Legal Ways to Reduce the Amount of Taxes You Must Pay

With the cost of living skyrocketing and the troubled economy heavy on our minds, we often are forced to cut out some of our necessities in an attempt to meet all of our obligations. Perhaps one of the most dreaded and hated of these obligations is taxes. However, even in this area, we can learn to save money, allowing our money to stretch even further in these difficult times. Ultimately, there are legal strategies for minimizing the amount of taxes you have to pay each year. These strategies can be broken down into five categories (Keown, 2007, p. 120):

"Maximize deductions."

"Look to capital gains and dividend income."

"Shift income to family members in lower tax brackets."

"Receive tax-exempt income."

"Defer taxes to the future."

Maximizing Deductions

Examples of attempting to maximize your tax deductions include investing in tax-deferred retirement plans, such as your 401(k), instead of using the money for investments that are taxable and which have gains that are also taxable. This will ultimately save you money in the long run since all money that could be wasted on taxes now and can be saved to earn interest until your retirement. Another example of this type of strategy is by having your house save you money as a tax shelter. First, do not forget to deduct the interest payments for your mortgage when you file your taxes. And also, if you ever decide to sell your home, you do not have to pay any taxes on gains up to a specified amount (depending upon how you file your taxes). Finally, you should learn everything you can about the types of deductions the IRS allows you to claim on your tax form. Learning when to itemize, when to put down the standard deduction, and when to postpone major expenses can really save you much money in taxes (Keown, 2007, p. 120-121).

Investing Wisely

Next, you might also be able to save yourself even more money in taxes if you watch your taxable investments. There are actually some tax breaks on the capital gain and dividends of some investments. Fundamentally, capital gain (the amount an asset is sold for minus its original purchase price) is taxable. However, it is not taxable until you actually sell your investment, and the longer you wait to sell, the less taxes you will eventually pay since the government awards long-term investors with lower tax rates on their capital gain (Investopedia, 2008; Keown, 2007, p. 122). In addition, the IRS offers similar tax rates (as the capital gain rates for long-term investments) for qualified dividends from both foreign and domestic corporations. As a result, if you choose your other investments wisely, you still might qualify for a number of tax breaks (Keown, 2007, p. 122-123).

Shifting Income

There are also two other tax minimizing strategies that few people ever think of or understand that can legally take advantage of. First, it is perfectly legal to give up to $11,000 to a single family member and this money will be tax free for both the giver and the receiver. This can be a wise decision, especially if you give monetary gifts to relatives that are within a lower tax bracket than you are. That way, if he or she chooses to invest your gift, the IRS will take less money for taxes than if you have invested the money yourself (Keown, 2007, p. 123).

Receiving Tax-Exempt Income

Furthermore, there are a number of specified sources of income that the IRS is not allowed to tax. For example, bonds issued through state and local governments cannot be touched by the IRS. Additionally, employers can offer compensation that is also non-taxable, such as employer-paid health and life insurance premiums or employer-paid transportation (under $100 a month) (Keown, 2007, p. 123; Schnepper, 2008).

Deferring Your Taxes

Finally, you also can save money on taxes by deferring your taxes to a later time, such as investing your money into a tax-deferred account (i.e., your retirement plan) or waiting longer to sell an asset (Keown, 2007, p. 123-124). Ultimately, if you do a little research and thinking outside the box, you can find any number of legal ways to minimize your taxes.

References:

Investopedia. (2008). A long-term mindset meets dread capital-gains tax. Retrieved June 23, 2008, from http://www.investopedia.com/articles/00/102300.asp

Keown, A. J. (2007). Personal finance (4^th ed.). Upper Saddle River, NJ: Pearson Prentice Hall.

Schnepper, J. (2008). 8 types of income the IRS can't touch. Retrieved June 23, 2008, from http://articles.moneycentral.msn.com/Taxes/CutYourTaxes/8typesOfIncomeTheIRScantTouch.aspx