Taxes - Making Small Changes Can Make a Big Difference
You have to pay taxes. Not fun, I know. But you don’t have to pay more than you’re required to.
The way our brains work, we want to save taxes right now, this year. Like, “give me all the sweet sweet tax saving tips I can use today,” you’re asking. I understand. That’s natural.
Hold on there, buddy. The way to actually be smart about taxes is to consider your entire lifetime of paying taxes, and to arrange the best ways to minimize your lifetime tax burden. Yes, this sometimes takes decades to do. This takes patience. What follows isn’t a “save taxes today!” list so much as it is a “over decades, pay less than everyone else pays while still staying within the legal guidelines and being a lot wealthier for it, patience” list. Got it? Let’s do this.
Save money - “A penny saved is a penny earned,” said Benjamin Franklin, but he actually under-estimated the value of savings, due to the way income taxes work. Because of income taxes every year, you have to earn more than a penny just to save a penny. If you pay a 25% tax rate on your income, then Ben Franklin needs updating: “A penny saved is worth about 1.25 pennies earned.” Because of income taxes, saving, rather than spending, is the ultimate tax savings plan.
Buy less stuff - We pay state and local retail taxes on nearly everything we buy. Buy less stuff: You’ll end up paying less in taxes.
Invest in tax-advantaged retirement accounts - If you hate taxes, you should love IRAs and 401(k)s. You get both an income tax break and a break from any interest, dividend and capital gains taxes on investments inside your accounts, for decades. The tax savings over a lifetime are huge. Or as one prominent political leader likes to say: YUUUUUGE.
Invest and derive income from wealth - Ok, if you weren’t born wealthy, this could take decades or your whole life to achieve. But just so you know: income derived from dividends and capital gains - in other words income from your wealth - is generally taxed at a lower rate than income you get from working for a living. This may sound unfair if you’re not yet wealthy, but that’s the way the tax code works.
Set a goal for yourself: Could you derive 5% of your income from your wealth 2 years from now? If yes, up the goal. In a decade from now, could you derive 30% of your income from wealth rather than a salary? Over a lifetime, shift your source of income to capital rather than labor, and you will pay far less in taxes.
Own your own business - Firstly, because income taxes on businesses are usually far lower than income taxes on a salary. Secondly, because many legitimate expenses from owning your own business happen to be extremely useful in your personal life. The cost of your car, phone, internet, space in your home, office supplies, subscriptions, postage, transportation, continuing education, some meals - if properly documented and blessed by a tax preparer - all could be business expenses, and lower your overall taxes.
Buy a house and live in it for at least 2 years, but preferably for 30 years or more - The 2 year minimum gets you the capital gains tax exclusion. The 30 years or more makes it much more likely that you’ll accumulate huge gains in the value of your house. The capital gains tax exclusion means you don’t pay taxes on increases in value of your house up to $250,000, or $500,000 if you’re married. Can you name another tax break for a quarter million or half a million that regular people can get? Nope, me neither. Yes, this takes years and decades to harvest the tax break. But good things come to those who wait.
Don’t buy lottery tickets - Lottery tickets are just voluntary state taxes, paid by the gullible. You won’t win. Lottery tickets fund our schools, veteran’s benefits, and other government programs. That’s their purpose. But unlike all the other taxes listed above, lottery tickets are totally voluntary. Don’t pay this tax.
Hire a professional tax preparer - This is controversial advice. Many people swear by their tax preparation software. I hear the software’s great. But I wouldn’t dare to do that.
You see, wealthy people don’t do their own taxes. Is this because the wealthy are lazy, careless with money, and unable to deal with software? Not usually. It’s because a professional tax preparer will save you a lot of money in taxes, over the years, by helping you think about all the issues I’ve outlined above. Set yourself up in life to pay your required amount of taxes, but not a penny more, by paying a professional to help you.
In summary: Don’t think of saving money on taxes as a short-term gimmick. The big tax savings - they ones wealthy folks are taking advantage of - are all multi-year and multi-decade tax breaks. Over time, arrange your financial life to pay the least amount of taxes by doing as many of the things outlined above as possible.