Do you want to pay less taxes? Me too. But, unfortunately, paying taxes is one of the two guarantees of life—the other being death. Compared to the latter, the former doesn’t seem so bad, does it?
Everyone from the billionaire business mogul to the hourly-wage worker wants to save on taxes, and the quest for the elusive “secret tax loophole” has become something of a myth in the modern financial era.
In this article, we’re going to debunk that myth and tell you the real “secret” to pay less taxes. Ready? Here we go.
For purposes of this article, “taxes” refers to federal income taxes.
There’s No Secret Tax Loophole
First and foremost, let’s set the record straight: there’s no secret tax loophole that allows you to magically pay less taxes without reducing your taxable income. Taxes are a zero-sum game.
If you clicked on this article with the hopes that I’d have some magical tax loophole that allowed you to enjoy the fruits of your labor without the associated tax bill… sorry to burst your bubble.
If someone promises you this, approach with caution. Or, just run in the opposite direction.
The majority of attempts to circumvent the tax code often end in hefty penalties or other legal repercussions. So, chasing such loopholes isn’t just financially risky; it can also land you in legal hot water.
The Only 2 Ways to Pay Less Taxes
If there are no magic secrets, then how can you legally save on taxes? The truth is straightforward:
1. Reduce Your Taxable Income
This might sound counterintuitive. After all, who actively wants to make less money? But it’s a simple equation: the less you make, the less you owe in taxes.
Of course, this isn’t a strategy most would prefer. In fact, it’s not really a strategy—it’s common sense. It’s important to remember that while you might save on taxes by earning less, you also have, well, less money.
Reduce Your Gross Income
There are times when reducing your gross income (salary) may be beneficial.
For instance, if someone is nearing retirement and chooses to work part-time or in a less demanding role, they might earn less and, therefore, pay fewer taxes.
This specific situation can be beneficial for those collecting Social Security. Individuals collecting Social Security may want to keep their income low enough to make sure their income isn’t taxed.
Instead of taking a pay cut, you could also reduce your income by contributing to pre-tax deduction opportunities.
The most obvious opportunities in this category include contributions to retirement accounts like a 401(k), 403(b), and IRAs. You may also qualify to contribute to a Health Savings Account (HSA) if you have a qualified high deductible health insurance plan.
These options are a great way to avoid or defer income without forgoing the compensation altogether.
Gross Income Reduction for Business Owners
I’m going to guess that most of you reading this blog probably don’t fall into that category. If you’re here, you’re probably self-employed or a small business owner who is tired of getting hit with a massive tax bill during tax season. Am I right?
So what about you—the freelancer or business owner? For starters, you too can choose to bring in less money. Generally, I don’t recommend making less money but there may be a point at which the additional time required to earn more money may not be worth the additional income.
In other words, at some point, the “juice might not be worth the squeeze.” This is mostly relevant to freelancers and solopreneurs who are doing the technical work of the business.
If you’re a business owner and can leverage other peoples’ time, you should power through and keep earning!
Increase Your Deductions
Unlike W-2 employees, self-employed taxpayers, freelancers, and small business owners are able to deduct their business expenses from their gross income.
There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business,[…]
IRC § 162(a) (Internal Revenue Code)
The IRS allows a deduction for expenses that are (1) ordinary; and (2) necessary in carrying on your trade or business.
So, next time you’re unsure if a particular expenditure is business deductible, ask yourself two questions:
“Is this expense necessary for me (or does it help me) operate my trade or business?”
“Is this expense something that someone else in my line of work would likely need for their business as well?”
Now, even if you can answer “yes” to both of those questions, you may not be out of the woods just yet. There are certain expenditures that the IRS specifically disallows.
For certain expenditures (like automobile expenses) the IRS has specific guidelines for how those expenses can be claimed.
Despite what you may have heard on TikTok… No, not everything is business deductible. No, not even for “influencers.”
2. Leverage Tax Credits
The other way to pays less taxes is to utilize tax credits. Tax credits are incentives offered by the government to encourage certain behaviors, like investing in green energy, buying a home, or furthering your education.
Unlike deductions, which reduce the amount of your income that’s taxable, credits are a dollar-for-dollar reduction of your tax bill. This means if you owe $3,000 in taxes but qualify for a $1,000 tax credit, you’ll only owe $2,000.
There are numerous tax credits available, ranging from credits for parents and education to energy and elderly taxpayers. You should familiarize yourself with the available credits and see which ones you might be eligible for.
It’s important to note that tax credits aren’t free. Every single tax credit requires an upfront cost. For instance, the $2,000 Child Tax Credit. How much did you spend supporting your child? I’d bet it’s a lot more than $2,000 per year.
Here’s the bottomline: tax deductions reduce your tax liability, but they also reduce the amount of money you take home.
So, just because you can doesn’t mean you should.
Is it possible to buy a G-Wagon and use bonus depreciation or Section 179 to expense most of it? Very possible. But guess what? You still have to pay for it! And that car payment is money you don’t get to take home to your family.
Keep in mind that taxes are just one piece of the cash flow puzzle. A big piece for sure, but don’t allow yourself to hyper-focus on taxes and forget to consider how much you’re taking home.
Businesses have to spend money to operate, but don’t let yourself spend $1 to save $0.30 just to stick it to Uncle Sam. That’s called “cutting your nose to spite your face.”
Free Lunch on Congress
Believe it or not, there may actually be a such thing as a free lunch. Congress has provided for two deductions that don’t require you to spend money to claim them.