons and dinners. Finally, I contribute over $50,000 a year pre-tax to a Solo 401k because I run my own business. You can check out my step-by-step guide on how to start your own website today. Once you’ve got your own website, you’ve helped legitimized your business.
* Manage Your Finances In One Place: I recommend signing up for Personal Capital, a free financial management tool online that helps you track your net worth, analyze your investments for excessive fees, and manage your cash flow. I ran my 401k through their 401k Fee Analyzer and found out I was paying $1,700 a year in fees I had no idea I was paying!
They’ve also come out with their incredible Retirement Planning Calculator that uses your linked accounts to run a Monte Carlo simulation to figure out your financial future. You can input various income and expense variables to see the outcomes.
Increase your retirement success to 99% by living on less
Updated for 2019 and beyond.
Is this based on filing as sole proprietor or LLC?
As far as I know, most 401K contributions are already free from tax and so you can’t count it again as a deduction.
? What do you think a tax deduction is? It’s money you don’t have to pay taxes on. If you didn’t take it as a deduction you would be paying taxes for money that you put in your 401k.
Deductions for state taxes or mortgage interest are UNFAIR.
I have worked since 1970 and had several mortgages but have never had enought deductions to file long form. Why should I pay all my taxes when you rich people with your overpriced mansions get all these writeoffs?
GET RID OF ALL WRITEOFFS AND CREDITS!
FLAT TAX!
Better yet, replace federal income tax with a federal SALES tax!
We already have a sales tax is most states.
The $10,000 SALT cap for 2018 and beyond is a step in your direction + the doubling in standard deductions.
Financial Samurai,
I need help. I make 150k a year and have to save $1,500 each month to pay taxes at years end.
I have a lot of bills, mainly 3 mortgages on 2 homes totaling 9k, 450$ credit card payment, utilities, tuition and some life Insurance. I was thinking of getting a second job to pay for sons college but that would put me to save even more for taxes. I made a huge mistake investing heloc cash that was stolen in the great recession and suffering for it.
lets say your bought a building for $1 million. with the mortgage, you are paying close to $2 million. the mortgage interest deduction from the rental income is so tiny, is it really worth not buying the building with cash? at the end of the day is it worth paying more on the mortgage that what you will save on the taxes?
How much were you making at 25 years of age to be paying $100,000 in taxes? Asking for a friend!
Hey Sam,
Do you have a recommendation for a solo 401k that has cheaper fees? There’s a mention in the article, but no link to any particular one…
Thanks!
I am 60 yo, have 5 rental homes as a business. Another Business, Horse lessons. Wife is a contract computer person. Your examples are really geared toward 1 million dollar properties or more. my typical rental house is worth $200,000, interest $5000, HOA $400, tax = $2500, repairs $2000, income for one $16,000. Now, my plan has been to build an income, so I can retire and also leave my Son a money machine. 4 of the 5 homes will be paid off soon. I do realize, that locations change character and am planning on selling then buying in a different area utilizing the 1031 tax exchange. Have done before. But your example numbers are sort of like a hotel in New York. A bit scary. And yes, you have little money to live on. It all works if you have 5 million in the bank then do your examples. And I deduct everything I can and year end taxes just kill me.
I have employment income, and max out my contributions at 20% which is company matched. If I start my own business, can I contribute an additional amount to save additional taxes?
Also consider utilizing savings strategies that grow tax deferred and the money can grow with uninterrupted compound interest over long periods of time. This is called The Infinite Banking Concept. If done correctly, paying taxes only once on the seed and compounding over mulitple generations then you too can be like the Rockefellers and other wealthy Dynasties. Hence the reason I called my business Dynasty Banking!
Some interesting ideas. An HSA is like an IRA for all practical purposes if you have a high deductible health plan. This can shelter an additional 6700-7700 per year.
The paying interest is a sucker bet. If I have the option of paying 30,000 in interest or 30% of that 30,000 in taxes, I’m paying the tax…unless I am leveraging that money to make more. IF it’s interest on my own house, forget it.
Hi, I just graduated from college and got a new job this month in SF Bay Area. The income tax is very high, a total of 35% taken off from my salary. How should I avoid paying this much? Should I create an LLC or an s-corp and report losses to that side business? become a contractor?
What is the best way for a young single professional who is struggling to make ends meet due to high rent, deal with lowering taxes?
Hi,
This article doesn’t make sense. My gross income is around 150k-160k filing jointly. There is no way I can pay no taxes. Do you have any suggestion in my case. Also buying mortgage worth 1million you atleast need 200k as down payment and if you do not take home any money. You will never be able to buy any mortgage.
I can guarantee this genius and ethical hacker…i didn’t know how he did but all i know is that i contacted him after a friend referred me and he helped me with his hacking skills and since then i have been paying lesser tax
So in the first scenario you are taxed 15% on $20k ($3k). So you should subtract the difference from your 28% on $100k ($28k), meaning you get a tax refund of $25k each year?
I am confused. If I make only 23k a year now and want to stay in this tax bracket, what is my best way to lower my taxed income? Ira or 401k? also this is a little different but in my state I we get greatly subsidized health care is you make under 23k, if my income rises about to lets say 25k, is there a way I can put money away in such a way that my over all income stays below 23? Thanks!
if most of your income is from w2, having your own side business no matter how big or small and claiming a net loss is the way to reduce your taxes.
I have a friend that has a wine blog where he makes about 10k a year off ads and consulting. He deducts almost 100k in actual wine as business expenses (he needs to drink wine in order to blog about it no?) and claims a 90k loss that he writes against his w2 income. Party will probably end for him soon but so far it’s been good (he has claimed net profit some years).
WHY WORK??
ugh.. it’s tax season again and I’ve been dreading it..
I just got my taxes back and I have to write a check to Feds for an additional $19k for a total 2016 tax bill of $88k AND to the great state of CA, I have to write a check for an additional $8k for a total CA tax of $28069.. Thanks to $6k on AMT and another $3k for O’bamacare tax.
I’m 58 and have been asking myself, why should I bother to keep working when i’m paying 37% for taxes (37% when you add Fed, State, SS, Medicare tax. Thankfully I have enough to retire on, so I think this may be the year!!
It makes me sick paying this to the gov for worthless wars and welfare for those that choose not to work or take advantage of the system.. Yes, I’ve become very cynical in my old age…
I can stop working.. pull out $72k annually from my investments, and save $20k per year by getting subsidized health care from O’bummer.. and sit on the beach drinking mai-tai’s!
Exactly. I stopped in 2012 to make much less money and I am SO MUCH HAPPIER! The best thing I’ve done is start a business with this website and be more free.
You can always go John Galt too :)
I guess I’m WAY out of your league for this to help me. I raised 3 kids who are all out on their own now. I work as a school nurse and another part-time job on the weekends for a total of $35K. Because my kids are grown and because I am within 10 months of paying off my home, I am paying Federal AND State taxes this year. They want another $1,000 of my money so that what I tried to save for an emergency will now be depleted. How can these principals work in my situation??
Just so you know, I file single and I have an excellent credit score of 825. I have credit card debt of about $2500. I’m afraid allowing more to be taken out of my paycheck will result in my not being able to pay household expenses. Any thoughts???
if you are not already, you could reduce your taxable income by putting into a 401k if your company offered it, or an IRA if your company did not offer it..
But taking more money out she my not be able to make monthly expenses?
I filled for bankruptcy chapter 7, 6 months ago, and got a letter 2 moths ago that i was granted and my case was closed. Couple days ago i received a letter from Arizona Department of Revenue saying i owe taxes from period ending in 12/31/2004., 12 years ago, and that i have 15 days to pay. According to them i owed 240.07 but they are now charging me 466.64 Is this right. I feel like this is buishit. They are calling it Bankruptcy Discharge. Should fight against this. Can they charge me for tax that i never knew, and never received anything from them in 12 years. Can someone help me on how to deal with this. I don’t hear pay for it. I think is an absurd. thank you.
Send them a copy of your bankruptcy discharge. It is also helpful if you can get in touch with an individual revenue agent and get them to look at your case. Do not pay anything no matter what they tell you, a single payment could be construed as affirmation of your debt and will only spur them on to collect the rest of it and possibly other taxes you might not know about either.
I cannot agree with you more on multiple points, great article, great way of thinking, thank you for sharing.
You will see my email ID with this comment, you mention that for the past several years you have been doing your own taxes so that you can understand the nuances and create pro forma scenarios such as AMT etc, do you have those in Excel that I can see? I have been trying hard to create an Excel that replicates the 1040 but it’s proving to be next to impossible.
Please help! I just turned 33. Have been working as a business owner in a hectic, high risk, exhausting industry for 13 years hoping for the right opportunity to come along and just as I was about to throw in the towel and take a new direction in life…. BAM! $800k in profit over the past year. Most of my business expenses related to this profit were incurred before the end of 2014 and I collected most of the receivables this year without many expenses to offset the income. I file cash basis as an S-Corp. This is pretty much a one shot business lick. I haven’t made any decent new money in 2015 and I may never make decent money again in this industry. I’ve maxed out retirement accounts (SEP IRA) and spent money on everything that I can justify for the business that has some amount of benefit to me professionally. After all this my CPA is telling me that I’m in the highest tax bracket and where I sit currently for 2015 I’ll owe approximately $185k in taxes!!! I just can’t stomach that amount. I feel like there has to be ways to not give the government that kind of money to squander. I risked every dime I had to invest into this high risk endeavor, slept on a blowup mattress for 10 months 1500 miles away from home and worked 12-14 hrs a day 7 days a week to make it happen. I stuck it out in a crazy business that has robbed me of any normal social life (constantly moving around the country), worked my tail off and risked it all and was fortunate enough to be in a good place at the right time and take advantage of an opportunity with every bit of energy I could muster. Bottom line is I don’t have faith in the wasteful, runaway train monster governments and don’t want to give them my hard earned money that I want to use to stabilize my family, finally. I know there’s lots of details someone that might be interested in helping me or providing insight would need to know to do so that I’d be happy to provide. I don’t have any mentors with the right experience to turn to so I’m looking for input out here on the web. Any guidance would be much appreciated. Thanks! Randall
Randall,
I agree with your CPA, maybe because I am a CPA, but mostly because I know there is no legal way out of it. I’ve seen many people in similar situations, they make a bunch of money one year and come in thinking there is some kind of magic dust that takes away tax obligations. That’s what good CPA’s do right? Unfortunately you have to get creative and do things like not receive the money in a certain year and even that strategy is dangerous because the wording of the law say’s something like “receive or could have received” payment for goods/services rendered.
I will caution you to not go in for scams that promise to eliminate your tax bill because chances are if you fall for one of these, you will wish to God you had just paid your taxes when faced with actual jail time, penalties and attorney fees.
Increasing business expenses has got to be the easiest most joyful way to enjoy life. Buy more assets which create more income. ;)
I like your examples Sam, but why not just live very low key? That 61,000 in passive income won’t have you paying more than $10000 in taxes (even living in California). I believe that we all should try to live by the old Spartan adage of never showing wealth. That Lamborgini over there? That’s for suckers… only making the Italians richer. So an extra $40000 a year is way better in my book–something a good investor could turn into over a billion dollars. And that’s power, and freedom to start great businesses for the sake of humanity.
I believe almost everyone is capable of the following:
Step one: get rid of all debt. Any debt over 4% get rid of it. Let’s face it, if you are not a spectacular investor, it is most likely not worth the risk. Without it, you’ll probably have a much clearer head anyway.
Step two: Decide why and where you want to live.
Step three: Locate suitable piece of land, water etc… Decide on a travel trailer, fifth wheel, boat, tiny house, stone house… As a slightly worse alternative, consider owner financing that land, renting it, or buying a fixer upper. But remember a house is not an investment! Thousands of dollars (I mean millions) in property taxes and maintenance are being discarded which could otherwise be put to use in the market or a hedge against inflation (Private gold/metals).
All for quality of life or take a gamble on the corporate ladder? No thanks. I’d rather keep all my money than give 85% of it back to interest, taxes, healthcare, and living expenses. A personal business is a much safer bet, or an educated gamble with infinity times the reward. You must know that since you started this blog, right?
Sure, sounds good. What’s your current situation now e.g. age, net worth, passive income, occupation etc?
I’ve got a new passive income post update for 2016 you can check out here. Progress!
Just wondering if anyone could answer this. If I earned $40,000 at my job, would the federal income tax be roughly the same as if I retired and earned the same amount in only dividends? Thx
Probably yes since the dividend tax rate is 15% and $40,000 income is also around 15%. You’re golden if you can get $40,000 in dividends. That’s a $1,000,000 portfolio at 4%. Not bad.
This is easy.
1) Move to Alaska or Florida
2) Be or get married
3) Earn up to $94,100 in Qualified Dividend Income
Federal Income Tax = 0
State income Tax = 0
So easy, I wonder why more people don’t do it?
I understand bringing income to zero. But if you do that and you need a loan or a credit card with a greater credit line for your business–how do you do that? They ask for tax returns…tax returns that show zero income don’t float well with banks, credit card companies or mortgage companies. No financial institution seems to care about the amount of money flowing through your accounts. Just curious.
Thanks
You’re right. The answer is that you probably can’t get a loan. Get the loan first while you’re paying taxes, and then get that income down to a level where you don’t pay taxes.
“I don’t mind paying my fair share of taxes”. This is a mindset we need to change. Just what our “fair share” is have we become, like cattle, so used to?
The 1776 American Revolution was started over a ONE PERCENT tea tax. There was NO personal income tax until 1913. When the Income Tax was first enacted, it was done so to pay for the costs of World War I. It was promised that once that war was over, the Income Tax would be repealed. It was not. Liars. When the Income Tax was first enforced, one had to make at least $40,000 to be taxed AT ALL…and was only taxed at ONE PERCENT. If you made $40,000 in 1913, you could live like a king! Yet today, the sheeple who struggle to make ends meet are content to be robbed, at what amounts to gunpoint, of a THIRD of their income by the government. Add state and local taxes and “fees” (disguised taxes) and we are raped and robbed of HALF our annual income.
Abolish the current Income Tax system, which is now more oppressive than RUSSIA’s, and replace it with a low, flat income tax, with no loopholes.
I have a few questions on paying little taxes.
Let’s assume you have a well paying job and are able to put away 20k per year in a 401k (pre-tax). You also end up buying two rental properties.
The rental properties produce about 30k but you have 15k in operating expenses as well as mortgage interest etc. You can then also deduct about 12k for property depreciation. So you would only have to pay taxes on about 3k (30k-15k-12k=3k).
So now you decide to quit your job and roll over your 401k into a pre-tax IRA.
You are able to frugally live from rental income and do not get a job again.
In this situation:
1) Is it possible to roll over a few thousand dollars from the IRA to the Roth IRA every year, just enough to stay in the 10% federal tax bracket? (e.g. 10k minus rental income)
2) Would you be able to get free Obamacare Health insurance because your AGI is under 12k per year? (full subsidy amount for single filers making under 12k) Despite the fact that your income is obviously higher but your deducting most of it with operating expenses etc?
3) To top it off, could you get a very low paying job for about 2k per year (think working for a few weeks in a summer camp or something like that) and contribute those 2k to a ROTH IRA, therefore qualifying for a $1,000 tax credit? (50% tax credit on up to $2k for single filers making under $18k) –> still insuring that the overall tax AGI stays around $10k/year to stay in the 10% tax bracket.
Are there any flaws with my line of thinking?
Makes sense. And if you need money, just take from savings.
The government doesn’t tax wealth over $5.4 million (death tax). Focus on growing net worth over growing income!
Interesting article. If there was a way to have a decent income and not pay taxes, the government would shut that down in a hurry.
I used to prepare taxes for individuals and businesses, and I have yet to see anything that really eliminates taxes beyond the obvious stuff like 401K contributions and charitable deductions. There was one return that I worked on where someone purchased some hideous looking yard sculptures, let them sit around for several years, had them appraised at pretty high values and then donated them to some organization. The taxpayer got the benefit of the appreciated value of 25K for each piece of “art”, which was probably BS and paid a lot less in taxes. I think the key to making this whole thing work is buying something from a semi-legitimate artist and then finding an appraiser who knows how to justify the high value of your unique art. Plus you really have to let the things sit around for a while to justify the appreciation in value.
Other than that, the best way to avoid taxes is to have a small business and cheat. Buy a new car and say it is 100% business while keeping a junker that you claim is a daily driver. Cheating on your taxes is like speeding on the interstate, a little over the limit isn’t going to get you into much trouble, but too much will land you in jail.
By the way, I will never admit to writing this article.
Mike – I think you’re pretty spot on. The only way to really not pay taxes is to cheat. Gotta love cash only businesses and huge deductibles that are obviously not real.
But here’s a good post I wrote on “Tax Rules for using your SUV as a tax deduction“.
Well one option that’s rarely mentioned is to simply make less money. We made the decision to go part time last year, couldn’t be happier. We did the math and between federal, state, local, medicare, and SS taxes 40% of our income came off the top. Add transportation costs, over half our income is gone. Going part time put us in lower federal and state brackets, now we’re taxed about 25% of our incom3. Time is money, I’m not interested in being taxed out of 50% of my life.
Sad but true Nick, high tax rates take away the incentive to work. Take a manager job that pays 25% more than a worker job for example, the manager pays more taxes, has more responsibility, probably has to work more hours and probably has to pick up the phone during off hours. Is it worth it? For many the answer is no. Thank you progressive tax system.
Hi Sam, thanks for the piece. I just wanted to add that a Solo 401k, while great, may not be applicable as most small-business owners who employ full-time employees will have to make equal contributions to all employee accounts. Of course, there are certain ways to circumvent this by hiring only employees who are non-resident alien, or union, or under 21, etc. but attempting to do so often ends up being more hassle than its worth. However, I would definitely recommend a solo 401k for anyone who’s an independent real estate agent, accountant, lawyer, tax professional or in any business only with their spouse and/or children as employees. As a retailer, I just don’t think the cupcake shop is the most fitting example here as its difficult to adhere to all the eligibility rules of a solo 401k in a restaurant business.
i am an 80 year old retired businessman. I am selling my business to my son under a formula that is good for both of us. this morning I received information on the business from my cpa and i am, paying on 250k. I was astounded at the amount. I do not want to go to work again on a startup company. I am an S corp.
I just stumbled upon this forum. If I am planning to make dividends & capital gains my sole income (disabled, very low expenses, house paid off, not near retirement age), should I do it through a corporation (& which type, S-corp, LLC., etc?) or just as an individual? Which way would be most beneficial tax-wise? Any thoughts? Confused.
I know this is an older fourm but how much would I have to donate in order to pay no income taxes. I make less than 25k a year and have no assets. I just feel the feds are misusing my funds. This year (2014) will be the 1st year I will not get anything back due to being self employed.
Without knowing all your details, I don’t know. How much in taxes are you paying now? If you make less than $10,000, you shouldn’t have to pay any federal income taxes at least.
Interesting post Sam. I’m just not sure how capital efficient it would be to save up $100-$200k to sit around in a saving account earning no interest which you draw down to live on. I assume you aren’t suggesting selling capital assets like your shares that are producing dividend income, which you’d incur capital gains on, nor other capital assets that you would incur tax on from a sale. The potential “lost income” from that $100k sitting there possibly something like $5-10k /yr? But perhaps, based on the example illustrated, you have $60k passive income coming in anyway that this isn’t such an issue :)
What percentage of the 1 percent own businesses? I feel that many of the one percenters make way more than 380,000, but use tax shields as the ones you described to show less income.
Well, I will soon be paying taxes on 6.4% less of my paycheck, since I’ve bumped my 401k up another 1% ).
Many thanks for the thoughts you post here and on Yakezie, trying to push everyone to put away as much as they can every year!
Congrats! Careful. Saving massive money will become addicting!
It has become a very fun indeed!
Great post, I’ve been thinking along the exact same lines recently.
After the standard deductions I have been thinking to donate increasingly large amounts to charities that fit my purpose, rather than allow the Govt to waste more of my tax dollars. I believe that you can donate up to 50% of your AGI which will wipe out taxes from all but the highest income earners.
Better to donate to someone in need rather than donate to the Goverment of greed.
BTW what about the minimum alternative tax?
Secondly depending what province you live in you can earn up to 75,000 dollars almost tax free in Canada.
The AMT is a tough one, but doesn’t really start hitting until after making $150,000 or thereabouts. With $150k you can bring your AGI down to around $100k or less and AMT will be minimal if nothing. It’s case by case.
$200k is my ideal income for Max happiness. Much more and the government starts getting you and deductions start getting phased out.
A quick note on German taxes, it’s based generally on family income, so my wife earning 6 figures takes home approx 64%, of I worked I would lose over half of it. A single person usually loses around 50% to tax.
Secondly while Germany is hurting due to an ageing population (mostly on healthcare), overall it’s doing very well, everyone and their brother from Spain is moving here.
Very odd but Germans are a nation of renters, not unusual to meet people who’ve rented the same place their whole life.
Best to get married then it sounds like! In the US we have a marriage Penalty tax. It’s crazy.
Interesting insight on renters vs owners. Might want to check that to corroborate. In US about 62% own.
I wish we had the same options in the UK. Like Steffen in Germany, we have it rough!
I’m sure you do! Who is the Financial Samurai of the UK to write this similar article for you?
S-Corp does seem better to save on the 12% in payroll taxes. Just gotta pay yourself a reasonable amount though. I wonder why entrepreneurs can’t get unemployment benefits…. or can they.
Make the move Marvin! I definitely plan to no longer feed as much to the beast as possible. It feels great not working anymore and being able to finally enjoy some of my contributions.
It seems the only way to do this is to own property. But I also imagine that owning property is more expensive than renting. Even though you’re saving on the tax deductions, you’re still saving on “interest” that is money you are losing to the bank. The business concept makes more sense, albeit requiring a lot of time. I make about $110k a year right now, s/o makes $0, so I don’t know if this would be a valuable exercise for me. I’m considering buying a condo right now and don’t fully understand the cost benefits versus renting, so need to do my research. Everyone says that the tax benefit of owning is so great but I try to do the math and it just doesn’t add up.
Depends on where you are. It would literally cost 2X more to rent my house now that the interest and property tax I’m paying. Of course, I bought my house years ago. In SF, the breakeven is about 2.5 years. In many other places, it’s cheaper to own.
the best way is to move to HK :P
But then one might die early from the pollution from China! And the fact that it costs $10,000 a month for a 1,700sqft 3 bedroom in mid levels.
“Ever since I was 25, I paid more than $100,000 a year in taxes.”
So basically >$300k/year in income from 25 onward? That’s very impressive. What was your past life again (IB, HF, or PE)?
Check this post out: How To Make Six Figures At Almost Any Age
There’s a good chance if you live in a free world, and want to make more money, you can do it. The post shares some guidance.
Thailand has dropped all their tax rates for 2013… my effective tax rate is down to 23% or so… still over what I’d pay in the USA with the foreign income exclusions so all is well!
Here’s to starving the beast a little bit more!
-Mike
23% ain’t bad at all Mike! What would you pay in the US if it was apples to apples?
Skinny beast, here we come!
I would guess that, including state taxes and social security / medicare, I’d be at an effective tax rate of 30%…
-Mike
@Jane, Mr. Romney has paid more than 13% of his income to charities for the past 20 years, including $4 million (more than 29%) in 2011. That is on top of the 13.5% in Federal Income tax, plus he paid State, Property, and other tax. Hope this is of interest to you.
A lot of Americans are wondering whether we can migrate up north during retirement to take advantage of free healthcare without having to pay a lifetime of income taxes. Thoughts on whether we’d be welcome?
I’ve been considering a retirement vehicle for my TCI earnings to shelter them from the tax man while saving for retirement. I see you mention a solo 401k, but what other options are there? Do you use anything?
Solo 401K and pertinent expenses are the best way I’ve found. After you max out your solo 401K to around $50,000, then you can use your mortgage interest shield.
Sam, These posts get better and better man! I paid very close attention to this one, since I am about to go from a six figure government job to a six figure CONSULTING gig for myself. And I am extremely worried about taxes! I’ll be reading this one over and over…
Congrats on the new gig Tony! I hope you do get those six figures in consulting. You’ll pay less taxes for sure due to the business expenses, however, just make sure you compare what you have in cash or on the balance sheet after each month.
In 2010 Romney paid $6.2 million in federal taxes. Seems like plenty to me.
Sam, you should write a post about what you did for a living and tips for recent grads who want to follow in your career footsteps! It seems like you made a lot more money than the average Joe.
Sure. But let me collect all my deferred compensation first. Might take a while though!
I hope they come w/ a fruit basket and find some unclaimed expenses and refunds they owe me!
One of the government’s biggest worries is people waking up to see the truth. It’s kind of like the Matrix. The government needs to keep the people in a zombie-like stake in order to maintain control.
The smartest thing the gov’t did was allow for massive ROTH IRA conversions to trick citizens into paying more taxes up front during the financial crisis. Genius by them. Silly rabbits for those who fell for their trick.
I always thought the same thing.. why would I want to pay taxes NOW vs later when I retire.. everyone would tell me, you’re taxes will be higher in retirement.. but I don’t see that happening.. they are sky high now..
Just remember – for each $ spent on interst – your taxes decrease by your top maringal tax rate. Thus, if you spend $10,000 a year in interest, your taxes decrease by only $2,500 (assuming your top rate is 25%). Addtionally, the “savings” only relates to $ above the standard deduction. If the standard deduction is $8,000 and your itimized deductions are $10,000 – your savings is only $500 (25% of $2,000).
What I’m trying to say is – paying interest on a mortgage is not all its cracked up to be.
Pay as little mortgage interst as you possibly can!!!!!
It depends on income. Which is why around a $200,000 AGI is the best balance imo to take advantage of the deductions, stay under the populace and gov’t radar, and live a merry life.
If you have to live somewhere, you might as well live in a nice place and take advantage of government gifts. The mortgage interest deduction is a secondary or tertiary benefit. The biggest benefit is living in a place you love where nobody can kick you out or tell you what to do.
What’s your homeownerhsip situation again David?
I own a condo that I bought 5 years ago with a 15 year mortgage.
I have been paying extra on my mortgage and thus have paid off more than half of the principle in 5 years.
I refinanced to a 10 year mortgage 3 years go.
I was just trying to make the point that the mortgage interest deduction is not the panacea that some people think it is.
Jane, is 25% your top marginal tax rate? What’s your total effective tax rate? I’ve always heard Canada is higher, around 40%. If you’re only paying 25% in total income tax, that is GREAT! Exect a migration from Americans up north for free health care.
Romeny makes money through long term capital gains. That is what we all need to move towards. Working for money is for fools, according to the gov’t.
It’s very important to differentiate between margina and effective.
The effective tax rate for someone making $500,000 is around 30%. But, the highest marginal tax rate for someone making $500,000 is now 39.6% (anything over $400,000). Effective tax is your tax bill divided by total income.
I think what the goverment doesn’t get is that the people who are smart enough to be the top earners in our society will either figure out how to circumvent a the system, or just generally be disenfanchised and quit working so hard to earn more. Why be responsible and work hard to give to a goverment that proves they cannot grasp fiscal responsibility? I used to be happy paying my fair share, but when I hear our Pres. explaining how he wants to expand our goverment and entitlements it makes me sick to my stomach. My tax bill will go down guaranteed, my income will not.
I read a study that a flat tax of 15% above a certain income level is the best tax rate to generate the most revenue because it is low enough for tax cheats to stop cheating, low enough for people to stay motivated, and high enough to maximize returns. Makes sense to me. Take out all deductions, tax at 15% and watch revenue surge.
Just look at Hong Kong and Singapore with their 15-20% flat tax rate. Budget surpluses and their economies are booming. Unfortunately, we aren’t as small and nimble as them. So let’s look at RUSSIA! Huge country and also a flat tax of under 15%.
Sam, you had mentioned that rate before, and I have read it elsewhere. Not asking for info you are uncomfortable discussing, but your conversation with the Undersecretary of the Treasury sounds very compelling. If you ever had thoughts on implementing that rate, and reconciling it with expenditures, I would love to read your analysis.
So many variables outside of the ‘lab’, though, including population growth/decline, existing debt, and mainly the ability to enforce payment.
A flat tax sounds like a great idea, but I just can’t see it happening. Beyond the ineptitude of the gov’t, there is a huge tax preparation and help industry that doesn’t want to see their business dry up when everyone only has to compute 15% of income to do their taxes!
Actually, in Russia income tax rate is 13% for residents.
However, if you’re operating a business as an entrepreneur you can pay either 6% (!!!) from net income or 15% from income minus expenses.
I don’t mind paying taxes but I would definitely like to pas as little as possible!
Complex tax rules? Ha, I come from the country which produces about 2/3 of the world’s tax literature, or so they say. Someone will have to test if it works similarly in a country like Germany. (Go Steffen! Do it!)
I hate taxes!
Which begs the question, which country do you come from?
Socialist Republic of Germany ;)
I thought Germany is like the America of Europe! Strong, powerful, and ready to bail out everybody?
Germany has to be better than Norway, Sweden, Holland, Belgium no? I took a business trip there last year, but folks were so happy there!
https://www.financialsamurai.com/2012/10/04/learning-from-the-worlds-happiest-people/
Germany might be the least ugly of those by fiscal and economical data. But still broke, like the others. Some day someone is going to have to eat the losses. Actually sorry…the savers of the world are already paying the bill.
Btw, if you believe in freedom and individualism the “happiness of a people” doesn’t make much sense, right? Who made this happiness statistics? Someone campaigning for office, planning new handouts?
I can tell you that at least once a month as an employee you shed some tears when about 50%-60% of your salary end up in political coffers.
It really is mind boggling how complex our tax rules are. Understanding basics like the difference between standard and itemized deductions goes a long way. I love how we have software like H&R to help fill out all those confusing forms, and that we can use those programs as learning tools to see how various changes impact how much one could owe or get refunded. Each year I feel like I learn something new about taxes and even though it doesn’t make paying taxes less painful, it makes me feel more aware and smarter about how I use my money.
My biggest annoyance is that the gov’t keeps CHANGING the tax code every single year, so that means there are more booby traps the gov’t can lay to penalize us.
The IRS are really nice folks though. They know the tax code is ridiculous, but they won’t stop to charge sky high interest rate penalties and wait 3 years before they ask to maximize their returns!
At some point I hope to reduce my taxes through legal means similarly to this, but at some point its money vs time (and you Sam have some money) so unless you find tax sheltering yourself inherently ‘fun’ it may be easier to skip some of the accounting and mortgage refis and just pay up. Not saying you should… I’m doing a refi though and its dreadfully boring. I have to remind myself about all the money were saving to do paperwork. But then in real life I make games so maybe my ‘fun’ bar is high. Or weird.
It actually is fun to figure out the best way to minimize expenses while trying to live the most fulfilling life possible. After a certain point, we don’t need much more to survive. Everything else becomes almost like a game. Up to us to find a balance and do something if we are out of balance.
If you’re retired, good for you…make certain you look into trusts to hold your ownings so when you get old if you have medical needs the gov’t doesn’t get their claws on your bank account and assets and they are protected for any family or friends you will them to. Better anyone but the gov’t.
I do not think I could afford it. Additionally, I think the ATM is likely to not allow you to bring your taxes to zero.
Carrying a huge mortgage in order to cut down on your tax bill is one of the worst pieces of financial advice I have ever heard. You are basically spending a dollar to save 35 cents (after you exceed the standard deduction), while the rest of your interest payment goes to the bank. Sure, you can make the argument that everyone needs a place to live, but that is no reason to buy more house than you need in order to get a bigger tax write off.
Read the disclaimer :)
I think this is about avoiding taxes, not about saving money overall. Bonus: get a really nice place to live at a slight discount.
Rather pay the bank with a chance to build wealth than pay the government. Please share with us your income and tax minimization strategies. Can you afford a $1 million mortgage?
You may enjoy this article: https://www.financialsamurai.com/2012/10/16/real-estate-is-my-favorite-investment-asset-class/
I have to agree, too much debt is what causes empires to fall. I could easily qualify and take $1M mortage on my home at some ridiculously low rate. Yes the math says do it, common sense says “are you freaking crazy, you have a paid for home”. The way to build REAL wealth is to be debt free, then build your alternative revenue streams. The goal with a home should be a roof over your head that gives you the lifestyle you want, a home is an expense, not an investment. Yes, there is a high probality that over time it will appreciate in value DO NOT COUNT ON THIS! Buy what you can afford & pay it off, once you do you’ll be shocked how fast your wealth accumulates! I love the general idea of being creative to pay less taxes, it is something I’m definitely spending time on.
Exactly. The housing stock for ownership is so superior here in SF that I did not want to rent.
Folks shouldn’t be afraid of a mortgage if they have the cash. It’s just accounting. I’d rather have $1 million to invest at over a 2.6% rate of return and be liquid and have the tax benefits than tie it up in a house. Of course, if you can’t afford a mortgage, don’t get it.
Imagine living in your house and waking up 20 years later to find out you not only didn’t have to pay rent, your house actually made you money.
Sam’s strategy is extremely effective when the real estate property is appreciating, and the difference between the mortgage APR (i.e. 2.6%, wow! My first mortgage was 10.5%, and I thought it could never go lower after 5%) and the invested difference (stocks returned 7.5%/yr over 2011/12, for a net of 4.9%/yr) is positive. For the past two years, Sam would have benefitted at $78,400, plus whatever capital appreciation to his home would have been ($250,000 cap gains tax free for single filers, after 2 years occupancy of primary residence).
Smart!
However, when the real estate market declines 15%/yr, the equity investments also decline 10%/yr, and one realizes they are paying (in my case 5%/yr) for the privilege of losing money while paying for a home eventually sold for 30% less than one paid, I can feel pretty stupid! Um, I mean, one can feel pretty stupid!
For the risk-averse, one might consider the investment directly into paying off the outstanding mortgage, an equivalent 2.6%/yr return, while freeing up cashflow and eliminating risk to that portion of one’s net worth.
It’s like adjusting one’s sunglasses, once you get started there is no end to it!:-)
But your house declines in value in a down market whether you pay the entire mortgage off or not! I’d much rather have $1 million liquid and NOT tied up in a house than the other way around.
Also, the topic of this post is tax minimization not real estate investing. Up or down market, a mortgage will shield income from taxes.
Absolutely. The $800K paying off the mortgage no longer produces passive income, but an implied return equivalent to the mortgage APR; tax minimization from the other side, no longer having to be offset by deductions. I wasn’t criticizing your decision, it makes excellent sense and you are doing just fine with your strategy. My real-life example is not for most, just the risk-averse.
No complaints from me to minimize taxes.
I love this site.
A tip as I just started a consulting business and recently discovered that section 129 and depreciation is your friend. Especially if you have other sources of income besides your startup business. Bonus depreciation is an interesting subject that people with a small business should know about.
Great article Sam. Definitely makes me interested in owning my own business in the future.
Quick note, I think in example 2, you meant to say depreciation instead of amortization. Amortization refers to spreading the cost of an asset over a period of time; where depreciation is a non-cash expense that you prorates the cost of an asset (like you describe with the rental property).
Thanks Mark. I had depreciation in the writing, but amortization in the charts. Corrected.
I never understood the power that owning a business brings to doing your taxes until I marred The Wife. It was amazing that first tax year!
and then they say business/corporate tax is too high…
I think this article is geared toward a retiree…?
Although starting a side business is a great way to optimize your taxes it seems. Despite all the rhetoric about “simplifying the tax code” … not sure that’ll happen in the next 40 years (my estimated retirement… I like working).
It may be, since I am retired, but it’s not. You can replace the Passive Income portion with W2 active income of $60,000 and the math still works.
No, this article is for anyone who makes less than $10,000 a year or who can reduce their higher income to zero.
Did you know that people who make less than $10,000 a year from what is considered ordinary income are not required to file an income tax return ?
If you go the IRS [dot] gov website and browse to Individual Taxpayer webpage there is a tool (webpage) that you can use to verify what I am saying is actually “TRUE”. People who make less than $10,000 are not required to file an income tax return.
How can this be possible ? Well, if a person has ordinary income from one or more jobs, the employer takes out all necessary taxes and if done correctly where enough taxes (Social Security, Medicare, Income taxes) and a person makes less than $10,000 that person will not owe any income taxes after all deductions are made if they were to file an income tax return. Resulting in “no taxes due” on their income and no requirement to file an income tax return.
Normally, this would only apply to people with ordinary income but, there is a way for people who are self employed to have the benefit of not having to file an income tax return. I say benefit because and as you will see, this opens a door for those who do not want to be part of ObamaCare or Medicaid. Yep, this is also true.
Under the Affordable Care Act those who are NOT required to file a income tax return are not required to maintain health insurance. Its that simple !
Forgot to mention the best part of all: You can file “EXEMPT” on your W4 and not pay income taxes all year just to get it back at the end of the year !!!!!
Do your own research and you will see that you can also not file an income tax return providing you make less than $10,000 of ordinary income, however, there is a way for people who are self-employed to repeat the benefits of non-income tax filing.
Its too late to effect your 2014 year income but, you can start on your 2015 self-employment tax quarterly payments. That’s Right ? Do you see where this is going ?
As a self-employed person who makes less than $10,000 a year can file quarterly Self-employment tax payments and if you do it right ! You will not be required to file a Federal Income Tax filing at the end of the year. Now, this will not help those who have children and need to deduct losses and carry those losses to future years but, if you are like me ? Good-bye to filing Federal Income Tax forms and Good Riddance to OBAMACARE !
Forgot to mention the best part of all: You can file “EXEMPT” on your W4 and not pay income taxes all year just to get it back at the end of the year !!!!!
In example 2 you have a line item for HOA. Is it really possible to deduct HOA fees on an Owner Occupied home? I pay about $3000/yr and would love to be able to itemize this expense.
No you can only do this for rental properties.
So you can end up renting a house from a company, which you own, so that that company can write off the HOA fees…
Is this really legal? Can you please send more info about this? I didn’t find much info how to do it.
I think anyway to reduce the amount spent to a runaway government is a good thing. I think that our government needs to start reducing the spending, and programs, and everything else that we have got and perhaps focus on the following: trade and war. Anyway, I think you’ve covered a good post here to find ways to reduce taxes overall.
I like the thought, but how does one live? The zeroing of income is using deductible expenses however eating and living etc are not deductible. In addition, there is the principal portion of the mortgage which is not deductible.
Through savings. Not sure why you think the principal portion of a mortgage would be deductible. then there would never be any taxes to pay as everybody would borrow up to the exact amount of their income forever.
Since you zeroed the income for tax purposes, there is no money to pay for the small portion of the payment that is the principal as well as food, clothes, utilities and other living expenses. All these things are not deductible.
The only way you can legally reduce your taxes is to use depreciation as a way to shelter your income. Unfortunately, that runs out too.
Plenty of businesses with accounts at Sams Club or Costco.
Plenty of real estate owned by businesses.
Corporate accounts exist for every facet of life.
Your savings will be with post tax dollars…so you’re not really dodging the taxes so to speak. Using deductions whereever possible is absolutely a good idea, but the idea that you can live on an income and deduct all of it isn’t realistic…you can’t deduct expenses you need. Yes you can have your deductions offset your income but then you’re living off of savings…which if your savings is insanely large, good for you…but as you built that savings, you paid taxes on it…
Unfortunately, it’s death and taxes…
You should discuss the concept of positive leverage, which is when you borrow money at 4% interest on a real estate investment that produces a 6% return. The more you borrow and the better leverage you get, the more it amplifies your return. Example below:
$300,000 down, $700,000 loan at 4% on a $1,000,000 real estate investment offering a 6% annual return or $60,000.
$60,000 less $28,000 ($700k @ 4%) equals $32,000
$32,000 divided by your $300k down payment equals a 10.67% ROI
That beats an all cash 6% return on a $1M down payment with no loan.
It’s all about return on your dollars invested. Banks do the same thing. They pay you nothing in interest on your savings and lend it out to real estate investors like me at 4%, which I turn around and invest at 6%.
That’s why it makes sense to borrow money, if you are earning more than you are paying. Otherwise, you don’t borrow.
See: Increasing Passive Income Through Leverage and Arbitrage
Ive just learned this by what Robert Kiwasaki just said on youtube, many people don’t know this ! I’m so excited, but people really need to Read that . Its crazy, but difficult to…Fatham.
I guess you can live on saving if your expense is low enough. That’s not an option for most people though because their saving will run out pretty quickly.