At a Glance
Billionaires avoid paying taxes all the time – and many of the avenues they use are legal. Here are ways average Americans can lower their tax bill too.
America’s 400 wealthiest families pay a lower tax rate than the average taxpayer, according to a 2021 White House analysis.
It’s no secret that billionaires excel at the art of avoiding taxes through legal loopholes. Illegal ones too, but there are plenty of legitimate ways to reduce your tax bill, which begs the question: Can the average American take a cue from the 1% in terms of tax savviness?
Tax avoidance vs. tax evasion
The idea of lowering your federal income tax bill may feel like entering sketchy territory. Will you get in trouble? Not if you understand the difference between tax avoidance and evasion. Tax evasion can land you in hot waters with the IRS and with the law. This consists of deliberately avoiding paying the taxes you owe by failing to report income. When billionaires hide money in offshore accounts, it’s tax evasion – and it’s a crime.
According to Investopedia, tax avoidance is “any legal method used by a taxpayer to minimize the amount of income tax owed.” When billionaires borrow money against their assets to avoid cashing out stocks and paying taxes on capital gains, they are leveraging debt to dodge taxes, and it’s perfectly legal. When Jeff Bezos declares zero income because of business expenses, it’s infuriating, but it’s legal too. The good news? As a professional who earns an honest living through a job, you too can minimize your income taxes through legal avenues.
Ways to reduce your income taxes
Gross income is the total amount of money you earn in a year before taxes. This includes wages, gains on investments that you have cashed out, or earnings from a business or side hustle. Taxable income is the amount of money that will be taxed from those yearly earnings – and there are plenty of ways to reduce it.
1. Max out your contributions to retirement accounts
Saving for retirement can help you save thousands of dollars of taxes in the long run. If you’re able to contribute money to a 401k or IRA account, do it. If you can max out your contributions, even better – it’s one of the easiest ways to reduce your taxable income.
2. Open a health-savings account
A health-savings account (HSA) is like a savings account that can only be used for medical expenses. To be eligible for one, you need to be enrolled in a high-deductible health plan (HDHP). Your contributions are pre-tax, so they lower your taxable income. And if you use the money on qualified medical expenses such as dental or vision care, you’ll be able to withdraw those funds tax-free too.
3. Tax-loss harvesting
If you’re an investor, consider tax-loss harvesting to reduce your tax bill. It’s a bit of an advanced investment strategy, but it’s worth looking into. The idea is that when capital losses offset capital gains, it creates a tax-deferred benefit that results in savings over time, according to Personal Capital. It’s about strategically selling stocks at a loss while you cash out some gains – and uber-wealthy people leverage this on a regular basis.
4. Start a business from home
Starting a business from home means that you can deduct certain expenses from your income, from a portion of your rent to part of your internet bill. This is best done with an accountant, as they’ll know how to calculate how much you can deduct for what – but it can lead to huge tax savings.
Take full advantage of tax credits
While tax reductions allow you to reduce your taxable income, tax credits reduce the tax you owe.
According to GoBankingRates, there are 17 tax credits for individuals that you can take advantage of in five categories: education, family tax, healthcare, homeownership and real estate, and income and savings. Being a low to moderate-income household can certainly qualify you for tax credits, but it’s not the only thing that can help you save money on your tax bill.
For example, if you’ve made home improvements that make your residence more energy-efficient, you can claim up to a maximum of $1,200 for them, according to eFile. If you are a student or have children or dependents, there are various resources available. For example, according to Investopedia, the American Opportunity Tax Credit offers up to $2,500 yearly for eligible students for the first four years of higher education, and the Child and Dependent Care Credit may offset expenses such as daycare, babysitting, or nurses and aids.
Every household is unique, and there are many factors that can influence which tax credits you have access to, so it’s important to do your research and work with a professional while navigating this.
Income tax calculation is complex, so working with an accountant is best to benefit from all the ways you can reduce your taxable income while claiming tax credits. You are responsible for providing an accurate and truthful income tax return, after all. Making the extra effort is worth it though, as it can help you grow your wealth over time.