Although paying taxes is a necessary evil, few individuals like giving the government a cut of their hard-earned money. Earned income is also subject to extra levies to pay federal programs like Social Security and Medicare, in addition to those imposed by the federal government, state governments, and local governments. While evading taxes may seem impossible, several options exist. Below are some smart strategies to protect your income from taxes but first, let’s get a firm grasp on the difference between tax avoidance and tax evasion.
In most cases, tax avoidance is fully disclosing relevant data to the appropriate tax authorities and following all legal requirements in order to minimize one’s tax liability. The use of tax deductions, reorganizing a company as a corporation, or setting up shop in a tax haven are all examples of tax avoidance.
In contrast, tax evasion refers to the systematic avoidance of tax obligations by dishonest or otherwise immoral ways. Dishonest tax reporting is a common kind of tax evasion, but other forms of nondisclosure of financial information to the tax authorities are also a component of this crime (such as under declaring income, profits or gains; or overstating deductions).
In most cases, the further off tax payments are made, the better. One way to delay paying taxes and reduce taxable income this year is to defer income into the following year.
So, if you’re an employee expecting a bonus at the end of the year, you might ask your company if they’d be willing to delay the bonus payment until the following year. While this tactic may reduce your tax bill this year, issues with taxes may arise the following year if you have deferred income and are in a higher tax bracket.
You should weigh the tax savings you can make now against the taxes you’ll owe in the future. However, if lowering this year’s taxes is your top objective, the less revenue you can generate in the current year, the better.
Purchasing a municipal bond is analogous to making a loan to a state or local government agency in exchange for a series of interest payments over a specified time period. At the end of the bond’s term, the purchaser receives back their entire initial investment.
Interest earned on municipal bonds is not subject to federal income tax and, depending on where you live, may also be exempt from state and local taxes. Investors are drawn to municipal bonds because interest earned is exempt from federal income tax. Historically, default rates on municipal bonds have been significantly lower than those on corporate bonds. Analysis of municipal bonds from 1970-2019 found that the default rate for investment-grade municipal bonds was 0.1%, significantly lower than the 2.25% default rate for global corporate issuers. However, the interest rates offered by municipal bonds are typically lower. Tax-equivalent yield is one reason why some investors favor municipal bonds. Your after-tax return will increase in proportion to your tax bracket.
Investing may be a useful technique for increasing wealth. The advantageous tax treatment for long-term capital gains is another advantage of investing in stocks, mutual funds, bonds, and real estate.
If an investor holds a capital asset for more than a year, the capital gain is taxed at a preferential rate of 0%, 15%, or 20%, depending on the investor’s income level. The capital gain is taxed at ordinary income rates if the asset is held for less than a year before being sold. Understanding long-term versus short-term capital gains rates is critical for wealth accumulation. In 2021, a married couple filing jointly would pay no tax on long-term capital gains if their taxable income was less than $80,800, and a single individual would pay no tax if their taxable income was less than $40,400.
For 2022, the zero-rate bracket applied to taxable income up to $83,350 for married couples and $41,675 for single individuals. A tax advisor and an investment advisor can advise you on when and how to sell appreciated or depreciated securities in order to minimize gains and maximize losses.
Tax-loss harvesting can also be used to offset capital gains taxes by selling securities at a loss. If capital losses outnumber capital gains, the lesser of $3,000 or the net capital loss can be deducted from other income. Capital losses of more than $3,000 can be carried forward to subsequent tax years.
Contributions to standard individual retirement accounts are tax deductible in the year they are made. Different IRS restrictions on IRA contributions apply in different scenarios.
If you and your spouse are not protected by workplace retirement plans, you may normally deduct the entire amount of an IRA contribution.
If you and your spouse are insured, your contribution may be capped depending on your adjusted gross income.
For example, if you are in the highest tax bracket of 37% and contribute $6,000 (the maximum for 2022), you may save up to $2,220 in taxes based on 2022 tax rates. The best part is that, unlike other tax-saving techniques, which must be implemented by December 31, you may contribute to an IRA until tax filing day.
If you incur a loss on a capital investment, such as a stock, you can deduct the loss from your taxes. However, you must first sell the stock at a loss, a process known as “realizing” a loss.
Once you have realized a loss, you can use it to offset any realized capital gains.
If you have more capital losses than gains, you can use up to $3,000 of the excess loss to offset your ordinary taxable income.
In the case of a “wash sale,” the IRS will disallow your loss for tax purposes. A wash sale occurs when you buy back the same or nearly identical investment within 30 days of taking a tax loss.
When combined with the offset of capital gains, capital losses can wipe out a significant portion of your tax liability.
Aside from earning extra money, a side business provides numerous tax benefits.
Many expenses can be deducted from income when used in the course of daily business, lowering the total tax obligation. Health insurance premiums, which are accessible provided certain conditions are satisfied, are particularly essential tax deductions for self-employed persons.
In addition, by strictly adhering to IRS guidelines, a business owner may deduct a portion of their home expenses through the home office deduction. Income can also be reduced by the amount spent on utilities and internet for the business.
To claim these deductions, the taxpayer must run a profitable business. The IRS considers a number of factors, which are detailed in Publication 535. Taxpayers who have made a profit in three of the last five years are presumed to be engaged in a profit-making enterprise.
In 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was passed. The SECURE Act provides tax breaks to employers who participate in multiple-employer plans and provide retirement options to their employees.
Employees who have a high-deductible health insurance plan can use a health savings account (HSA) to reduce their tax liability. As with a 401(k), payroll deduction HSA contributions (which may be matched by the employer) are excluded from the employee’s taxable income; direct contributions to an HSA are 100% tax-deductible from income.
The maximum deductible contribution level for 2021 was $3,600 for individuals and $7,200 for families. These limits increased to $3,650 for individuals and $7,300 for families in 2022. These funds can then grow without having to pay taxes on their earnings. An additional tax benefit of an HSA is that withdrawals are not taxed when used to pay for qualified medical expenses.
The Earned Income Tax Credit is one of many IRS tax credits that reduce taxes. For the tax year 2021, a low-income taxpayer could claim credits of up to $6,728 if they had three or more qualifying children, $5,980 if they had two, $3,618 if they had one, and $543 if they had none.
In 2022, the credit increased to $6,935 for three or more children, $6,164 for two children, $3,733 for one, and $560 for none.
The American Opportunity Tax Credit provides a maximum of $2,500 per year for eligible students during their first four years of higher education, while the Lifetime Learning Credit provides a maximum 20% credit for up to $10,000 in qualified expenses or $2,000 per return.
For moderate and lower-income individuals looking to save for retirement, there is also the Saver’s Credit; individuals can receive a credit of up to half of their contributions to a plan, an IRA, or an ABLE account.
Managing one’s wealth is a difficult task. Getting your money to work as hard as possible for you requires more than just the correct tax reduction strategies for high-income earners.
The right financial advisor makes all the difference.
Strategic Wealth Advisors is an all-round wealth management firm that focuses on high-net-worth individuals and takes the time to get to know each client and their beliefs and goals. We’ll work with you to develop an approach to wealth management that will help you achieve your objectives and make the most of the fortune you’ve amassed over the years.
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Disclosure: This information is not intended to substitute for specific individualized tax, legal, or investment planning advice. Neither Royal Alliance Associates nor its representatives or employees provide legal or tax advice. If legal or tax advice or other expert assistance is required, the service of a currently practicing professional should be sought.