Social media was a buzz with concerns about the whether the wealthy pay enough taxes. This topic rears its ugly head ever so often, as evidenced by the discussions following The New York Times release of Donald Trump’s tax returns in late 2020, and now more recently because of a Propublica article chronically the wealthy and their taxes. If you’re like me, you’ve read the article and are more interested in how they paid less taxes versus the conspiracy that wide spread tax fraud is occurring.

I’ve mentioned before that I hate taxes, but the reality is understanding the importance of tax planning and how to use the tax laws to your advantage is of the upmost importance for everyone.

The tax loop holes used by the wealthy are also available for use by the not so wealthy. A great example of this is detailed in a 2013 GoCurryCracker blog post titled, “Never Pay Taxes Again”.

So lets go over a couple of steps you can follow to pay less taxes.

Step 1 – Maximize your tax advantage accounts.

This should go without saying, but the reality is most people don’t maximize their yearly contributions to tax advantage accounts, such as employer-sponsored retirement plans (i.e. 401K, 403b, 457), Traditional and Roth IRAs, or if they have them, a SEP IRA. In fact, via a blog post by Financial Samurai, Vanguard reported that in 2018, only 13% of its plan participants maxed out their 401K. This is alarming, considering the max contribution is $19.5K and not contributing up to the max misses out on a significant amount of potential tax savings.

There is a additional $6K that could be tax deducible if you contribute the max to a traditional (or roth) IRA. Those two contributions alone can potentially decrease your taxable income by at least $25,000 and thus should be step number one in your tax planning process.

Step 2 – Don’t realize your capital gains.

The Propublica article applied some funny logic to the definition of capital gains, but the reality is, you either have unrealized gains which are untaxable and taxable realized gains.

Unrealized gains are the potential profit that exists on paper from your investment. Perfect example is you bought a stock that went up substantially but you haven’t sold. These gains are potential and thus not taxed by the IRS. So if you don’t use need the money, don’t cash your investment in and you’ll avoid the amount being taxed possibly as ordinary income.

Step 3 – Realize your capital losses.

Realizing a capital loss is important. The IRS allows you to deduct (i.e. harvest) up to $3000.00 from your income based upon realized capital losses per tax year. This is huge because it can offset an investment that did well and it can lower your taxable income up to $3K. That’s a win.

Step 4 – Be charitable and donate.

During the 2020 calendar year, the IRS suspended the limits on charitable deductions. That suspension allowed for an individual to deduct up to 100% of their adjustable gross income (AGI). Any contribution that exceeded that amount is allowed to carry over to the next year. This is a great option, as it allows you to get an exact dollar for dollar deduction in your taxable income.

A great way to do this is via Donor Advised Funds (DAF) . Physician On Fire has a great example of how he uses a DAF to take advantage of the charitable donation tax loophole.

We should all aim to give more to charity. The Propublica article does a very poor job of discussing the wealthy and their charitable donations. The reality is the wealthiest 1% of Americans provided about 1/3 of the charitable donations given in the U.S. and roughly 1.4% of the Americans are responsible for 86 percent of the charitable donations made at death. Charitable donations are a great way to decrease your taxable income on paper while helping others.

Step 5 – Invest in depreciable assets.

These steps are just some of the ways you can lower your taxable income, pay less taxes, and be like the wealthy. These loop holes are available to everyone no matter the income level. However you have to know how to use them properly. Some loop holes require a lot of effort and others not so much. If you want to be wealthy, you need to learn how to use the existing tax laws to your advantage.

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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