Paying tax is part of living in a productive, progressive society. The government uses tax dollars to invest in the economy by building infrastructure and offering other public services. Your taxes help run the country, but sometimes it feels like an unfair burden we all have to pay.
If you listen to the media, you’ll hear some reports of how corporations don’t pay any taxes. If they can shift their tax liability, why can’t you? Is it possible to reduce your tax bill and save yourself thousands of dollars in tax payments each year?
What’s the Average Tax Bill for an American?
During the 2017 financial year, the Internal Revenue Services collected more than $2.4-trillion in taxes. That’s a lot of money, and equivalent to just under 2% of U.S GDP. The IRS also processed over 245-million tax returns, issuing over 121-million refunds for a total of nearly $437-billion.
It might come as a surprise to note that the highest income earners shouldered most of the tax burden. According to the 2016 data from the IRS, 97% of all federal incomes taxed received were from the top half of taxpayers. Furthermore, the top 5% of all taxpayers were responsible for 58% of all taxes paid.
Those taxpayers that fall in the lower half of all income earners were responsible for only 3% of the total taxes collected while earning 11.6% of the total income generated for the financial year.
Every time an election rolls around, as is the case with 2020, politicians start talking about how they’re going to lower taxes. In a heated topic in most debates, and all candidates make promises to the people that they’ll reduce the tax burden for the average American.
However, it seems that presidential candidates continue to incentivize business over income-earners (employees) when altering the terms of the tax code after their election into office. As a result, the middle class takes the brunt of the tax burden, while the business gets a break.
In this article, we’ll discuss ways that you can use tax breaks in the tax code to reduce your total tax bill. Sound good?
Can You Pay No Tax? How Does It Work?
The next time you’re out with friends, bring up taxes as a conversation starter. That’s a great way to kill the mood.
The fact is that most people know they have to pay tax, and their employer takes care of that for them. If they’re lucky, the taxman gives them a refund after they file their return.
The majority of Americans’ tax knowledge is terrible. It’s a mystical subject to many, and most people don’t have a complete understanding of the tax code unless they’re an accountant or lawyer.
Let’s try to unpack this complicated subject, by understanding that the tax code is a simple framework; as your income increases, your tax responsibility gets higher. The complexity arises when we start to look at what earnings the government considers as income.
You also have to take into account the deductibles on offer, which are essential tax breaks to help you reduce your total tax bill. Some deductibles might phase out as the taxpayer’s income migrates into other tax brackets.
The tax code is complicated for many reasons. The government offers business incentives and initiatives, while some individuals might try to take advantage of loopholes, in turn leading to the establishment of new laws.
Every time a new leader takes office, they seem to implement a new system that makes things more confusing. For instance, the terms President Donald Trump’s 2017 Tax Reform and Jobs Act, make matters even more complicated.
You might be thinking that the only way to get around paying taxes is to start earning less money. However, by taking advantage of itemizing your deductions, you can make your expenses equal to or more than your income, resulting in you legally paying no tax.
Employee or Sole Proprietor
Paying less tax also depends on your legal status as an income earner. For instance, if you work as a W2 employee, then you have more limitations over what you can deduct from your income when tax season rolls around.
If you work for yourself, as a freelancer, or a consultant, then you can register as a sole proprietor. Sole props get the advantage of taking more deductions when filing. If you own a business, register as an LLC or S-Corp, and you get even more tax breaks.
In essence, the government tries to stimulate the economy by rewarding small business and large business entities with more tax breaks that they use to write off against income. Does that mean if you’re an employee that you can’t take more deductions? No, but if you do operate as a freelancer or business entity, you sure do get a lot more incentives.
Paying No Tax on Passive Income
As an employee, nothing is stopping you from investing your earned income into assets to generate wealth. You don’t need to own a business or work for yourself to make yourself rich. There are plenty of employees that steadily amounted a cash pile over their career and prudently invested that money into high-yielding, passively-managed investments.
As a result, they acquire a portfolio of investments paying them monthly passive income flows. Since they have a hands-off investment strategy, they still have plenty of time to work at their job. If you’re an aerospace engineer, and you love your work, you don’t need to be a business owner to be rich. All you need to be financially independent is a good investment strategy.
Passive Income Strategies
Passive investment strategies like rental real estate, stock dividends, P2P lending, and any others that have a hands-off approach, generate passive income. However, you’ll still need to pay taxes on the income you generate through your assets.
However, property and state taxes are also deductibles, and the money isn’t going to the federal government when you pay them. If you want to lower your total tax liability, then you’ll need to either move to another state or change your nationality.
Therefore, as an employee, you do have the option of taking advantage of tax breaks in the form of itemized deductions, provided that you have investments you can use to validate your claim. Otherwise, you’ll have to take the government’s standardized deduction when filing.
How Can You Pay No Taxes on Rental Income?
Landlords get the advantage of treating their rental property as a business. As a result, landlords can deduct the costs of mortgage interest, management fees, property taxes, and maintenance costs from their total tax liability.
However, it’s important to note that there are changes in deductions once you start making more than $166,000 per year in income. You also get the advantage of deducting depreciation from your income as well. This value is a non-cash expense accounting for the average reduction in the value of your assets over the year.
While you’ll still have to pay property taxes, but using depreciation allows you to claim the minimum value of your home, reducing your property tax burden.
After retiring, you’ll probably find yourself in a lower tax bracket, and you should also find that you receive more rental income because rents are higher, and the costs of your mortgage are lower. However, as you get older, the less you’ll want to involve yourself in the management of the property.
As a result, you might want to start using a management service that eats into your profits. However, those management fees are a deductible you can use to offset your tax burden.
Real Estate Crowdfunding
Another option is to use crowdfunding real estate platforms like Fundrise and Roofstock. Both of these platforms allow non-accredited and accredited investors to connect with other individuals looking to fund their real estate projects.
You can either buy direct ownership in a single-family home or a shareholding in a large real estate project. All of the investments on offer on these platforms are entirely hands-off. The opportunities on offer on both of these platforms come with all the due diligence completed by professionals.
All you need to do is select your investment and transfer your money. From there, you collect checks, while someone else worries about the hassle of managing your investments. However, with these crowdfunding platforms, you don’t get to include the deductibles of managing the property from your income taxes, limiting your tax break.
How Can You Pay No Taxes On Business Income?
Opening a business is one of the best ways to reduce your tax bill. As a business owner, the IRS lets you deduct business expenses from your business income. Therefore, if your business spends $100,000, but only brings in $100,000 for the year, you don’t owe any tax because the company didn’t make a profit.
It’s a similar situation for small business owners and personal expenses as well. The IRS lets you deduct the cost of certain expenses from your tax bill. Conferences, hotels, working lunches, and transportation are al valid deductions that you can use to reduce personal income and thereby reduce your taxable income as well.
There are plenty of ways that business owners can write down their tax bill using loopholes in the tax code that favor businesses.
Best Recommendation for Lowering Your Tax Bill – Start a Small Business
Starting a small business is the best way to reduce your tax bill. That doesn’t mean you need to go out and rent a business location and start employing people. You can open a website and start a blog, and that’s a business. From that moment on, you can take advantage of taxes that apply to sole proprietors.
It might seem like you need to open an LLC, but it’s not necessary when you start. Sole props get almost all of the same tax breaks as LLCs, but they don’t have to formalize their company. All you have to do is report your income on the Schedule C form and then itemize your deductions.
Subtract these expenses from your gross profits, and you get the net profit that you’ll have to pay tax on to the government. A skillful accountant can ensure that you pay as little as possible to the taxman when you file.
You can claim all your travel expenses as company expenses, as long as you attach a reason to justify its inclusion in your deductions. Car lease payments, lunches, and even your 401(k) and IRA payments might also be valid deductions from your income as well.
Hire an Accountant
Trying to complete your return by yourself is possible, but it’s a hassle. Not only does it take time, but there’s a chance you’ll overlook many areas of your expenses where you could be saving money. Hiring an accountant is the best strategy for reducing your tax bill. A competent, trained, and qualified accountant can make magic happen with numbers.
An accountant might cost you in service fees, but you can deduct those costs as well. The money that an accountant saves you on your tax bill can be staggering, and it’s well worth the money you pay in consultancy charges.
If you have friends in business, ask them how their accountant performs. If they got a good deduction or refund in the past tax year, arrange for an introduction. Getting a referral is a far better strategy for finding an accountant by yourself. There are thousands of these professionals working in America, but not all of them have the experience and skills to help you.
As long as you hire an accountant, and itemize your deductions, its possible to file a 1040 form that has a zero tax liability. Here are the key takeaways.
- Open a company or start investing.
- Pay attention to tax credits.
- Track your expenses.
- Hire an accountant to do the heavy lifting.
There are plenty of incentives that can help you slash your tax bill at the end of the financial year or quarter. Even if you earn a high income, you can significantly reduce your taxable income using deductions and tax loopholes.
Talk to a tax professional for the best advice.