Taxes are an important part of the money we spend every month. Here are some secrets the rich have to pay fewer taxes, which are legal and can help you increase your income.
To know how to save on taxes, first, we need to understand how they work. It may seem difficult, but, there are really only two pieces in this puzzle: expenses and income.
Income means any money coming in (paycheck, investments, canceled debt, etc) and you are taxed based on what type of income it is. Some of them pay higher tax rates than others, depending on what actions the government wants to incentivize.
Expenses, on the other hand, means any money you are spending, and you may be able to deduct them from your income according to what expenses the government wants to boost.
Now that this basic information is clear, let’s see how to make things work in your favor.
Not all income is taxed the same way
Someone with a regular job will be paying federal and state income taxes on all income. They also pay a payroll tax, which is known as FICA. The Social Security portion, 6.2%, is assessed on income up to the wage base ($128,400 for 2018). The Medicare portion, 1.45%, is assessed on all income.
Someone self-employed will also be paying federal and state income on all income. They too will pay a payroll tax but it's called a self-employment tax. The tax works out to be 15.3% for all income up to the wage base and then 2.9% on income above it.
Qualified dividends are taxed extremely favorably and If you sell a business and have the proceeds taxed as long term capital gains, it's treated the exact same way.
So, if you are a small business owner, it is better for you, tax-wise, if you reinvest all income and build equity in the business that you can sell in the future.
Defer taxes with 1031 Exchanges
This lets you avoid taxes on gains when you sell something if you, immediately (within 45 days), reinvest the proceeds into a similar property as part of a “like-kind exchange.” The tax is deferred, so it's not tax-free, much like a 401(k).
There are investing platforms that identify 1031 eligible properties for you to invest in, so regular folks will be able to take advantage of 1031 Exchanges.
Move to a Lower Tax State
We often overlook state taxes because federal taxes are a more popular subject, but state taxes are significant. State and local governments need taxes to fund their budgets but each state does this in a different way. Some states have high personal income taxes, some have a high sales tax, others rely on property taxes or business taxes. There are seven states with no personal income tax, for example, and five states with no state sales tax.
Keep Good Home Records
When you sell your primary residence, you do not have to pay $250,000 of capital gains. If you are married, you don't have to pay $500,000 of capital gains. your primary residence is determined by where you've lived for two out of the last five years. An investor will buy a house they hope to flip, live in it for two years while they renovate it, and then sell it for a tax-free gain. Repairs and maintenance are not deductible but home improvements are.