Author Topic: How can I lower my tax rate?  (Read 5385 times)

BlueHouse

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How can I lower my tax rate?
« on: March 28, 2015, 02:53:04 PM »
I saw this comment in another discussion and I am looking for ways to lower my income tax rate.  I just had my taxes done and my tax bracket is 33%. 
I max out my 401k and it doesn't make sense financially to open a Roth at this point.  I don't bother putting additional $5500 in traditional IRA, because I can't deduct it and I'm not sure how to track it separately from the rest of the IRA that was pre-tax. 

I have a business and can deduct certain costs, but the truth is that my overhead is extremely low -- so not much to deduct. 
I donate to charity an amount that I am currently comfortable with, but nowhere near enough to substantially reduce taxes (between 1-5% total income).  Please don't judge unless you know everything about my circumstances.   

How are people reducing their tax burdens so much?  What can I change to pay less tax?  Thanks for any advice. 

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My accountant called the other day after finishing our taxes. He was impressed that our fed tax rate on our AGI of $96K was 1.26%. I told him it's is still too much, he chuckled.

But seriously, we worked hard to be in the position that we are in and we are proud of what we accomplished.

MDM

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Re: How can I lower my tax rate?
« Reply #1 on: March 28, 2015, 03:22:02 PM »
How are people reducing their tax burdens so much?  What can I change to pay less tax?  Thanks for any advice. 
I suspect the person quoted is receiving much of their income from long term capital gains and qualified dividends - correct?.  If you are in the 33% bracket now, it would seem you have the ability to save now and be in similar circumstances (i.e., income from LTCG and QD) later.  E.g., see http://www.gocurrycracker.com/never-pay-taxes-again/.


RexualChocolate

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Re: How can I lower my tax rate?
« Reply #2 on: March 28, 2015, 03:22:40 PM »
Depreciation on rental income the easiest gimmick for individuals. If you're a salaried employee  or run a high margin business there's not much to be done unless you want to start expanding your business.

I wouldn't worry about it too much. Micro tax burdens should be related to actual economic expenses though we can argue the formulas for depreciation. For example you're basically saying while you made 96k you lost 80k to depreciation. Or you just recognized those losses all in one year.

Retire-Canada

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Re: How can I lower my tax rate?
« Reply #3 on: March 28, 2015, 03:38:18 PM »

I have a business and can deduct certain costs, but the truth is that my overhead is extremely low -- so not much to deduct.

Are you sure? I've got a low overhead business [just me + my computer + cellphone + vehicle]. Having your own business is one of the best ways I know of to reduce your tax rate.

Here are some of the deductions I make:

- vehicle [amortization and operating costs]
- computer
- software
- cellphone
- internet
- home office [I have a 300 sq ft studio separate from the house]
- travel
- professional memberships
- office supplies
- tools
- bicycle [I have a business pedal bike]
- meals/entertainment

Between my business deductions and my RRSP [tax deferred] contributions I can drop 1 full marginal tax bracket and get most of the way to next 2nd lower one.

At the start of the deduction process for each dollar I deduct I save $0.38 in taxes. Eventually that effect is reduced as my marginal tax rate changes.

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Meanwhile, almost everything in life has become tax-deductible. The main things I spend money on besides groceries are: tools, a good computer or camera occasionally, and cell phone and internet service. All of these are required by the business, so the business pays for them. With this newfound additional blog writing hat in the closet, I might even be able to write off some travel expenses in the future.

http://www.mrmoneymustache.com/2011/06/08/the-joy-of-self-employment/

I've been doing the same thing for 20yrs so I have all the deductions worked out, but it's a worthwhile exercise to go through your expenses and see if there is anything you can deduct that you aren't.

-- Vik

BlueHouse

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Re: How can I lower my tax rate?
« Reply #4 on: March 28, 2015, 05:10:29 PM »

Are you sure? I've got a low overhead business [just me + my computer + cellphone + vehicle]. Having your own business is one of the best ways I know of to reduce your tax rate.

Good point.  Now I feel like a complete tool for having overlooked all the expenses that are covered by the business.  Sorry if I'm being complainypants to those who can't expense what I can. 

I suspect the person quoted is receiving much of their income from long term capital gains and qualified dividends - correct?.  If you are in the 33% bracket now, it would seem you have the ability to save now and be in similar circumstances (i.e., income from LTCG and QD) later. 
You're right.  As long as I'm a working stiff, I guess I'll get taxed like a working stiff.  I don't have much income from capital gains yet, but I'm working on that.  Still, if there's anything I can do to optimize, I would like to try.

 
Depreciation on rental income the easiest gimmick for individuals.
I am an accidental landlord, but I really don't have a full understanding of the tax workings of it yet.  It seems that all of the rental income is offset by expenses and depreciation, but I cannot claim losses.  I have no idea what will happen when i finally sell the condo, and what the implications will be then.

Sometimes I just have the feeling that I'm the only person paying "full" taxes.  But now I realize I'm getting a lot of other benefits. 

Thanks for your help!

MDM

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Re: How can I lower my tax rate?
« Reply #5 on: March 28, 2015, 05:28:48 PM »
As long as I'm a working stiff, I guess I'll get taxed like a working stiff.  I don't have much income from capital gains yet, but I'm working on that.  Still, if there's anything I can do to optimize, I would like to try.
It's not clear from the OP whether you work for a company and have a side business, or if your business is your major income.  Options will vary depending on which situation you have - if you are willing to provide more details (e.g. see the reader case study sticky) you might get more actionable suggestions.

One thought: with gross income >$200K (assumption based on taxable income >$186,350), you should have plenty of investable cash.  Why not put $5500/yr into a backdoor Roth?  In other words, not sure I understand the quote in the OP: "it doesn't make sense financially to open a Roth at this point."

BlueHouse

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Re: How can I lower my tax rate?
« Reply #6 on: March 28, 2015, 05:39:34 PM »
As long as I'm a working stiff, I guess I'll get taxed like a working stiff.  I don't have much income from capital gains yet, but I'm working on that.  Still, if there's anything I can do to optimize, I would like to try.
It's not clear from the OP whether you work for a company and have a side business, or if your business is your major income.  Options will vary depending on which situation you have - if you are willing to provide more details (e.g. see the reader case study sticky) you might get more actionable suggestions.

One thought: with gross income >$200K (assumption based on taxable income >$186,350), you should have plenty of investable cash.  Why not put $5500/yr into a backdoor Roth?  In other words, not sure I understand the quote in the OP: "it doesn't make sense financially to open a Roth at this point."
I'm an independent consultant, with the business set up as an S-Corp.  Most income comes from my billings.  $20k comes from rental income.    I actually did a case study last year.  The income hasn't changed, but my spending has drastically reduced and will continue to reduce for another year or two when it should stabilize.
I don't do a Roth because my income is currently the highest it is likely to ever be and also because I have a few older rollover IRAs.  If I opened a Roth, all of the money in tIRAs would be subject to taxes as if I rolled it all over.  My only way out of that I can think of is to wait until I'm close to FI and ready to retire, then I can take all the money in my tIRAs and roll it into my 401k.  From that point, rolling into a Roth may make sense, but by that time, I may be too old to benefit from the transactions anyway. 



kpd905

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Re: How can I lower my tax rate?
« Reply #7 on: March 28, 2015, 06:23:28 PM »
Why doesn't it make sense to open and max out a Roth IRA?

MDM

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Re: How can I lower my tax rate?
« Reply #8 on: March 28, 2015, 06:40:58 PM »
I actually did a case study last year.  The income hasn't changed, but my spending has drastically reduced and will continue to reduce for another year or two when it should stabilize.
Ah, yes - you had done / were doing some good things: http://forum.mrmoneymustache.com/ask-a-mustachian/reader-case-study-am-i-a-big-fat-liar/msg247290/#msg247290.  Appears that continued well - good for you!

Quote
I don't do a Roth because my income is currently the highest it is likely to ever be and also because I have a few older rollover IRAs.  If I opened a Roth, all of the money in tIRAs would be subject to taxes as if I rolled it all over.  My only way out of that I can think of is to wait until I'm close to FI and ready to retire, then I can take all the money in my tIRAs and roll it into my 401k.  From that point, rolling into a Roth may make sense, but by that time, I may be too old to benefit from the transactions anyway.
I suppose I might have remembered http://forum.mrmoneymustache.com/ask-a-mustachian/help-me-figure-out-how-to-allocate-money-to-my-stache/msg590217/#msg590217....

seattlecyclone

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Re: How can I lower my tax rate?
« Reply #9 on: March 28, 2015, 06:44:25 PM »
I don't do a Roth because my income is currently the highest it is likely to ever be and also because I have a few older rollover IRAs.  If I opened a Roth, all of the money in tIRAs would be subject to taxes as if I rolled it all over.  My only way out of that I can think of is to wait until I'm close to FI and ready to retire, then I can take all the money in my tIRAs and roll it into my 401k.

I think you may be confused about how to set yourself up for a backdoor Roth IRA. If you move all of your old pre-tax rollover IRAs into your 401(k) now, you would then be able to open a new traditional IRA, make non-deductible contributions to it, and roll the balance to a Roth IRA. None of this would increase your tax bill one bit.

Back to the main topic at hand:

As others have mentioned, you should be sure to deduct all of your business expenses.

Beyond that, do you have a solo 401(k) through your S-corp? Are you contributing the full $53k/year to it? Do you have an HSA?

What are your long-term charitable plans? You could front-load some of your charitable contributions by donating a larger balance to a donor-advised fund this year and distributing that balance to charities over the next several years.

BlueHouse

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Re: How can I lower my tax rate?
« Reply #10 on: March 28, 2015, 08:56:32 PM »
I don't do a Roth because my income is currently the highest it is likely to ever be and also because I have a few older rollover IRAs.  If I opened a Roth, all of the money in tIRAs would be subject to taxes as if I rolled it all over.  My only way out of that I can think of is to wait until I'm close to FI and ready to retire, then I can take all the money in my tIRAs and roll it into my 401k.

I think you may be confused about how to set yourself up for a backdoor Roth IRA. If you move all of your old pre-tax rollover IRAs into your 401(k) now, you would then be able to open a new traditional IRA, make non-deductible contributions to it, and roll the balance to a Roth IRA. None of this would increase your tax bill one bit.
I am not seeing the difference. Unless it is to do this now, in which case, I believe my tax rate is higher now than it will ever again Be. Am I missing an obvious point? 


Quote

Back to the main topic at hand:

As others have mentioned, you should be sure to deduct all of your business expenses.

Beyond that, do you have a solo 401(k) through your S-corp? Are you contributing the full $53k/year to it? Do you have an HSA?

What are your long-term charitable plans? You could front-load some of your charitable contributions by donating a larger balance to a donor-advised fund this year and distributing that balance to charities over the next several years.

Yes, I have 401k and max it. I'll look into changing to HSA next year. That's definitely one thing I can do to stash more cash. Thanks for the advice!
« Last Edit: March 28, 2015, 09:05:49 PM by BlueHouse »

terran

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Re: How can I lower my tax rate?
« Reply #11 on: March 28, 2015, 09:37:28 PM »
Are you maxing the 401k in terms of salary deferral (18k) or also in terms of employer contributions? At your income level you're probably near or above the amount you need to be able to truly max a solo 401k (assuming you have no employees) to the tune of 54k.

MDM

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Re: How can I lower my tax rate?
« Reply #12 on: March 28, 2015, 09:58:08 PM »
I think you may be confused about how to set yourself up for a backdoor Roth IRA. If you move all of your old pre-tax rollover IRAs into your 401(k) now, you would then be able to open a new traditional IRA, make non-deductible contributions to it, and roll the balance to a Roth IRA. None of this would increase your tax bill one bit.
I am not seeing the difference. Unless it is to do this now, in which case, I believe my tax rate is higher now than it will ever again Be. Am I missing an obvious point?
Roth and taxable are identical when first funded.  Don't know how obvious, but the point is...thereafter, Roth grows tax free and may be withdrawn tax free after age 59 1/2, while you pay taxes on dividends/interest/capital gains in your taxable account.

Given your income and assets, it may or may not be worth the work (and possibly higher fund fees?) to move your tIRAs back into your 401k in preparation for the $5500/yr back door option.

seattlecyclone

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Re: How can I lower my tax rate?
« Reply #13 on: March 28, 2015, 10:40:23 PM »
I don't do a Roth because my income is currently the highest it is likely to ever be and also because I have a few older rollover IRAs.  If I opened a Roth, all of the money in tIRAs would be subject to taxes as if I rolled it all over.  My only way out of that I can think of is to wait until I'm close to FI and ready to retire, then I can take all the money in my tIRAs and roll it into my 401k.

I think you may be confused about how to set yourself up for a backdoor Roth IRA. If you move all of your old pre-tax rollover IRAs into your 401(k) now, you would then be able to open a new traditional IRA, make non-deductible contributions to it, and roll the balance to a Roth IRA. None of this would increase your tax bill one bit.
I am not seeing the difference. Unless it is to do this now, in which case, I believe my tax rate is higher now than it will ever again Be. Am I missing an obvious point? 

Yes, the point is to do this now. Your current tax rate is irrelevant. Everything I described above is a non-taxable event.

johnny847

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Re: How can I lower my tax rate?
« Reply #14 on: March 29, 2015, 06:01:28 AM »
For your amusement http://www.bogleheads.org/forum/viewtopic.php?p=677232#677232

Quote
1. Contribute max to 401(k) and self-employed retirement plans.
2. Contribute to Roth IRAs (only reduces future taxes, not today's taxes)
3. Invest tax efficiently (only reduces future taxes)
4. Give your money away to charity
5. Buy biggest house in world and pay huge property taxes
6. Have huge mortgage on that house and pay huge amount of interest
7. Get married and have lots of kids
8. Be sure to lose money in the stock market since $3000 of losses are deductible each year against ordinary income.
9. Move to a state with high income taxes because state income taxes are deductible.
10. Have severe health issues that you pay for out of your own pocket as you can deduct health care expenses above 7.5% of AGI
11. Grow old, you get more exemptions for being old
12. Go blind, you get more exemptions for being blind
13. Buy property and rent it out at a loss. The more losses the better.
14. Quit your jobs. With no earned income, it's not surprising that your taxes drop.
15. Avoid investments that create taxable income. You want losers to reduce your taxes.
16. Etc.
Oh and you to knock out two birds with one stone, you should stab yourself in the eye to meet #10 and #12.


But in all seriousness, aside from contributing to the max to a 401k, IRA, HSA, and harvesting capital losses, there really isn't that much you can do to lower your taxes without costing yourself more than the reduction of your tax bill. If you want the master list of how to reduce your taxes, just take a look at each line on the 1040 and see if it applies to you. There really isn't any magic to it.

BlueHouse

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Re: How can I lower my tax rate?
« Reply #15 on: March 29, 2015, 07:34:27 AM »
I don't do a Roth because my income is currently the highest it is likely to ever be and also because I have a few older rollover IRAs.  If I opened a Roth, all of the money in tIRAs would be subject to taxes as if I rolled it all over.  My only way out of that I can think of is to wait until I'm close to FI and ready to retire, then I can take all the money in my tIRAs and roll it into my 401k.

I think you may be confused about how to set yourself up for a backdoor Roth IRA. If you move all of your old pre-tax rollover IRAs into your 401(k) now, you would then be able to open a new traditional IRA, make non-deductible contributions to it, and roll the balance to a Roth IRA. None of this would increase your tax bill one bit.
I am not seeing the difference. Unless it is to do this now, in which case, I believe my tax rate is higher now than it will ever again Be. Am I missing an obvious point? 

Yes, the point is to do this now. Your current tax rate is irrelevant. Everything I described above is a non-taxable event.
Ahhh.  It's finally sinking in.  Roll all existing tax-deferred IRA into 401k and leave it there (until much later).  then start a Roth (taxable income to tIRA to backdoor Roth) with money I would be putting into a taxable account anyway.     Thank you for your patience in getting me to see that. 

Sounds like a good plan and I'll check my 401k to see when it makes sense to start that. 
Related question:  in my existing tIRA, there is at least $4000 (possibly $8000) AFTER-TAX money because the year(s) I contributed separately to IRA, I earned too much to deduct it.  Can or should I roll that back into my 401K as well? 

Plan is now to:
1.   Consider moving existing 401k to Vanguard to reduce fees (especially for closing/moving accounts.  I only want to pay this once more in my lifetime)
2.  Roll all tIRA funds into 401k.  Maintain my desired allocations.
3.  Each year, contribute $5500 to new (empty) IRA, then backdoor Roth it. 
4.  Next fall, consider new Health plan with an HSA

I like this.  I feel as if I have some control again.  It may take me 9 months before all of this gets done, but in terms of real time, it's probably just a few phone calls. 



BlueHouse

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Re: How can I lower my tax rate?
« Reply #16 on: March 29, 2015, 07:43:48 AM »
As others have mentioned, you should be sure to deduct all of your business expenses.
I know I miss a few, but negligible.  I don't claim home office deduction because company is set up as S-Corp, which doesn't allow for it.  But I can deduct a portion of all utilities because I have an office in the house.  All equipment, supplies, software, cell phone, used for business is expensed as business expense.  I expense gas OR mileage, but don't do amortization on car -- it's been paid off for a few years.  Use of the car is really pretty low (for both work and personal).  I did buy a bicycle last year and plan to bike commute much more this year.  Can i really deduct something for this?  M&E - I don't entertain much for business.  I wish I could deduct for every meal I eat out, but I really couldn't justify it. 

Are you maxing the 401k in terms of salary deferral (18k) or also in terms of employer contributions? At your income level you're probably near or above the amount you need to be able to truly max a solo 401k (assuming you have no employees) to the tune of 54k.
Yes, $53K goes to 401k immediately.  It's been a god-send to me.  My 401K balance from 6 years of maxing out to the 415(c)(1)(a) limit has allowed me to save almost twice as much as I had saved from previous 401k/IRA saved over 18 years! I've made huge progress in the past few years and MMM is helping me to optimize that.  Honestly, despite the fact that I've never really lived beyond my means, I would not have been prepared at all for retirement. 
« Last Edit: March 29, 2015, 07:59:28 AM by BlueHouse »