Remember this post from last year?
“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…”
It’s been almost a full year since that post and I definitely haven’t forgotten it. In fact, all last year I was consciously making moves that would drive us to a wealthy future, but with much fewer taxes. And guess what happened? We paid in nowhere near $22,000. In fact, we earned $5,000 more and paid just $11,776 to Uncle Sam this year. BOOM!
So how the heck did we do it? How could we possibly earn more money and pay half the taxes?
What we’re doing must be illegal, right?
Wrong. (If it were, I probably wouldn’t be announcing it to the world on this insanely popular blog now would I?)
I was so ticked off about our taxes last year that I decided to research all the different ways we could shield our income from the grubby hands of Uncle Sam.
Without really realizing it, I took action on almost every single item I came up with! And, I actually discovered a few more along the way as well. Here’s exactly how we earned more, but paid far less in taxes this past year.
1) We Stopped Trusting Our Accountant
Our accountant isn’t a bad guy, but he looks at our tax situation once a year…for about 30 minutes. During this time, he’s not going to have a eureka moment that’s going to save us $10,000 on the spot. No, we need to be intentional about how we earn, invest, and spend so that we end up paying the minimum in taxes. …And that’s exactly what we did this past year.
Action Step: Start thinking about the long-term. Do your future goals line up with these methods of paying fewer taxes? If yes, then you’ve got a win-win on your hands!
2) We Had a Child
Yeah, I know…kids are expensive. They certainly aren’t as costly as the media proclaims ($250,000 for each kid? That’s B.S.), but they definitely cost money….and likely more money than you’re going to save in taxes. BUT, that’s not the reason we have kids is it? We have kids because they’re loving, carefree, imaginative, and they keep us young and curious.
Liz and I had our first daughter last year. She’s happy, healthy, and a joy to be with (haha, I type this as she’s screaming at the top of her lungs…rebelling against nap time. Still cute though ;)). AND, it turns out that she’s making tax season much more fun!
According to Turbo Tax, there are tons of tax benefits if you’ve got kids! Including:
- Deducting $4,000 per dependent from your income
- Earning a $1,000 tax credit, which reduces your taxes owed dollar for dollar!
- Child care credit, which credits you up to 35% of your childcare costs each year (up to a certain cap depending on the number of children)
- And an earned income credit for those that have children with a lower than average income
For Liz and I, we were able to capitalize on #1 and #2. We earned the deduction and the tax credit, which helped lower our taxes by about $2,000. Saweeeeet!
Action Step: Turn down the lights, queue up the Barry White, and make some babies. Hahaha, just kidding. But if you do have some kiddos, buy their toys used and grab all the tax credits you can get!
3) We Loaded Up our HSA
Last year we contributed $3,600 into our Health Savings Account. To be completely honest, we didn’t build it up to save in taxes; we contributed a ton because we knew we’d have big bills from the delivery of our first daughter. Thankfully, it worked out beautifully for both reasons.
Since we’ve discovered that an HSA account is not only a fantastic way to pay for medical expenses without getting taxed, it’s also a fantastic tax shelter where you can actually invest your savings (it’s basically like a 401(k), and if you use the money for medical items, you’ll never pay tax…EVER!)!
Even though the delivery has been paid for many months now, we still contribute $200 of each paycheck (and we’ll likely do this forever) for these very reasons.
Action Step: Look into your insurance options at work. If you’re fairly healthy and don’t spend a ton of money at the doctor each year, dig into the High-Deductible Plan. As the name suggests, the deductible is more, but along with this plan typically comes an option to contribute into a Health Savings Account. It’s a great way to avoid paying taxes on your income, and it’s awesome to have the money there in case anything should happen!
4) We Invested In Real Estate
This was a biggie. Liz and I purchased our first rental property at the end of 2015. We fixed it up and rented it out in April of last year.
Real estate is brilliant when it comes to tax time for two main reasons:
- Unrealized Gains
Our rental property is a single family house. Its value increases with the rest of the housing market, but yet we’re allowed to depreciate it like it’s only going to last for 27.5 years (this is how the depreciation table is set up).
Here’s our Profit and Loss statement from this past year:
We earned a rental income of $10,325. Our expenses totaled $7,812.27 (due mostly to the initial one-time repairs), leaving us with a profit of $2,512.73. BUT, then we were able to depreciate the seven months that we had the house rented, which totaled $1,732.91, making our “earnings” just $779.82. That’s a beautiful thing.
Okay, so the depreciation rule is pretty awesome, but this is ten times better. Unrealized income. Mmmm, it gives me shivers just typing it. 😉 (I’m not nerdy at all am I?)
Liz and I bought the property for $81,694.13 and fixed it up with another $7,500. So we essentially have $89,000 into the home. Guess what it’s worth today, just one year later?
Through the purchase and the improvements that we put into the property, we “earned” $36,000. Here’s the beauty of the whole thing. While our net worth has definitely jumped by this thirty-six grand, since we haven’t actually sold the house and put the earnings into the bank, the government can’t tax us on it.
It’s unrealized gains.
Instead, we’ll keep the house and enjoy the income it provides, and we’ll also have fun watching it increase in value each year.
Action Step: If you’re completely out of debt, start saving up your dollars for a rental property! It’s a great way to earn a passive income, pay less in taxes, and to increase the value of your assets!
5) We Invested Some After-Tax Dollars
Since we’re pretty certain that the next recession is coming soon, we invested a couple thousand dollars into a silver and gold motif.
Here’s the theory:
- The market will tumble
- Demand for silver and gold will rise and drive up the price
- I’ll sell the motif for a profit and only pay capital gains tax (which is less than the income tax rate)
- We’ll swoop in and use the money (along with other savings) to buy a foreclosed property for our next rental
It may not work as perfectly as the steps above, but I still think it’s a pretty decent plan. And, my investments can grow within the motif without taxation. Only when I sell them will I actually owe something to Uncle Sam.
Action Step: Don’t just spend your money because you’ve got some. Invest it. You’ll grow your net worth and you won’t have to pay any tax on the growth until you sell the shares.
6) We Paid Attention to Our Earnings
If Liz and I earned a taxable income of more than $75,300, we would have entered the 25% tax bracket on any earnings above that. I calculated our taxable earnings a few times throughout the year to make sure we stayed beneath this threshold.
Alright alright…Before you jump out of your chair and start typing your incoherent expletives, understand this – I’m not suggesting that you should earn less to avoid going into the higher tax bracket. That doesn’t make any sense. What I DO recommend is that you direct your earnings in a way that reduces your taxable income (ie. Put more money into your 401(k) or HSA account).
This way, you still earn your income, but you’re able to pay far less in taxes.
Action Step: First, you need to understand how how much you’re actually paying into Uncle Sam each year. Then you need to understand why. If you’re in a high tax bracket and can live on less, then I would highly suggest that you do. And then invest what you don’t need into tax-sheltered accounts. Your future AND present self will thank you. 😉
7) We Gave
Thankfully, the government still rewards cheerful givers. Liz and I gave away thousands of dollars last year – to charities, churches, schools, and to other worthy causes that came our way. It’s healthy to give and help others and the tax break is just a cool by-product of what we should all do anyway.
Action Step: Give some money away this year. It might not have a tremendous impact on your taxes, but I’m confident that the impact it will have on you as a person will be reward enough!
8) We Stopped Paying Penalties
In 2015 we did two stupid things:
- Liz was technically uninsured for three months….which we were penalized for. Thanks President Obama….
- I may have forgotten to pay two quarters worth of taxes on my business income….which we were penalized for.
We definitely didn’t make these mistakes in 2016. We were penalty free!
Action Step: Do not take your tax preparation lightly. Avoid doing anything that will result in a penalty!
Honorable Mention – Contribute to Your 401(k)
Liz and I didn’t contribute any pre-tax money into our 401(k) last year because my work offers a Roth 401(k). I contribute 7% of my salary and they contribute another 10% (I know, it’s wicked awesome!!).
We choose to contribute to the Roth for two reasons:
- Given the direction that our country’s headed, I figure that the income tax rate will be much higher in the future, so why not just pay the taxes now?
- We will be far more wealthy when we’re old, so I’d rather pay the 15% income tax now and pull out money in much larger quantities tax-free in the future.
Action Steps: If you don’t have a Roth 401(k) option at work and you’d like to shelter your income from taxes now, then contributing to your traditional 401(k) is a fantastic way to do it.
We Paid Far Less In Taxes…Now It’s Your Turn!
Liz and I paid close attention to our earnings and our taxable income this past year and it paid off tremendously! Now it’s your turn!
Here’s your checklist for this tax season:
- Stop trusting your accountant
- Take the deductions and credits for your children
- Put tax-free money into your HSA
- Invest some real estate
- Invest your after-tax dollars for the long-term
- Make sure your earnings don’t put you in a massive tax bracket
- Give some money away
- Stop paying penalties
- Contribute your pre-tax money into a traditional 401(k)
Take all the deductions you can! Hopefully you’ll earn more and pay less in taxes like us! Good luck!
AUTHOR Derek Sall
Derek has a Bachelor's degree in Finance and a Master's in Business. As a finance manager in the corporate world, he regularly identified and solved problems at the C-suite level. Today, Derek isn't interested in helping big companies. Instead, he's helping individuals win financially--one email, one article, one person at a time.