The reality is taxes suck. We all know this, But I got to say it again…TAXES SUCK!
My childhood taught me nothing about the tax system except that a new soon to be broken down car was in my family’s future after we got a refund every year. The reality is that those who teach financial education do a terrible job discussing the tax system nor tax optimization. We as the public get very upset when we find out that the wealthy do not pay the taxes “we believe they deserve to pay.” When it comes to taxes, misery loves company.
The reality is the wealthy understand how the tax code works and they use it to their advantage. Recent events in the news has prompted more of a spotlight on the tax code. While spending some time on Twitter, I realized there is a wide range of understanding of tax rules and regulations by the general public and its time we realize what type of world we live in.
The cold reality, is our tax code is meant for two populations: the poor and the wealthy.
Everyone in between is screwed, unless you know how to play the game. To play the game, you have to understand tax optimization.
Tax optimization the process of maximizing the benefits of the current tax law without doing something that will land you in jail. To do this, you need to understand tax deductions and tax credits, which are extremely important in playing the game.
There’s a well-known personal financial blog that I love to read, by the name of Go Curry Cracker and he goes over his application of tax optimization in great detail and if you haven’t read that blog I suggest you read it. It’s very eye-opening. His entire goal is to make his income look on paper like it’s in the lowest tax bracket possible and he uses the tax code to his favor at an elite level.
In order for us to play this game, we need to set some ground rules.
Rule #1 – Maximize your Tax Deductions
A deduction by IRS definition lowers your taxable income. Why is this important? The lower your income is “on paper,” the less taxes you pay.
Most people are familiar with the IRS standard deduction. In fact, the Urban-Brookings Tax Policy Center estimated in 2018 that about 90 percent of households utilized the standard deduction rather than itemizing their deductions. However there are a number of deductions that you can take or claim on your taxes for your daily actions throughout the year. This is important because if you can itemize your deductions and exceed the standard deduction, you can decrease your taxable income even more.
Now onto what I deem is the most important rule…
Rule #2 – Maximize your Tax Credits
Tax credits decrease the amount of money you need to pay the government and are applied after deductions. In my opinion this is where the your skill in playing the game is applied.
There are two categories of tax credits: refundable and non-refundable. You need to know the difference and utilize them both.
Refundable tax credits allow you to receive a refund once that credit is applied and you no longer owe money. For example if you owe $2000 but a $3000 refundable tax credit is applied, you will receive $1000 as a tax refund from the government. That’s free money based upon the current tax law, and who doesn’t love FREE MONEY?
Receiving free money is amazing, but the key is not owing money at all to the government. That is where where non-refundable tax credits help.
Like the name suggests these credits will not generate a refund however they can take the amount you owe down to zero if applied correctly.
There are a lot of great articles which go over the different tax credits and deductions and here are a few that I like:
- Tax Deductions Guide and 20 Popular Breaks for 2020 by NerdWallet
- Tax Deductions/Credits by Investopedia
- Tax Credits for 2019 by efile.com
Its time for us to play the game and start optimizing our taxes.
As always if you have questions or concerns regarding creating an emergency fund, investing, real estate, insurance, or planning for the future, don’t be afraid to speak with qualified financial advisor. Smart Asset has a great tool to find an advisor in your area or feel free to email me (contact@surgifi.com) to help you on your path to financial independence.
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