Most articles around this time of year talk about what to do or not do with your tax refund. I’ve already talked about that, so instead I’m going to help you come up with ways to avoid paying taxes next year. I don’t mean stashing all your money in offshore savings account but we can probably all agree that paying taxes sucks! What makes matters worse is how inefficiently the government spends your money. I’m all for re-distribution of wealth to the people who need it but we know that doesn’t happen very often. I’d rather donate my time and money directly to the organizations that need it and pay less in taxes than get gouged by the US government.
Taxes are a necessary evil in any civilized nation, we need roads to drive on, we need schools to educate our kids and so on. But it’s not all bad with taxes, the government does provide some options in order to help every day taxpayers like you and I to save money on taxes.
Standard Tax Deductions
These are the deductions that the average taxpayer usually takes advantage of. They may include:
- Retirement Accounts: 401k, IRA, HSA, etc
- Owning a home: Mortgage Interest Deduction, Property Tax
- Charitable contributions: Cash/Gifts, Stock
Reduce Your Tax Rate
Last year during the presidential election, there was a popular anti-Romney sentiment that blasted him for paying a lower percentage than the average taxpayer. But that’s because Romney earned most of his income from capital gains,which is taxed at a much more favorable rate than regular earned income based on a tax calculator. But most every day people won’t be able to really take advantage of this since they get paid W2 salary. Even though executive-types are the last ones who need it, they are generally the ones that tend to get compensated in company stock.
Gray Area of Tax Avoidance
Ok those are some of the more legal ways to avoid paying tax. Like I said, I don’t recommend blatantly lying on your taxes but I don’t think there’s anything wrong with knowing where to take advantage of the tax code. The IRS tax code is anything but fair. In 2013, a single filing taxpayer would pay a marginal tax rate of 39.6% on income over $400,000. A married couple would pay a marginal tax rate of 39.6% on income over
$800,000 $450,000. Huh? Does that make any sense to you, why should married couples face such a high tax penalty for getting married? I might feel bad about cheating the tax code when these unfair policies are reversed(I’m getting married soon so this makes me even more mad!)
Earn Tax-Free Income
If you’ve ever gotten paid in cash you know how sweet it is. Legally, you are required to report this income to the IRS but I don’t think many people do. If you’re looking for a source of second income, cash jobs can be a huge boost to your total income. Since your primary job will most likely be W2 income, every additional dollar you make at a second job will be taxed at your marginal(highest) rate. Here’s an example:
Joe the plumber makes $50,000 a year in W2 income. He takes on a second job with Home Depot to make a little extra cash and gets paid $10,000 in W2 income over the course of the year. That’s great for Joe but that $10,000 in Home Depot income is being conservatively(would be more with state, fica, medicare) taxed at 25%(federally, assume no deductions).
So he really only made $7,500 extra after taxes. Instead, Joe decides to tutor up and coming plumbers willing to pay him in cash. Now once he makes $7,500(or maybe even less) from tutoring he’s at the break even point with the Home Depot job.
There are quite a few options when it comes to finding cash jobs and some may take more work than others but once you build up a small clientele it will become easier and easier to make tax free income. I’ve done everything from selling used textbooks for a profit to tutoring and coaching high school aged students. Everything I did was fun, easy and I got paid in cash. Here’s the list I came up with:
- Child care jobs: everything from tutoring to babysitting
- House-sitting or pet sitting can be very lucrative
- Cleaning Jobs
- Private lessons in some niche sport(I do volleyball lessons at $65/hr) or field(ie music lessons)
Get a Roommate
If you own your own house or condo, you can find a roommate and immediately start saving money. Again, it’s up to you to report the rental income but you can come up with creative ways like having them pay for all the utilities, food and housing supplies so that you don’t have to pay taxes on that income. I think the rules are a lot less strict when you’re living in the property and charging someone rent as opposed to renting the entire unit out to someone.
Start a Business
Did you know that I own my own business? I work as an independent contractor for my volleyball club so the IRS considers me a business owner. The income is minimal(less than 10k/year reported as 1099-Misc) but it allows me to take on many deductions that I would normally never be able to get. I’m able to deduct my home office, the miles I drive to and from practice and tournaments, meals/entertainment, hotel stays, etc. Each year, I’m able to nearly deduct my entire coaching stipend and pay almost nothing in taxes. This makes a huge deal to me for the reasons outlined above in our ‘Joe the Plumber’ example.
I actually end up making about the same on a per hour basis at my coaching job as I do at my real job. And the former is a lot more fun, I would actually barely call it a job. On this one, you might be best served to talk to a friend who’s a CPA/tax professional because you might be able to find a ‘business’ you can open and start saving on taxes.
Readers, are you ok with paying these ridiculous tax rates or do you look for every avenue to try and legally slip past the IRS rules? Do you think it’s ethical to skirt the IRS? If your answer is no, what do you think about the marriage penalty, how is that fair?
Track All Your Accounts With Personal CapitalPersonal Capital lets you see all of your accounts in one convenient place. Sign up now for free.
-Harry @ PF Pro
I know! It’s such an annoyance that our tax rates are so much more than every other developed country
I’m afraid of any means of avoiding taxes that wouldn’t survive an audit. Luckily, there are plenty of options written into the tax code that are more easy to take advantage of now that I make a little money. Buying rental property is a big one. Pumping big bucks into a retirement account is another.
Harry Campbell says
Would you consider cash jobs as surviving an audit? I would. And I agree there are tons of options written into the tax code. Real estate is probably one of the biggest ones as you can exclude up to 250,000 in capital gains!
I actually don’t know much about what triggers an audit. Sort of a black box to me. It’s something I should look into as I’ve been a pretty complex case for a long while.
Yup. The treatment on capital gains is very nice. But even being able to deduct everything from mortgage interest to utilities isn’t bad. Deducting depreciation has also been very good to me.
Marriage penalty is SO not fair. And promotes women not working. My current plan because of that is not to get married until I’m FI and quit my job, haha.
I’m not a huge fan of the mortgage interest tax deduction though. It puts too much value on expensive mortgages rather than affordable ones.
Harry Campbell says
I couldn’t agree with you more about the marriage penalty and now that I’m getting married it makes me even more upset! But either way, those are the rules and it’s what motivates me to pay as little in taxes as possible.
You’re right on about mortgage interest deduction, it is a huge benefit to the wealthy but it’s hard for people to overlook the immediate short term gains in favor of longer ones. There was a good planet money podcast that elaborated on this and I think nearly ever economist agrees with us.
I’ll have to find the link, but have read that more couples pay *less* taxes than those that pay more due to the treatment of taxes in marriage.
For obvious reasons, it’s better for couples in which one spouse makes significantly more than the other and worse for couples that make similar income.
And continuing the theme, it also hurts the working poor the most.
Harry Campbell says
The reason for that is not due to the treatment of taxes, it’s because one spouse tends to stop working. Still doesn’t make sense or seem fair to me.
And I’m saying this even though it will help me for the first 4-6 years of marriage since my fiancee will be in school while I’m working. So we’ll be married but with only one income(mine).
Well no. Let me put some numbers on it using the 2012 tax tables, here: http://www.irs.gov/pub/irs-pdf/i1040tt.pdf
At the extreme, suppose a woman makes $97,000 and her boyfriend makes $1000. Separately, they would pay:
If they got married and filed jointly, they would have a total income of $98,000 and pay:
That’s a savings of $4,163 or 20%
Sure, but in the majority of the relationships I’ve had thus far, I have made a similar income to the guy, meaning that if we were married, our AGI would be around $250,000 to $300,000. For some people, it works out better, but I expect it to be a marriage penalty in my situation.
Certainly. It probably wouldn’t be good for me either because I’ve mostly dated women who were similarly educated and had similar incomes.
Apparently though, a majority of American couples pay less through the current married-filing-jointly structure than they would individually. By extension, a majority of American couples have pretty disparate income.
That’s pretty lame about the marriage penalty. On an unrelated note, I’d love to hear your thoughts on wedding costs if that’s not too personal. I’m always curious as to how the PF community manages it, but don’t think I’ve heard a guy’s perspective on it yet.
Harry Campbell says
Yea I know. Hmm, wedding planning. I’ll have a whole series of articles on wedding planning, don’t worry. I’m actually trying to decide if I want to start another site for it or not, but still debating.
Operating a cash business is something that I think is abused (from the IRS perspective). I’ve known a number of folks that had cash businesses. Many of them get double savings on taxes. Writing off gas in their “work” vehicles for example. They pay for this with their businesses funds so bring down the businesses taxable income, since this is a gas fill they normally would have paid out of pocket, they are saving on “taxable personal income” as well.
Harry Campbell says
Yea that doesn’t really bother me at all for the inequality reasons I discussed above. And it’s not really a double savings but it is a single savings(see double taxation myth).
Obviously I understand why you are against this, but what makes you more mad: this or the unfair tax treatment of married couples? The latter is what I think is truly unfair so if I can make up all that unfairness by using my work vehicle for personal use that’s fine with me.