How To Save On Taxes The Way The Wealthy Do

how to save on taxesThe following contribution is from The Money Template, a personal finance blog exploring all things related to wealth and well-being.

Taxes are simply one of those things where no matter how much you fight them they never seem to go away. That is … unless you know a few tricks on how to get around having to pay more than your fair share.

Believe it or not, this is actually one of the contributing reasons why wealthy people stay wealthy. Even though the tax code appears to be written in such a way that you should owe more money the more you make, this is generally not the case. In fact it was famously revealed in the 2012 presidential election that millionaire republican candidate Mitt Romney was paying an effective 14% tax rate. Are YOU enjoying a nice 14% tax rate?

Similar to Romney’s case, the trick in knowing how to save on taxes is learning how to use legal tax incentives to your advantage. Though you may think this is something that is only reserved for the ultra-rich, the reality is that a lot of these same techniques can be applied to your own situation with the aid of financial planners and accountants who are familiar with the tax laws.

Here are a few you can start using now:

7 Strategies for How to Save on Taxes:

1)  Retirement Accounts:

Contributing to your employer-sponsored retirement funds is one of the simplest ways to take advantage of tax-sheltering. With these types of programs the contribution is taken out of your gross pay, meaning that it is no longer considered to be taxable income. Your regular income taxes are calculated on the total amount that is left over. The more money you defer to your retirement plan, the less money there is to be taxed! The IRS will allow you to defer up to $18,000 per year to your 401k plan starting in 2015.

The other cool thing about this strategy is that it actually gives you way more money to invest. If your tax rate is 25%, that’s effectively like the government giving you a 1 / (1-25%) = 1.33% increase on your savings!

2)  Self-Employed Retirement Accounts:

If you make any sort of a side income either from odd jobs or hobbies where you get paid, you might also be eligible to save even more money tax-deferred – beyond your 401k or IRA.

Any substantial earned income is always subject to taxes, and often those taxes are more than what you currently owe on your employment income. However one thing I discovered not too long ago was that you could reduce the amount of taxable income you present to the IRS by deferring a portion of your earnings into a self employed retirement account.

The most types of self employed retirement accounts are an SEP-IRA, Solo 401k and Keogh Fund. Each of these plans have their own unique benefits and restrictions. I would strongly encourage you to check with an accountant to make sure qualify for one of these plans before you set one up.

3)  Capital Gains and Dividend Income:

Going back to the Romney example, one of the ways he was able to cleverly reduce his overall tax bill is because a substantial portion of his income comes from capital gains and dividend income payments from the stocks he owns.

Most people only know to save their money in bank accounts and pay regular taxes on the interest they earn. But more affluent savers will know that capital gains and dividends are taxed at lower tax rates than standard earned income (generally 15% vs 25%) making them more attractive of an asset to own.

4)  Rental Income:

Though it takes a special kind of person to be landlord, you might consider it after seeing how the tax benefits can help reduce your overall bill.

Unlike your primary residence, expenses like repairs, upkeep, depreciation, etc are all tax deductable on a rental property. Own enough rental properties and you could effectively offset the taxes owed on your regular income down to nothing.

If you’re turned off by the idea of rental properties, remember – there are management companies you can hire to take care of many of the undesirable aspects of being a landlord.

5)  Donations:

Doesn’t it feel good to give? When you donate cash, clothes, a car, whatever, you can count that as a deduction against your taxes.

Just make sure to always get proof with a receipt. The IRS will want proof that you legitimately made a donation and you’re not just saying you did simply to get a tax break. Legitimate organizations that are supported through donations are more than willing to provide receipts to their donors.

6)  Energy Efficient Upgrades:

Sometimes it pays to modernize. Improvements you make to your home in order to make it more energy efficient can be claimed on your income tax forms and therefore get you a tax break. For example, changing out or improving equipment to provide solar power to your home can be a huge tax break.

There are lots of other energy efficient programs to consider as well. You can find this information through the Energy Policy Act. As with tax regulations, these programs changes from year to year, so make sure to check them out thoroughly before using them each year to save on your taxes.

7)  Use a CPA to Help You Find More Options:

Certified Public Accountants know much more about tax laws and how to save on them than the average person. With one look at your overall finances they will more than likely be able to identify or at least bring up incentives that you probably aren’t even aware exist.

Though paying a few bucks on the Internet can seem like the better way to do your taxes, sometimes that’s being penny-wise and pound foolish. If you think you qualify for any of the items above then I’d recommend at least having a consultation with a tax professional to see if they could find more ways on how to save on taxes.

Image courtesy of FreeDigitalPhotos.net

11 thoughts on “How To Save On Taxes The Way The Wealthy Do”

    1. @MoneyMiniBlog: I use a solo 401k plan and love that I am saving for my retirement. I make it a point to put aside a good portion of my income each month before I pay myself so I can be certain I save something.

  1. Love the SEP!

    If you are in a fairly high tax bracket, you might also try tax-free government bonds. Interest from bonds issued by state and local governments is not taxed like other bonds. Even though the rate may be lower, you could save a bundle on taxes.

    Great post.

  2. I’m self employed and am probably going to look into a SEP once we can afford to max out my IRA. (Work in progress.) But I wish they had Roth options for SEPs. That’s why I’m going to max out my regular Roth, which I know isn’t tax deductible, before starting the SEP.

    I think we probably will get a boost thanks to the $3,000 we spent on energy upgrades. Unfortunately, donations don’t help us because we don’t itemize. That means we don’t get the boost most people do from having a house. On the other hand, it means our house is really that cheap.

    So, ya know, hard to begrudge it.

    1. @Abigail: Very true!! Having the house deductions is nice, but you are still paying a ton in interest charges. I wish more people understood that a deduction is good, but a tax credit is even better.

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