Resources to Learn How to Reduce Taxes

[sky]

What are some resources to learn how to reduce one's tax burden?

I am in the US, and pay income, sales and property tax. Probably a few more taxes as well.

[chenda]

Other than having a low income and expenditure, I doubt there are any legal ways to significantly reduce your tax bill.

[Sclass]

Stop working.

[jacob]

The 1040 manuals. Work through them by hand (never use software!) and pay attention to what the worksheets do to see how you end up with the various numbers, e.g. "if line 27 is over $40000, skip lines 28-30, and transfer number to line 31". 1040 is basically one big algo with if then statements contingent on what numbers one puts in. What I usually look for are blank lines ... if a line is blank and looks like a deduction, I pursue it down the tree seeing if I could find a way to get it.

If you want a guided tour, there are books on how to pay zero taxes (just google or look on amazon). I learned how to do it simply by doing my taxes by hand.

Add: If you're really ambitious you could build the 1040 and the worksheets (the one for sched D would be most interesting) directly into a spreadsheet. This would allow an immediate calculation of your effective tax rate as a function of where you put your deductions.

[sky]

I am not working!

I found this: http://nwtrcc.org/war-tax-resistance-re ... istance-5/

[chenda]

@jacob - how much have you saved Jacob, and how many hours does this take ?

[jacob]

@chenda - I spent about 30-40 hours doing it by hand the first time around. Subsequent years mostly just required looking at last year's return and adding a new line or two so doing by hand only required a couple of hours, mostly from gathering forms. When doing this year's return, I just look at last years return seeing what I did then and then use the updated numbers.

(Of course after DW became an enrolled agent, I don't do anything beyond very big picture planning. I would say that in order for this to be worthwhile one has to enter with a planner/strategic/creative mindset playing a lot of what-if games. E.g. the brain has to find it curious that there's a SEP IRA line and wonder how that could be used rather than just go "not relevant for this year's return, next line please"---which is what software and also many humans do.)

The difference between how I've structured my income (taking all the deductions we can and making the money in the most tax-efficient way possible, e.g. I only have qualified dividend payers in my taxable account; I tax-loss harvest; ... ) and doing more or less nothing like most people I talk to outside of the pf-space is roughly $60k in deductions where we're not paying taxes and if we do, they're lower because capital gains taxes are lower than income. When Buffett makes his recurring remark that he pays less taxes than his secretary, I know what he means ...

Roughly, I'd say we've lowered our taxes around $10k/year compared to the average person with similar level incomes from spending those initial hours looking into it.

[chenda]

@jacob - interesting, thanks for the detailed info

[Kriegsspiel]

How to Resist the Federal Income Tax by Getting Under the Tax Line

Pretty comprehensive site here.

[halfmoon]

@Jacob wrote:
'The 1040 manuals. Work through them by hand (never use software!) and pay attention to what the worksheets do to see how you end up with the various numbers, e.g. "if line 27 is over $40000, skip lines 28-30, and transfer number to line 31". 1040 is basically one big algo with if then statements contingent on what numbers one puts in. What I usually look for are blank lines ... if a line is blank and looks like a deduction, I pursue it down the tree seeing if I could find a way to get it.'

Not to contradict someone I hugely respect, but I would suggest using software. There are too many interactive variables in tax calculations to easily tally the impact of your choices unless you have the time/skill/interest to recreate tax software. I like to use TurboTax despite its obnoxiously invasive attempts at upselling and identity rental. When making tax-sensitive decisions, I pull up my return as it was the previous year, then change the projected variables and look at their effect on the bottom tax line. There will be minor inconsistency in tax brackets and exemptions, but it's a useful exercise barring significant tax code changes year over year.

One way to pursue deductions down the tree in TurboTax (and probably other software with which I have no experience) is to choose all options instead of letting the program guide you through the choices. I also recommend googling something like "most-missed tax deductions" or "tax deductions for the self-employed" or "tax deductions for landlords"...I think you get my drift.

[johnbroker]

Work through them by hand (never use software!) and pay attention to what the worksheets do to see how you end up with the various numbers, e.g. "if line 27 is over $40000, skip lines 28-30, and transfer number to line 31". 1040 is basically one big algo with if then statements contingent on what numbers one puts in. What I usually look for are blank lines ... if a line is blank and looks like a deduction, I pursue it down the tree seeing if I could find a way to get it.

This is clearly a very good advice. I did the same a couple of years ago and it really helped me to understand what the options to reduce taxes are (which are not that many where I live).

[ebast]

Add: If you're really ambitious you could build the 1040 and the worksheets (the one for sched D would be most interesting) directly into a spreadsheet. This would allow an immediate calculation of your effective tax rate as a function of where you put your deductions.

+1 increment for this idea. I'm sure there are people here that do their taxes like they do their sudokus, in pen and with small digits, but for me, in the years I used software and the more recent ones doing it by hand, there's always something I forget to include and have to do the whole thing over again. It was on one of these recent bouts doing it by hand, upset that I was recalculating a dozen values because of one little change that I decided to finally just put all the lines from the 1040 in a spreadsheet. At least the ones with simple logic that I could; the worksheets and the reference to tax tables, etc, I would do by hand.

Better. But then if I make a change, the 1040 backbone was mostly good, but I still often had to update the worksheet calculations or look up in tax tables for that change. So then, when making a change, for whatever I still had to do by hand, I replaced by adding tab sheets for the worksheets I use or fit functions for the lookup tables.

And recurse!

It's not all there yet.. there are still a few lines a la

Code: Select all

=if(F40<258250,4000*F6,"WTF?")

and a lot of the constants and formulas will require updating every year, and of course I still have to manually check everything before submitting, but during the tax year before submission, what a help for rapidly prototyping what your taxes are going to look like given life & portfolio choices.

I'm curious how people do it without? Something like sched D - I guess if you've gone through the process a few times you have a good idea of the limits you'd like to stay under to avoid all tax - stay on the path and you're good. But if you have to venture off, say you're trying to get together some cash and will need be above the limits to take a tax hit, there's the tradeoff between short-term/long-term, impact of carry-overs, and then now that's all going to hit your ACA subsidy eligibility besides..

Same kind of thing if you were deciding to switch your port over to high yield or something in preparation for FI. Nice to know ahead of time. I assume it's pretty easy to do this with the tax prep software out there.

But however you do it, I've got a nice power boost from assessing tax impact before I make decisions during a year rather than my previous beneficent approach of cleaning up (and paying for) the mess after.

[jacob]

But however you do it, I've got a nice power boost from assessing tax impact before I make decisions during a year rather than my previous beneficent approach of cleaning up (and paying for) the mess after.

I think that is a key approach to optimizing taxes. I would even go so far as to say we've made major life decisions like which job offer to accept (the W-2 or the 1099), where to work or even whether to work at all, where to live (rent or own), how to invest and make choices even if they aren't optimal from a business perspective, they still might be better from an after-tax perspective, etc.

I presume these are the kind of behavioral outcomes the politicians intended when they wrote all these different rules into the tax code.

However, it's been my anecdotal experience (blog, forum, being married to a tax pro) that most people treat taxes by being reactive about them instead of being proactive.

[OTCW]

I agree wholeheartedly with using a spreadsheet that you build yourself. Use it throughout the year instead of just at tax time. Learn, rinse, repeat, optimize.

[The Old Man]

I have always done my taxes by hand (without software although I do use a calculator). Tax software makes it a black box, so you learn nothing. An understanding of the tax system makes you a more informed person in terms of major life decisions.

Read the 1040 and follow the process described by Jacob. There are certain legal practices that are not intuitively obvious (i.e. tax loss harvesting), but a google search on tax minimization, early retirement tax planning, estate planning, etc. will identify them. You should think of this as a multi-year process for minimizing your taxes. For doing complex trade-off analyses I developed my own spreadsheet.

[bad_LNIP]

A few things are key to reducing US taxes:

First, You need to set a goal to achieve and framework. Creating a plan to shelter 10M in income is not the same as creating a plan to shelter 1M in income vs 250k in income. How much income do you need? What is your spending level and on what? Where do you want to live geographically in the US out outside the US? Planning on living in the Philippines or Ecuador vs the US are totally different considerations and living in say El Paso, Tx or even Dallas vs San Diego, CA or NYC or Boston are totally different things.

Personally, I am exploring how to live offshore and shelter an income of 250-350k max, although I doubt I'd spend more than 50k annually living the most opulent lifestyle I possibly think of. I'm just not a big spender. Bare essentially are probably going to run 20-25k and that has a fair degree of luxury baked into it already.

Key areas of interest are: don't work for wages and get paid in the form of qualified dividends, carried interest, distributions, ANYTHING but W-2 wage income. If you can cut out SS, Medicare, and state taxes you are ahead of the game to the tune of 20% or better.

In line with not geting paid via wages, always have your domicile in a no income tax state: Florida, TN, and Texas are all nice places that spring to mind with no state income tax to worry about.

Once you don't have to worry about Medicare and State income tax, the only thing remaining is Federal income tax.

This is where living offshore is nice with the Foreign Earned Income Exclusion.

You don't HAVE TO live offshore as getting paid via qualified dividends will a married couple can make over 93k annually TAX FREE. That's equivalent to 120k+ taxable. I know I can get by on 100k per year quite well in the US.

If you move offshore, you have the FEIE which allows for a single tax payer to make over 100k TAX FREE. If you add in qualified dividends, a married couple can clear well over 200k annually tax free.