Reduce Your Taxes

4 Ways The Rich Reduce Their Taxes (And How You Can Too!)

by KNS Financial on March 28, 2011

For as long as I can remember, people in the so-called middle and lower classes (as far as income is concerned) have always felt that the “rich” have far too many tax breaks. They point toward those wealthy individuals who are able to retain a significant portion of their income through various income tax deductions and credits (which serve to reduce your taxes).

With the US economy in the toilet for the last few years, these talks of unfair tax breaks for the wealthy have been getting much more prominent.

However, what many people fail to recognize is the fact that many of these same deductions and credits are available to taxpayers of all income levels. Here are a few ways in which you can reduce your taxes, just like the rich!

So let’s look at how to reduce your taxes like the wealthy!

Giving To Charity

Donating money to a charitable organization is one of the most common ways that the wealthy reduce their tax bill. You don’t have to make it on the cover of the next Philanthropy magazine in order to make an impact. Just be sure to receive a receipt for any donation that you make to your local church, or food bank and deduct those amounts from your taxable income. Even if you are just giving to the poor – as long as it’s through a charitable organization – will give you an additional tax deduction!

Also, include any donations which you may have made to disaster relief efforts and other 501(c)(3) organizations (such as foundations connected to educational institutions, medical research, etc). In this case, you are able to reduce your taxes by helping others!

Owning A Home

There are two ways in which you can benefit from “owning” a home.

Take Out A Mortgage

I think it’s becoming a pretty well-known fact that I hate mortgages. However, they do carry tax benefits to them. If you have a mortgage, then you are allowed to deduct both the interest paid against the loan and the property taxes paid during the tax year, from your income. For those of you who have looked at your statements, you know that these amounts can be quite large (especially if you live in New Jersey)!

Own Rental Property

Another way in which the “wealthy” are able to mitigate some of their tax liability is to purchase rental property. All expenses that are incurred in both the improvement/renovation and maintenance of your rental property can be deducted from your income. Don’t forget to include the costs for advertising, property management, legal fees, and even travel related to your rental property!

If you take out a mortgage on your rental property, then you are able to deduct both the interest and property taxes as well, and reduce your taxes even further.

Start A Business

This is probably how the majority of non-celebrity wealthy people established themselves. For most people reading this article, quitting your job to start a business is probably not feasible (it surely isn’t for me)! However, you can easily take a hobby and turn it into a side business.

You can give lessons, offer services, or even create various products, and all without turning your life upside down! You may even want to create a website or start a blog as part of your business.

No matter what you choose to do, any expense related to this business will be tax deductible. With the ability to capitalize certain expenses, starting a business would be a great way to manage your tax situation. If you decide to pay yourself, make sure you are aware of the self employment tax rate.

Invest In Tax-Friendly Accounts

The key here is to get to a point where you can gain a significant portion of your income from income from your investments. Most municipal bonds are exempt from both state and local taxes, and so they are a favorable investment – especially in states that have high tax rates!

If you are looking to save on your tax bill today, then look no further than either a Traditional Individual Retirement Arrangement (IRA), or a 401(k). Both of these accounts allow you to defer your taxes until the time in which you begin to take distributions (up to age 70 1/2). This means that the money you put into these accounts today will not be taxable (up to the limit).

If you desire to gain huge tax savings in the future, you can look into either the Roth IRAs or Roth 401(k)s. What’s special about these accounts is that unlike their “traditional” counterparts discussed above, you pay taxes on the contributions in the year that you make them. However, once you are ready to take your distributions, no taxes are owed.

If you are able to take large enough distributions in order to support yourself, then you will greatly diminish your tax liability.

Take a look at the IRA contribution limits and 401k contribution limits and reduce your taxes!

Nothing Special

As you can see, all of the items listed above can be accomplished by taxpayers of most income levels. You will also notice that these are not earth-shattering, secret financial gems known only to a few!

On the contrary, these are situations that millions of Americans find themselves in every day. The only difference is that many of us don’t realize what a huge difference these overlooked tax deductions can make in our tax liability. If you have not yet completed your tax preparation, then take a look at your finances to see if you are already taking advantage of some of these techniques.

photo by Arvind Balaraman

Reader Questions

  1. What situation in your life gives you the largest tax benefit (mortgage, marriage, children, business, retirement accounts, etc)?
  2. Do you consider your tax situation before making certain financial decisions?
  3. What is the one tax code you would change?

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