Liz and I are idiots. While many of our friends have paid nearly nothing in taxes, we found ourselves paying over $22,000 to Uncle Sam in 2015. “How could this be??” we started asking ourselves. It was time to man up and dig into our (*yawn*) tax detail. Pretty boring, but quite necessary if we wanted to stop paying obscene amounts of money to the government.
8 Ways to Pay Less In Taxes
What’s the typical question that people ask when tax time rolls around? You got it:
“How much did you get back in taxes?”
Here’s how it typically goes:
One co-worker gets a huge smile on her face and proclaims, “I got $4,000 back this year”. Another employee pipes up, “I got $4,200!” They gaze into the distance, already dreaming about what they’ll do with their monstrous income tax returns.
This is where I typically smile and say something like, “I owed $600”. They look at me with pity and express their sympathies for my misfortune, while I pitied them because they gave Uncle Sam their money for an entire year free of charge. For the longest time, I thought that this made me smart and by default made them stupid…but neither of us had the whole story…
They paid money into the government all year and received money back. I paid money into the government all year and owed a bit more. But how much in total did each of us pay?? That’s the real question that needs to be asked, and it’s typically the question that nobody has the answer to:
“How much did you pay in taxes this year?”
This is the right question, and it’s the question that Liz and I just recently started asking ourselves this year. When I dug into our tax documents I woefully discovered the answer: $22,000. REALLY?? We’re giving the government a brand new car each year so that they can do wheelies and donuts (while occasionally doing good and giving an old lady a ride across town) with it?? Yeah…I don’t think so. It’s time to start paying less in taxes.
This is our plan. I hope it will work for you too!
1) Stop Trusting Our CPA
Our tax guy is good at filling out our taxes properly so we don’t get audited. That’s his job. What he’s not good at (and doesn’t necessarily get paid to do) is giving us pointers about how to reduce our tax liability each year. For the first time in my life, I realize that that responsibility is on me…hence, this article.
Our tax guy is there to file our taxes, NOT to save us money. If we want to pay less in taxes, we simply need to start paying attention.
2) Have a Child
In about 3 weeks, Liz and I will bring our first child into the world. Now, of course we didn’t have a kid so that we could pay less in taxes. Given the extra expense of raising a child, I’m almost certain that the tax deductions and credits will never work out in our favor. BUT, since we want to have kids anyway, the tax help is just an added bonus!
For each dependent in 2015, $4,000 is deducted off from your earnings. Between Liz and I, we earned a credit of $8,000. Now, with another dependent, we can deduct $12,000 off from our taxable income!
Beyond this, there is also a $1,000 child credit that we might qualify for. If it turns out that we owe $5,000 in taxes, then we’ll apply the child credit and only owe $4,000. It’s another pretty sweet deal.
Five years ago, I probably wouldn’t have been able to tell you what an HSA fund was. Today, I’m a huge advocate of the Health Savings Account. Through your work, you can easily contribute tax free money up to $3,350 as a single and $6,750 as a couple. Then, you can use this money tax free on most things health related. Things like:
- medical surgeries
- dental procedures and visits – think crown, root canal, etc.
- vision such as contacts, glasses, check-ups, eye drops, even laser eye surgery!
- cough syrup
The list could go on and on. And beyond this (check with your plan to make sure), you can even use your HSA for Medicare expenses and long-term care costs! All while never paying taxes to Uncle Sam.
That’s right! HSA contributions are all tax deductible. If you earned $50,000 last year and put $5,000 in an HSA, you’ll only be taxed on $45,000 of your income. It’s a tried and true way to pay less in taxes year after year.
4) Invest in Real Estate
Real estate is pretty common among the wealthy, so there must be a huge benefit in it right? Yup, on three fronts.
- Real estate will earn you a passive monthly income
- The property will likely go up in value – typically at a greater rate than inflation
- You’re allowed to depreciate your asset for 27.5 years
So not only does real estate earn you money, but it also is a bit of a tax shelter because of the expense deductions and depreciation.
Here’s a look at our real estate investment this upcoming year:
- Income in 2016: $10,350
- Property Tax: $1,850
- Renovation Costs/Maintenance: $5,500
- Depreciation: $3,000
- Taxable Earnings: $0.00, which means no taxes owed!
In reality, Liz and I will earn $3,000 from our rental property, but thanks to depreciation it will actually earn no money on paper. It’s always nice to earn an income but pay absolutely nothing in taxes!
Want to pay less in taxes? Consider real estate. It’s the method of countless rich people around the nation.
There are some people that pay absolutely nothing in taxes, but that’s mainly because they’re loading up on their 401k contributions. Here’s what their taxes look like:
- Total Income for husband and wife: $55,350
- 401k contributions: ($36,000)
- HSA contributions: ($6,750)
- Couples deduction: ($12,600)
- Taxable Earnings: $0.00
By contributing heavily into their 401k plans and living on just $12,600, people are paying absolutely nothing in taxes and creating a potentially massive retirement fund for their future.
I’m not a huge fan of the 401k by itself. Sure, it’s a good tax shield today, but if I’m worth $5,000,000 in the future and want to withdraw $200,000 a year 40 years from now (when taxes will likely be higher), then it’s not that great of a plan is it?
Instead, we’re contributing more heavily into our Roth 401k, then real estate, and then we’ll invest a small amount more into our regular 401k as a tax shelter for today. Sure, it’s exciting to pay absolutely nothing in taxes, but it just seems a bit too risky to depend entirely on the stock market for retirement. Since we do want to pay less in taxes, we’ll be sure to put some money away into our 401k, but we’ll be smart about it at the same time.
6) Start Investing Our After-Tax Dollars
I already talked about investing in real estate, which is done with our after-tax dollars, but there’s another investment technique that works well if you’re looking to shield some of your income and pay less in taxes.
It’s called long-term gains.
Long-term gains are typically from a dividend payout or from a stock that you’ve held for more than a year and decided to sell. Capital gains are typically taxed at 15% – or 20% for those that have an incredibly high income.
Now here’s the beautiful thing. If your regular earnings are within the 15% tax bracket or lower, then you’ll pay absolutely nothing on your capital gains!
The lesson here? Liz and I need to start investing our after tax dollars into dividend-producing stocks to follow the lead of the rich (FYI, this is exactly how Mitt Romney paid an effective tax rate of just 14% in 2011). We can use long-term gains to increase our total income and reduce our taxable income at the same time. It’s a beautiful way to pay less in taxes!
7) Pay Attention to Our Taxable Income
Since I started earning an income, I’ve just tried to make as much as possible every year. After all, the more I earn the better, right? Well, that’s not always the case when it comes to paying taxes.
Let’s continue the conversation of the long-term capital gains from above. If you want to truly capitalize on those long-term capital gains and pay less in taxes, then you absolutely need to pay attention to your income. Take a look at the 2016 tax table below for married couples filing jointly:
As I understand it, there are two very real scenarios that could play out here:
1) You earn a taxable income of $75,000 after all deductions and land in the 15% tax bracket. This means, that your $30,000 in dividend income (long-term capital gains) is tax free. You owe $10,367.50 in taxes.
2) You earn a taxable income of $76,000 after all deductions and land in the 25% tax bracket. Your $30,000 dividend income is no longer tax free. Because your taxable income landed in a higher tax bracket, you suddenly owe 15% on those dividend earnings! You now owe $15,117.50 in taxes.
By earning just $1,000 more at your day job, you effectively increased your tax bill by $4,750.
You know how you could have avoided it? By giving…
Charitable donations are tax deductible. If you earned $50,000 last year and gave $20,000 away, then you would only have to pay taxes on the $30,000 that you have left.
And in our example above, if you would have just given away $750 to a worthwhile organization then you could have kept the other $4,000 in your pocket instead of handing it over to the government for them to mismanage.
If you want to pay less in taxes, then consider giving some money away. It can be a very effective tax planning tool, and it can positively impact many lives along the way!
Liz and I are ready to pay less in taxes this year. Are you?
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.