Tax invasion

[TerriM]

Tax evasion....the legal way!   What are your best strategies for lowering your taxes?  Throw me all your ideas from retirement accounts to picking up garage sale leftovers from the trash and donating them to Goodwill for the Schedule A write-off! And if you're self-employed/running a small business, I'm especially interested in tricks you might have.  Thanks!

[iamlindoro]

If you're self employed and not maxing out both the employer and employee portions of a Solo 401k (52K for you, 52K for your spouse, all tax free) then you're insane.  I can think of no single more effective tax deferral.

[seattlecyclone]

...picking up garage sale leftovers from the trash and donating them to Goodwill for the Schedule A write-off!

About that...if you donate something that's worth more than you paid for it, you can only deduct what you paid.

[rothnroll]

I itemize my taxes and I am always looking for ideas..............

[TerriM]

...picking up garage sale leftovers from the trash and donating them to Goodwill for the Schedule A write-off!

About that...if you donate something that's worth more than you paid for it, you can only deduct what you paid.

I'm seeing the word "generally" in there, and it's not clear whether it is meant to apply to clothing....  If you receive a gift of a new shirt, and you donate it once you've worn it a couple of times (or not at all), would you not take the deduction for fair market value of that shirt?


But this one under food donation is interesting: "The food is to be used only for the care of the ill, the needy, or infants."   I wonder if moms could get a fair market deduction for donating breastmilk. "1. Enter fair market value of the donated food"...

[SaintM]

Please do not refer to "legal" tax evasion, because there is no such thing.

If you mean "tax avoidance" I offer the following:

- Passive income is better than wages in every way. No employment taxes, 0%-%20 income tax rate.
- Rental properties are the absolute most tax-efficient means of earning income because the depreciation wipes out most of the taxable income.
- Tax-exempt bond funds but watch out for the fees.
- Hold companies that pay qualified dividends in taxable accounts and those that pay ordinary income in Roth accounts. Ditch the traditional 401k or IRA accounts ASAP.

You will notice I don't say anything about deductions. If you keep your expenses low, they will not exceed the standard deduction.

[SaintM]

If you're self employed and not maxing out both the employer and employee portions of a Solo 401k (52K for you, 52K for your spouse, all tax free) then you're insane.  I can think of no single more effective tax deferral.

Negative. You will pay enormous fees to Wall Street over time. What income and gains you do get, along with your contributions, will be taxed at ordinary income rates instead of favorable dividend and capital gains rates.

[iamlindoro]

If you're self employed and not maxing out both the employer and employee portions of a Solo 401k (52K for you, 52K for your spouse, all tax free) then you're insane.  I can think of no single more effective tax deferral.

Negative. You will pay enormous fees to Wall Street over time. What income and gains you do get, along with your contributions, will be taxed at ordinary income rates instead of favorable dividend and capital gains rates.

Huh?  I wasn't suggesting a particular investment.  As always, people should be using low-cost index funds such as those from Vanguard.  You will absolutely not pay enormous fees to Wall Street.  Your income, gains, and contributions will be taxed as ordinary income on distribution *in retirement*, when most people can expect to be in a lower tax bracket than they are during their working life.  Most mustachians can expect their effective tax rate to be well below the capital gains tax rate in retirement.

Are you sure you're on the right site?

[gaja]

But this one under food donation is interesting: "The food is to be used only for the care of the ill, the needy, or infants."   I wonder if moms could get a fair market deduction for donating breastmilk. "1. Enter fair market value of the donated food"...

When I gave surplus milk to the hospital for premature babies, I was paid a small sum for the time and effort. I think the rate was $15-20 per liter.

[waltworks]

Um, what?

Seriously, I'm not even sure what to make of this comment. Is it a joke? If you want to pay less in taxes, the #1 way to do so, by far, is 401k/403b/tIRA contributions, assuming you are an ordinary citizen living in the US. It is quite easy for many people to *completely eliminate* any federal tax liability by doing this, and for most folks here, legal withdrawal strategies can be optimized to mean no tax burden in retirement as well.

If you don't like equities, you can certainly invest in other things with those instruments as well, but your fees comment isn't even accurate. I pay .05% (note, that's not 5%, that's 1/20 of 1%) in annual fees on the majority of my investments.

-W

If you're self employed and not maxing out both the employer and employee portions of a Solo 401k (52K for you, 52K for your spouse, all tax free) then you're insane.  I can think of no single more effective tax deferral.

Negative. You will pay enormous fees to Wall Street over time. What income and gains you do get, along with your contributions, will be taxed at ordinary income rates instead of favorable dividend and capital gains rates.

[TerriM]

Please do not refer to "legal" tax evasion, because there is no such thing.

I was trying to offer a little humor on the forums, and maybe a catchy title to get people's attention.

[seattlecyclone]

I'm seeing the word "generally" in there, and it's not clear whether it is meant to apply to clothing....  If you receive a gift of a new shirt, and you donate it once you've worn it a couple of times (or not at all), would you not take the deduction for fair market value of that shirt?

They say your basis is "generally what you paid" for an item. There are exceptions as explained in Publication 551 (inherited items have a basis equal to their value at the time of the previous owner's death, gifted items tend to retain the giver's basis, and more rules). I don't see an exception for discarded items. Unless you can find a clear statement otherwise, I would assume that you cannot claim a deduction for taking something out of a trash can and depositing it at a thrift store.

[TerriM]

Publication 551 doesn't appear to address household goods, but land and stock.

This link addresses goods, and says they must be in good condition  (fair enough):

http://www.irs.gov/publications/p526/ar02.html#en_US_2013_publink1000229705

"Used clothing.   The fair market value of used clothing and other personal items is usually far less than the price you paid for them. There are no fixed formulas or methods for finding the value of items of clothing.   You should claim as the value the price that buyers of used items actually pay in used clothing stores, such as consignment or thrift shops."

That seems pretty straightfoward--if a good-condition pair of pants sells for $5 in the thrift shop, you can claim $5 for it.  But I don't think the above needs to be interpreted as you had to pay for them, only that the price is far less than the buyer paid for them.

However, for household items, not having a receipt could be a problem:

"Household items.   The fair market value of used household items, such as furniture, appliances, and linens, is usually much lower than the price paid when new. These items may have little or no market value because they are in a worn condition, out of style, or no longer useful. For these reasons, formulas (such as using a percentage of the cost to buy a new replacement item) are not acceptable in determining value.  You should support your valuation with photographs, canceled checks, receipts from your purchase of the items, or other evidence. Magazine or newspaper articles and photographs that describe the items and statements by the recipients of the items are also useful."

But arguably, the value of a used household item is what the thrift store can sell it for....  So what goes with clothing probably should go here.

I'm not seeing anything here that prohibits you from getting a tax-deduction on items you received as a gift (which is what you're getting from your neighbor :), just that you have to be very practical about basing its value on thrift-store resale values, and that it has to be in "good condition" i.e., working, usable, and resalable.

[TerriM]

Just to be clear, I was joking about the trash-day donation thing (though i think it's a great idea :), but I do deduct kid's clothing, a lot of which was gifted to me.  I use a combination of thrift store and garage sale prices--($1-3 which is between the $1-2 for the neighborhood garage sales and the $3-5 that SVDP wants to sell it for), and I take photos.  I think this is entirely fair since some of the clothing is barely worn.   If my MIL gives my kids a nice shirt which gets donated after only 10 uses, do I really need to send it back to her so she can take the deduction?

[wardkf]

If you're self employed and not maxing out both the employer and employee portions of a Solo 401k (52K for you, 52K for your spouse, all tax free) then you're insane.  I can think of no single more effective tax deferral.

Negative. You will pay enormous fees to Wall Street over time. What income and gains you do get, along with your contributions, will be taxed at ordinary income rates instead of favorable dividend and capital gains rates.

I'm largely  in agreement with this.  If you are a buy-and-hold investor, under current tax law you are likely to come out ahead by investing in taxable accounts rather than tax-deferred accounts.  Unfortunately, it may not always be the case that capital gains and dividends are taxed at lower rates than regular income.  On the other hand, there's no guarantee that Roth accounts will never be taxed in the future.  So...

[iamlindoro]

If you're self employed and not maxing out both the employer and employee portions of a Solo 401k (52K for you, 52K for your spouse, all tax free) then you're insane.  I can think of no single more effective tax deferral.

Negative. You will pay enormous fees to Wall Street over time. What income and gains you do get, along with your contributions, will be taxed at ordinary income rates instead of favorable dividend and capital gains rates.

I'm largely  in agreement with this.  If you are a buy-and-hold investor, under current tax law you are likely to come out ahead by investing in taxable accounts rather than tax-deferred accounts.  Unfortunately, it may not always be the case that capital gains and dividends are taxed at lower rates than regular income.  On the other hand, there's no guarantee that Roth accounts will never be taxed in the future.  So...

Sorry, but again, this is completely incorrect.  Perhaps you can provide some facts to back up what you're saying?  And who mentioned Roths?

The specific advice given was that someone who is self employed with adequate income should max a Solo 401k, also known as an Individual 401(k), which is materially different from a corporate sponsored 401(k) in that the individual is both the employee and the employer.  Thus, the individual can defer up to 52K for themselves, and 52K for their spouse, completely avoiding taxes on up to $104K of income per year, or $118K if you are over 50.  This income, and all gains and dividends, are completely untaxed until withdrawal.  On withdrawal, they are only taxable as normal income.  Since they should be withdrawn during retirement, and annual income should (for most) be far less than during working years, there is a massive savings here. 

Contrast that with investing the same income in taxable accounts-- it is taxed when you are paid (at your current tax rate, liable to be higher than your in-retirement tax rate) and then your gains are taxed on sale (whether it be long or short term capital gains). 

[Fuzz]

Just a qualifier on the discussion of the solo 401k. So the $52K year for the solo 401K limits the employer's contribution to 25 percent of profits and the employee's contribution is the rest.

(and I'd love to be corrected on this, some of you sound like accountants).

So if your small business grosses $100K per year and it's all profit, the business can contribute 25K untaxed. Then the employee would contribute the rest out of wages, so you're probably still going to pay payroll on that part. Right?

[wardkf]

You are correct, iamlindoro.  I somehow completely missed the Solo 401K aspect, and was thinking of regular 401(k)s, which require one to invest the (taxable) difference between the max 401(k) contribution and the total taxable income required to have the after-tax maximum 401(k) contribution in order to come out ahead.

I mentioned Roths because, just as with preferential tax rates for capital gains and dividends, all of our planning requires knowledge of tax law some years hence, which we obviously do not have.

[iamlindoro]

Just a qualifier on the discussion of the solo 401k. So the $52K year for the solo 401K limits the employer's contribution to 25 percent of profits and the employee's contribution is the rest.

(and I'd love to be corrected on this, some of you sound like accountants).

So if your small business grosses $100K per year and it's all profit, the business can contribute 25K untaxed. Then the employee would contribute the rest out of wages, so you're probably still going to pay payroll on that part. Right?

Basically right.  Also worth noting that there are some slight differences between a Sole Proprietorship and an S-Corp that allows the S-Corp to contribute a little bit more at the same income levels, since the self-employment taxes are tax deductible for the S-Corp.

Edit to clarify:

The 100K scenario would be, for an S-Corp (to keep the numbers simple and round):

18 K untaxed from the employee
$25 K untaxed from the employer (which in this case is still the employee)

For a maximum untaxed contribution of $43K.

You can max out employer + employee to $53K by having ~140K in income as an S-Corp.  Takes about $185K to max it out as a sole proprietorship.

[RapmasterD]

What bracket are you in, OP? Also, I didn't find your title to be funny either.

[clifp]

If you're self employed and not maxing out both the employer and employee portions of a Solo 401k (52K for you, 52K for your spouse, all tax free) then you're insane.  I can think of no single more effective tax deferral.

Negative. You will pay enormous fees to Wall Street over time. What income and gains you do get, along with your contributions, will be taxed at ordinary income rates instead of favorable dividend and capital gains rates.

No No No. Do the math on this. Taxed deferred compounding is the best money saving tip out there.

Joe can afford to save $10K/year in after tax income. Option A stick the 10K in an index fund.  Over the next 30 years it appreciates at 9%/year after modest expense at the end of the 30 years  he has $142,676. Say he owes 20% (15% fed +5% state) on the gain after tax he is left with $116,141. Option B is to stick it in a 401K/SEP IRA, since Joe is in the 28% Fed+5% State a $15,000 contribution is equivalent to $10,000 after tax.  $15,000 after 30 years @9% will turn into $214,015.  Even if Joe is still in the same tax bracket (28%+5%) you are left with $143,390 after tax or more than $27,000 more than advice given.

And that is best case of the index funded investing. Realistically about 2% of the gain each year in the after tax account will be taxed (dividends+ small capital gains) reducing the amount Joe can save. Also in many case Joe will be in lower tax bracket after retiring further increase the benefit.

There are times like right before retiring when doesn't make sense to max out tax deferred savings, but in general it does.
I'm largely  in agreement with this.  If you are a buy-and-hold investor, under current tax law you are likely to come out ahead by investing in taxable accounts rather than tax-deferred accounts.  Unfortunately, it may not always be the case that capital gains and dividends are taxed at lower rates than regular income.  On the other hand, there's no guarantee that Roth accounts will never be taxed in the future.  So...

[TerriM]

What bracket are you in, OP? Also, I didn't find your title to be funny either.

Ahh well, each to his own.  I changed it.  Now it's just silly.

I think it's a good question for people at any bracket.   

We are in a higher bracket 28-33% depending on the year plus 9-10% CA taxes.  Self-employment would add 15% on top of that.

[Cpa Cat]

Just to be clear, I was joking about the trash-day donation thing (though i think it's a great idea :), but I do deduct kid's clothing, a lot of which was gifted to me.  I use a combination of thrift store and garage sale prices--($1-3 which is between the $1-2 for the neighborhood garage sales and the $3-5 that SVDP wants to sell it for), and I take photos.  I think this is entirely fair since some of the clothing is barely worn.   If my MIL gives my kids a nice shirt which gets donated after only 10 uses, do I really need to send it back to her so she can take the deduction?

No. You inherit your mother's basis in the item when she gifts it to you, so you are entitled to the tax deduction.

[RapmasterD]

As long as you're working for someone else, there is not a whole lot you can do that makes a MEANINGFUL difference.

Stay within your 28% bracket if you can.

That's a pretty low bracket.

[TerriM]

As long as you're working for someone else, there is not a whole lot you can do that makes a MEANINGFUL difference.

Stay within your 28% bracket if you can.

That's a pretty low bracket.

My husband is W-2.  I will be self-employed next year.

When you say "stay within your 28% bracket", what do you mean by that?  My goal isn't to pay less taxes because I think the gov't spends them on evil things, but to minimize the taxes I have to pay.  So I wouldn't want to *earn* less to pay less if that's less $$ in my pocket.  Aside from maxing out 401Ks, what do you mean by that?

[TerriM]

No. You inherit your mother's basis in the item when she gifts it to you, so you are entitled to the tax deduction.

Awesome!  Thanks.

[Jeremy]

I intended to legally never pay taxes again

http://www.gocurrycracker.com/never-pay-taxes-again/


Last year we had an AGI of about $90k with $0 tax


Use your tax deferred accounts, retire early, take advantage of the 0% tax rate on long term capital gains and dividends and the 20k or so in tax-free income every year

[RapmasterD]

As long as you're working for someone else, there is not a whole lot you can do that makes a MEANINGFUL difference.

Stay within your 28% bracket if you can.

That's a pretty low bracket.

My husband is W-2.  I will be self-employed next year.

When you say "stay within your 28% bracket", what do you mean by that?  My goal isn't to pay less taxes because I think the gov't spends them on evil things, but to minimize the taxes I have to pay.  So I wouldn't want to *earn* less to pay less if that's less $$ in my pocket.  Aside from maxing out 401Ks, what do you mean by that?

Good for you! Then earn a shit pile. One of you (your or your spouse) can singlehandedly hit the 39.6% bracket, meaning for the other of you....given that you guys live in California, you can work half the year before you see any of your money.

Then you can invest some of your after-tax money in some nice dividend paying stocks where YOU take all the risk. And, if our President has his way, you can then pay ANOTHER 28% to the government from the dividends you receive -- up from 15% when he first took office.

Please...earn as much money as possible. And thank you for that.

http://www.latimes.com/nation/la-na-obama-taxes-20150117-story.html

[RapmasterD]

I intended to legally never pay taxes again

http://www.gocurrycracker.com/never-pay-taxes-again/


Last year we had an AGI of about $90k with $0 tax


Use your tax deferred accounts, retire early, take advantage of the 0% tax rate on long term capital gains and dividends and the 20k or so in tax-free income every year

Jeremy - You wrote a great post. Thank you for this link.

[TerriM]

As long as you're working for someone else, there is not a whole lot you can do that makes a MEANINGFUL difference.

Stay within your 28% bracket if you can.

That's a pretty low bracket.

My husband is W-2.  I will be self-employed next year.

When you say "stay within your 28% bracket", what do you mean by that?  My goal isn't to pay less taxes because I think the gov't spends them on evil things, but to minimize the taxes I have to pay.  So I wouldn't want to *earn* less to pay less if that's less $$ in my pocket.  Aside from maxing out 401Ks, what do you mean by that?

Good for you! Then earn a shit pile. One of you (your or your spouse) can singlehandedly hit the 39.6% bracket, meaning for the other of you....given that you guys live in California, you can work half the year before you see any of your money.

Yes.  I know that.  I know that very well.  It's a great incentive for me to work instead of staying home making furniture and growing my own veggies which would be tax free. 

So helpful suggestions with less sarcasm please.


SaintMichael and iamlindoro, thank you... The comments on self-employed 401K and rentals are very helpful.

[RapmasterD]

Right....sort of like the sarcastic responses you've provided to multiple people whose viewpoint didn't agree with yours, particularly on your real estate/savings query -- or your snarky thread titles.

You seem to already have so many answers.

Best of luck to you.

[caliq]

FWIW, I thought your original title was funny, TerriM :)

[starterstache]

A few questions on the solo 401k... 

Do you have to be setup as an LLC to start an individual 401k?

Does Vanguard administrate any solo 401k acts?

Any recommendations for a thread on MMM specifically on this topic?

Thanks!
-SS

[iamlindoro]

A few questions on the solo 401k... 

Do you have to be setup as an LLC to start an individual 401k?

Nope!  A fictitious business name registration ($25 through my county) and an IRS EIN for a 401k (free, doable online) is adequate proof for Vanguard.  Very easy.

Does Vanguard administrate any solo 401k acts?

Yep!

Any recommendations for a thread on MMM specifically on this topic?

Boom!  Make sure to read it all the way through-- it makes the most sense that way and you'll see me clear up some of my own misconceptions/misunderstandings as it continues.

http://forum.mrmoneymustache.com/investor-alley/sole-proprietorship-and-individual-401k/

Thanks!

You're welcome.  It freakin' rocks.  Do it if you can.  Single best retirement savings step I've taken.  I'll never go back to being employed as a W2 employee if I can avoid it, thanks completely to the Solo 401k.

[starterstache]

^^ Awesome!  Thank you so much for the clear and concise info.  I'll read through that thread in detail.

[TerriM]

FWIW, I thought your original title was funny, TerriM :)

Thanks :)

[TerriM]

iamlindoro, Thanks for the link-I will read that through.  Quick question though--can you pool incomes to put extra in the 401Ks through the Solo 401ks, or does it max out at what the self-employed person earned?  I'm assuming it's the latter, but thought I'd check.

[iamlindoro]

iamlindoro, Thanks for the link-I will read that through.  Quick question though--can you pool incomes to put extra in the 401Ks through the Solo 401ks, or does it max out at what the self-employed person earned?  I'm assuming it's the latter, but thought I'd check.

The max contribution is calculated from the Schedule C income, so yeah, it's the latter.  This article does a pretty good job of explaining spousal participation:

http://www.irafinancialgroup.com/solo401kcontributionlimits.php

Unfortunately there's no good solo 401k calculator online that also includes spouse numbers (at least, none that I've found).  There are some pretty good ones for the individual, though.

[Fuzz]

A few questions on the solo 401k... 

Do you have to be setup as an LLC to start an individual 401k?

Does Vanguard administrate any solo 401k acts?

Any recommendations for a thread on MMM specifically on this topic?

Thanks!
-SS

FYI - I'd avoid the Fidelity Solo 401K. They do not allow you to contribute with an online transfer. You must write them a check and put it in an envelope.

[TerriM]

Here's an interesting one about children on payroll.  Obviously, they have to actually be doing work for you....

http://www.smbiz.com/sbfaq022.html

[SaintM]

If you're self employed and not maxing out both the employer and employee portions of a Solo 401k (52K for you, 52K for your spouse, all tax free) then you're insane.  I can think of no single more effective tax deferral.

Negative. You will pay enormous fees to Wall Street over time. What income and gains you do get, along with your contributions, will be taxed at ordinary income rates instead of favorable dividend and capital gains rates.

No No No. Do the math on this. Taxed deferred compounding is the best money saving tip out there.

Joe can afford to save $10K/year in after tax income. Option A stick the 10K in an index fund.  Over the next 30 years it appreciates at 9%/year after modest expense at the end of the 30 years  he has $142,676. Say he owes 20% (15% fed +5% state) on the gain after tax he is left with $116,141. Option B is to stick it in a 401K/SEP IRA, since Joe is in the 28% Fed+5% State a $15,000 contribution is equivalent to $10,000 after tax.  $15,000 after 30 years @9% will turn into $214,015.  Even if Joe is still in the same tax bracket (28%+5%) you are left with $143,390 after tax or more than $27,000 more than advice given.

And that is best case of the index funded investing. Realistically about 2% of the gain each year in the after tax account will be taxed (dividends+ small capital gains) reducing the amount Joe can save. Also in many case Joe will be in lower tax bracket after retiring further increase the benefit.

There are times like right before retiring when doesn't make sense to max out tax deferred savings, but in general it does.
I'm largely  in agreement with this.  If you are a buy-and-hold investor, under current tax law you are likely to come out ahead by investing in taxable accounts rather than tax-deferred accounts.  Unfortunately, it may not always be the case that capital gains and dividends are taxed at lower rates than regular income.  On the other hand, there's no guarantee that Roth accounts will never be taxed in the future.  So...

When I buy a stock, rental property, or any other investment, I do so for the income. It's not really buy and hold, because that still implies a sale at some point. Instead, I'm looking for companies that grow their distributions every year. In a taxable account, those distributions can be return of capital (0% the best), qualified dividends (0-15%), long term cap gain (15-20%), or ordinary income (15-40%). The tax on the capital gains is completely optional...if you don't sell there is no tax. Your heirs can inherent the property at a stepped up basis, meaning the capital gain is completely wiped away.

Want to do one better, while you are working, set the account to automatically reinvest those distributions. You make money if the stock goes up. You make MORE money in the long run if the stock stays flat or even declines, because you add more shares to your share count every month or quarter.

I have read many times on here that one can convert chunks of deferred accounts up to their standard deduction and personal exemption every year without incurring a tax. That is true so long as you do not have any other income. Throw in any other income such as pension, annuity, SS, portfolio income, or I-have-to-feel-useful-so-I-got-a-part-time-job, and will be paying tax on that conversion. Plus, the kids grow up and age off of their parents' tax return. If you were prudent and fortunate to amass a large 401k account, but are unable to convert it all to a Roth in your lifetime, you leave a tax time bomb to your kids.

I will take my chances with the Roth becoming taxable over the current income tax rate schedule remaining as is. Finally, with taxable and Roth accounts, you can access your money on your terms, not the terms that the government dictates to you.

[MDM]

If you're self employed and not maxing out both the employer and employee portions of a Solo 401k (52K for you, 52K for your spouse, all tax free) then you're insane.  I can think of no single more effective tax deferral.

Negative. You will pay enormous fees to Wall Street over time. What income and gains you do get, along with your contributions, will be taxed at ordinary income rates instead of favorable dividend and capital gains rates.

No No No. Do the math on this. Taxed deferred compounding is the best money saving tip out there.

Joe can afford to save $10K/year in after tax income....

When I buy a stock, rental property, or any other investment, I do so for the income. ... Your heirs can inherent the property at a stepped up basis, meaning the capital gain is completely wiped away.
...
I have read many times on here that one can convert chunks of deferred accounts up to their standard deduction and personal exemption every year without incurring a tax. That is true so long as you do not have any other income. Throw in any other income such as pension, annuity, SS, portfolio income....

As is often the case with matters financial, it's not the conclusions so much as the assumptions.  Given their different assumptions (clifp: withdrawing invested assets to pay retirement expenses, no significant other income stream in retirement, etc.; StM: bequeathing invested assets to heirs, having significant other income in retirement, etc.) each reaches a consistent conclusion.  Because the assumptions differ, so do the conclusions.