Request for “TAE" - Tax Avoidance Extreme

[Legthorn Brownboat]

Not to be confused with tax evasion. Tax avoidance is the legal usage of the tax regime to one's own advantage

In retirement planning, there’s 3 sort of buckets that people fall in, which I’ll call: dormant, active, and extreme. Dormancy is the condition of not saving enough to retire. Active is following the typical mantra of save 10% if you’re good, 15% if you want to excel. Extreme (ala ERE) is what we’re all familiar with which is pushing the highest savings rate we can achieve. Many are dormant; some are active; few are extreme.

I want to use these buckets to talk about tax planning. Dormancy is the position of not planning: paying the maximum amount of taxes. Active is contributing to 401k/IRA/HSAs, getting employer match if you’re good or reaching your legal contribution limit if you want to excel. Extreme is pushing for the lowest effective tax rate. Many are dormant, some are active, few are extreme.

I am an active, “excelling” tax planner. However, that only means that I contribute as many tax-advantaged dollars as I legally can. I have no major deductions or write-offs, and my state has one of the country’s highest income taxes. Online calculators show me hitting a 30-40% effective tax rate (they vary in their exact figures) when I account for FICA, federal, and state income taxes. I’m happy (but not complacent) with the progress I’ve made in ERE so far. I’ve been controlling flexible spending instead of letting it control me; and I’m looking at what I can do to change my fixed costs. This is great and I have further to go along that S-curve. But, at some point in time it makes sense for me to focus my efforts on the elephant in a bowler hat standing nonchalantly in the corner of my room.

I’m interested in ERE for taxes. The more I think about it, the more parallels I see between tax planning and ERE. One’s current employment status limits one’s options, just like one’s current geographical location limits one’s options in ERE. Perhaps forming a C/S-corp is analogous to geographical arbitrage in ERE?

Anyways, is anyone aware of a “Tax Avoidance Extreme”-like book or resource?

[Chris]

Wage income is just about the worst way to get income, from a tax-perspective. If you're taking a paycheck from someone else, there isn't much you can do to avoid paying taxes after 401k/IRA/HSA deductions (there are lots of other deductions and credits, but those involve you spending money first). Once you have the money, there are ways to avoid further taxation, but that's after you've already taken one hit on it.

As you suggested, there are some strategies that can result in lower taxes if you are self-employed or employed by a corporation that you control. These largely surround how the income gets to you and making extensive use of deductions. How you go about doing this is often dependent on your job field.

Another idea, if you must earn income through work, is to have a position that requires off-site work or a lot of travel. For example, as a salesperson, the company will pay for food, lodging, and transportation. These are all business expenses for the company. They are also all living expenses that you do not need to pay. And they're not taxed as income to you. So, you could actually get ahead with a lower salary -- but end up saving more -- because your living expenses are paid for. This is more applicable to ERE-minded people, since living expenses are the majority of their expenses.

But if you think about it, a huge chunk of tax avoidance is "built-in" to ERE. If you manage to hit FI in 5 years, you have a short amount of time paying high taxes, followed by decades of taxation in the bottom tax brackets. Getting out of the working world and getting income like a retired person quickly will save you hundreds of thousands.

And for post-ERE, there was an excellent thread some time ago.

[theanimal]

Joshua of the Radical Personal Finance podcast interviewed someone who "resists" and avoids taxes. A bunch of links in the show notes. http://radicalpersonalfinance.com/17/

[JamesR]

Non-americans can try the 3/5-flag trick for minimal taxes. Three flags represents - the flag of your citizenship, the flag of the country you reside in, and the flag of the country you generate your income in. This minimizes your tax profile dramatically. http://en.wikipedia.org/wiki/Perpetual_ ... lag_Theory

[WYOGO]

This matter of taxation is of the utmost importance to me. While the OP lives in one of the highest tax burden states, I reside by choice in a state with very close to the lowest overall personal tax burden in the nation and it saves me multiples of thousands annually as a result. It is no light matter and is a integral part of achieving our goal. Tax optimization strategies are most certainly worth your attention.

The MadFientist tends to specialize in posts devoted to this topic.

[Legthorn Brownboat]

Wage income is just about the worst way to get income, from a tax-perspective. If you're taking a paycheck from someone else, there isn't much you can do to avoid paying taxes after 401k/IRA/HSA deductions (there are lots of other deductions and credits, but those involve you spending money first). Once you have the money, there are ways to avoid further taxation, but that's after you've already taken one hit on it.

Thanks for your comments! Yes, it seems like most of my income is counted as wages and there's little I can do with those. It's almost as if the tax code was written to target wage earners. However, I do have other smaller sources of income that I believe I can funnel through a company of my own. If I can (legitimately) pay some of my expenses through said company (e.g. I use part of my home for this work), then at least that income might be able to be reduced for tax purposes.

And yeah, ERE is eventually good for tax purposes. But I'm in my accumulation phase, and in the middle of my efforts to squeeze out a few more % savings rate, I can't help but notice a third disappearing off the top. I'll definitely check out that other thread (I'm a fan of akratic).

This matter of taxation is of the utmost importance to me. While the OP lives in one of the highest tax burden states, I reside by choice in a state with very close to the lowest overall personal tax burden in the nation and it saves me multiples of thousands annually as a result. It is no light matter and is a integral part of achieving our goal. Tax optimization strategies are most certainly worth your attention.

Yes, but currently for me the increase in income from my current location as well as the potential for income growth over the next few years dwarfs the difference in income taxes I owe. But, I am keeping my eyes open for that point at which it makes sense to run some geo-arbitrage.

I like MadFientist, but most of his tax advice is of the IRA/401k/HSA variety, which I fully max out already. I guess I should also mention that I do some light tax-loss harvesting (but I haven't seen many losses that I wanted to realize), and I always take the standard deduction as I don't really have many deductible expenses. I saw a thread on here about rather significant non-deductable 401k contributions that can roll over to a Roth IRA eventually, so that could be another backdoor-Roth-like scheme. To be honest, though, Roth doesn’t excite me very much right now because I’m in a mass accumulation phase. I’m pretty sure that over the course of my life I’ll have plenty of opportunities to roll over/convert funds at a lower tax rate.

First world problems

[bad_LNIP]

I agree on tax avoidance, and I am doing all of the above to avoid as much as I can. Moving to a different country for tax arbitrage essentially, I am also going to structure my investments to generate a significant amount of income from dividends or tax free distributions as much as possible to minimize taxes.

All of this is done through a corp to again maximize the tax benefits.

Staying in the US with wage income is pretty tough from a tax standpoint.

[thelucster]

I'll chime in on this one. My current situation of tax avoidance wasn't my goal, but it is a welcome side effect. I'm originally from the UK and still have citizenship there - there are no taxes on foreign income if you aren't a tax resident, if you are it is treated the same as local income (are there any countries in the EU where this isn't the case?).

--

A couple of years ago I left full-time employment and started contracting. The most tax efficient way to do this in the UK is to setup a limited company - what is called a "personal service company" - rather than self-employment or working through an umbrella company. If you are a lower rate earner it's not really worth it, but if you earn £100,000 per year it means you are paying around 10% less tax than being a salaried employee.

In the UK you pay corporation tax on profits of 20%. I have to charge VAT (sales tax) to my clients at 20%, but I only pay it back to the tax man at 14%, as I am registered for 'flat rate VAT' (apparently it's to make accounting easier, not really sure how, but I'm not complaining). The tax rate on dividends varies, but there are various tax credits which cancel this out - as a director you can take up to £40,000/year tax free, so you can spread the dividend out to pay even less tax. The real kicker though is that you can also make your spouse a director of the company too, and they will have the same tax free allowance.

So just to summarise, if I earned £100,000 per year (I wish), as a salaried employee I would take home £64,000 of that. If I setup a company, with myself and my fictitious spouse as directors, and availed of all the above we would take home £83,000 of that.

--

Earlier this year I moved to following the three flag theory, this wasn't my intention (I moved for love - how romantic ). I am a resident in a Middle East country that has no personal taxation, and only taxes oil companies and investment banks (someone here has the right idea...). To sponsor a visa I had to setup a company here, so I now charge clients directly through that and avoid the UK company. This means I don't pay any taxes. There are no requirements on filling accounts here, but I have to pay a license fee for the company of around US$8,000/year - this is a lot less than the tax I paid in the UK though.

Although this country is fairly stable, if the rulers decided they wanted to start charging 50% tax they could just like that, so it's not quite as stable as the UK. If I move back to the UK within three years from when I left I have to pay tax on all my foreign income - although I don't plan on staying here long term, I don't think I'm going to go back just yet.

I wouldn't really recommend this place to setup a company mind as it's a bit backwards (it took me 6 weeks to get a business bank account) and I'm not really sure how you would do it without being on the ground - somewhere like Hong Kong is probably a better choice.

[GandK]

Do. Not. ASSUME. that taking the standard deduction is what you should be doing! Do the math!

We save thousands every year by itemizing. Yes, it's a PITA when we file, but when everything is added up, we come out significantly ahead.

Basic starting info from TurboTax

[Legthorn Brownboat]

Oh, crap, state income tax deduction has to be itemized. Well, there goes the standard deduction.

What all do you itemize? State income tax would be the big one for me, as well as interest if I had a mortgage (I don't).