There are all kinds of uncles: The favorite uncle, the absent uncle, the uncle who always tells stories about how his teachers took the paddle to him if he dared chew gum in history class. But there’s one uncle—the big-hatted, finger-pointing man named Sam—who wants you to pay your taxes – or perhaps even more than your fair share of taxes.
Actually, he does more than want it, he requires it. Sam is the uncle that every one of us has to deal with every year – and every paycheck – for our entire lives.
And for good reason.
Without taxes, our country doesn’t operate—no schools, no services, no defense. Our taxes are what make our government run. Now, we can sit here and debate whether we think our taxes are too high or how we think our country’s money should be spent, or how the tax brackets are broken down. But that’s not what we’re here to do. I’m not going to talk politics, and I’m not going to preach about who should pay what and why.
I’m talking finance. Our goal here is this: minimizing what we pay the government (legally) so that we can keep more of our money in our own pockets. I love Sam as much as any of our 300-million-strong American family, but that doesn’t mean I want to stuff his pockets with more money than he’s due.
Let’s make this clear: This isn’t about scamming the system or fudging numbers. Reducing your tax liability is about understanding tax laws and guidelines so that you’re fulfilling your legal obligation while not mistakenly paying more than you should.
- H&R Block often cites research that shows 20 percent of people overpay their taxes by an average of $450 in unclaimed taxed benefits.
- A General Accountability Office (GAO) study estimated that close to 1 million taxpayers took a standard deduction when they could have reduced their tax bill by itemizing deductions for mortgage interest and points, as well as state and local income taxes.
- The GAO estimated that taxpayers could save $473 million by itemizing instead of taking the standard deduction.
They further estimated that if charitable contributions and property taxes were also considered, there may be as many as 2.2 million taxpayers not taking advantage of itemized deductions and that the potential tax savings, in this case, would be almost $950 million.
Remember, our end goal—saving any money anywhere you can find so you can direct it to investments that make you your millions—is one of the strategies that every successful wealth-builder uses. That goes for cutting back on your Starbucks habit, and that goes for knowing the places you can pay less taxes.
We all know the basics of taxes:
- You have to pay them at the federal, state, and local level, as well as in other categories, such as states that have sales tax on any items you buy and property taxes if you own a home.
- We’re all legally obligated to pay what’s required, and rules vary depending on your state, income level, and a variety of other factors.
You need to understand the guidelines and strategies for navigating your taxes so you know what to look out for, what to ask, and how to cut the amount you’re required to pay the government.
I should also say that certainly one of the strategies you can use is working with your personal wealth advisor and a certified public accountant who is savvy with tax laws so that you don’t need to know every nuance about tax law. However, I also realize that, especially in the tax arena, there are so many do-it-yourselfers. This is particularly evident with the massive surge in software and online services that make it simple to plug in your numbers and then file away.
In any case, we can’t talk about building your wealth from a global picture until we cover one of the major expenses—the money that comes out of paychecks automatically.
Here are some of the things you should look out for when analyzing your financial picture.
Get Militant In Your Record Keeping
The bottom line is this: If your brain, your files, and your home look like an army of ants scattering in different directions, then you’re going to have a hard time keeping any of it straight—or taking advantage of potential tax breaks.
If you haven’t done so already, you need to make sure your documents, your receipts, and your investment information are all in a secure and well-organized format. You can’t claim tax breaks that you can’t document, and you can’t document your potential tax breaks if your paperwork (or digital files) is either lost in some file-cabinet crack or scribbled on a cocktail napkin.
You have to get your records in order. If you haven’t already, it’s time to start. This is much easier for the younger generation or those who use an online program or service to file, record, and manage paperwork. And major banks aren’t far behind in terms of creating services that will allow you to organize and categorize all of your major financial documents. But it is worth noting that if you don’t take advantage of these organizational tools, then you need to make sure you do it on your own.
Take a Little (Money) Off the Top
This might be familiar to you as a phrase men use with their barbers, but it’s one of the main keys to minimizing your taxes.
Your goal, of course, is to earn as much income as you can. To reduce taxes, you want to reduce your income. How do you pursue both goals? Take a little off the top.
That is, there are certain expenses you may be able to deduct from your total income, such as mortgage interest, medical expenses, childcare expenses, charitable contributions, and business or professional expenses. Flexible spending accounts or health care savings accounts (HSAs) are another popular option offered by many companies in the United States to lower one’s taxable income. With these accounts, you can use some of your income before taxes to pay for certain eligible out-of-pocket medical expenses.
That’s a huge help, so make sure to take advantage of those plans if they’re available.
Money contributed to an HSA/FSA is “pre-tax,” meaning that it lowers your taxable income by the amount that is contributed each year. When you deduct them from your total income, your reduced income is what you’re taxed on, meaning that you’ll pay a lower amount of taxes. Some of these are major expenses, of course, and can reduce your tax burden.
All come with limitations, so it’s wise to research thoroughly or employ pros to help with your understanding of these plans and their usefulness to you and your family.
Say you made $50,000, but contributed $2,500 into a flexible spending account. Your
employer would only report $47,500 in income to the IRS. Assuming you were in the 15 percent income tax bracket (and paying 7.65 percent in payroll taxes), you would save $566 in taxes by contributing to a HSA/FSA.
- In the case of FSAs, you must use all the money by the end of the plan year or you “lose” that money.
When it comes to professional expenses, you can deduct expenses associated with your job, such as a home office, a business phone line in your home, and things of that nature. However, that area is grayer than a stormy sky, so you have to be careful in the deductions that you’re claiming.
Ideally, you need to be thinking like an entrepreneur (that is, working independently, even if you don’t) to determine the things you can do to take full advantage of the proper tax exemptions and deductions.
Developing that entrepreneurial spirit gives you a wide array of options for deductions when it comes to tax time.
Why is this so important? Because the government is already moving away from the incentives to work for big companies (like defined benefit pension plans that guarantee a set income after retirement), the burden now falls squarely on you to come up with the plans and tactics that will allow you to develop income for the future and save taxes along the way.
While Social Security increases are modest at best and the average American income level is not keeping up with the cost of inflation, all money management comes down to the individual—and saving those tax dollars every year becomes that much more vital.
So, if you don’t take responsibility, you’ll be in deep, deep trouble, which is why I’ve emphasized the entrepreneurial spirit throughout the book. It’s all about creating more cash flow, whether it’s in increased income or in saving dollars in your taxes.
Take Your Pay Later
I don’t mean that entirely in the way it sounds. You aren’t asking your boss to give you one large paycheck at the end of every year rather than every two weeks.
What I mean is what’s referred to as deferred income. That means you earmark some of your yearly income toward accounts that get taxed in the future, not now (i.e., your IRAs and other retirement or deferred compensation accounts).
You should be doing this anyway as part of smart saving and investing strategies, but it’s also an intelligent tax strategy because the money you put in these accounts isn’t taxed on the income in the year in which you earn it. So in a way, you’re deferring that portion of your salary down the road because you’re not using it now and you won’t be taxed on it now either.
That’s the beauty of compounding: It works the same way with your other retirement investments too. Once you get that base going, it grows exponentially.
Use Your Home as Your Shelter
It already serves as your physical shelter, but it’s more than just a physical space with a roof and windows and an emotional space with photographs and memories. It’s also a fiscal place.
Within that home, there are lots of ways to ease your tax burden. If you’re going to use a portion of your home as a home office, you can deduct a portion of it from your taxes. For example, you can deduct a portion of your property taxes and the interest from mortgage payments from your income, as well as anything associated with a home office (such as the physical space and the cost of any equipment or services specifically and solely used in that office).
And that’s not even mentioning the incredible tax break you get by flipping homes, and not being taxed on the capital gains proceeds earned from the sale of a home. While I don’t advocate using your home to store your money in the literal way (in a closet, under a mattress, or buried in a hole in the backyard), the truth is that your home is a place where you can keep more of your money, save your money, and, by extension, make more money in the process.
Divide Your Money Up Among Family
There will be some cases where it will make some sense to divide your income among family members. What do I mean? You may be able to get tax breaks by making an annual gift of up to $15,000 to your children by using the annual exclusion recognized in the IRS tax code, which is adjusted periodically.
In addition, instead of giving money to your child for college, you can pay the college directly (with no gift taxes), not utilizing the annual exclusion, and then you could give another amount to your child for expenses, reaping the tax benefit.
Important Changes to Tax Codes for Homeowners
The Tax Cut and Jobs Act of 2017 made things more complicated tax-wise for homeowners, especially those wanting to buy more expensive homes.
The law reduces the amount of deductible mortgage debt to $750,000 for new loans, though existing loans of up to $1 million were grandfathered in and homeowners can refinance existing loans of up to $1 million and still deduct the interest. Congress also set a $10,000 cap on deductions for state and local income, sales, and property taxes.
If you live in a state with high state income tax rates, you may be limited in your ability to deduct property taxes. Several states are considering alternative tax plans to help their residents deduct local taxes, so you should check with your accountant to see if any options are available to you.
While the tax benefits of homeownership are dramatically reduced, I still believe that using the leverage offered by a mortgage can help you save a significant amount of money. There are some other ways to save under the new tax law.
For example, Congress decided to expand tax-deductible 529 plans, which were previously only permissible for paying college tuition, to now include payments for private schooling from kindergarten to grade 12.
Final Thoughts
You may be required to pay taxes – but you don’t have to overpay your taxes. There are perfectly legal, ethical ways to take a little bit off the top and lessen your tax liability.
Some strategies will work better in some instances than others; no two people will have the exact same financial situation. However, even if you’re not a millionaire or someone who has a wealth of assets in their portfolio, you need to start thinking like you live in that world. The tax codes do apply to people who are in all sorts of situations – it’s not a rich person vs. poor person problem.
Find ways to make the taxes work to your advantage so you’re only paying the right amount. Then, you won’t have to worry about old, grouchy Uncle Sam coming for your hard-earned money.