How to Pay Less Taxes - Legally

Hey, what's up everyone, and welcome to the School of Personal Finance. In this video, I'm gonna talk about different ways that you could reduce the amount of taxes you pay. I'm gonna give you a general overview of how it all works, and then I'm gonna give you specific examples of things that I've done to reduce my tax bill. Let's get to it. First things first, I am not a CPA. I am not here to give you tax advice. I am here for educational purposes only. Do not take personal advice from some dude that you're watching on YouTube. Consult with your own CPA, with your own financial advisor, before trying to implement anything that I'm about to share with you. If this is your first time here, I talk all about personal finance and just trying to help you become great with money. If you're into that kind of content, make sure to subscribe to this channel and hit that little notification bell so you get notified every time I upload a new video. All right, so the tax code. Nobody wants to sit and read the tax code, but if you actually did, you would realize that all it really is, it's like a roadmap of incentives. It's a way for the government to kind of point you in the direction of doing things that they want you to do. Some examples would be like providing housing for people or having a family, having children, or starting a business and employing people. These are all things that the government will give you tax incentives to go ahead and do. If you don't do any of these things, then chances are you are going to pay more in taxes. But no matter what you do with your life, if you're an employee, if you're an employer, if you're just an investor, there are ways to reduce your taxable income. And that's the name of the game. It's legally reducing your earned income, the amount of income that is going to be taxed by the government. So I'm going to break this down into those three different groups that I just mentioned. The employee, the W-2 employee who has a job, maybe you have some children, but that's really about it. You're not a business owner. You're not really an investor besides your retirement accounts. I'm going to go through some ways that you could save on taxes. But just being honest, you're the ones that get taxed the most. You're limited in your options for reducing your earned income. Then I'm going to talk about the small business owner. Being a small business owner or an entrepreneur, a solopreneur, it has major tax benefits. And I will get into all that as well. And then there are investors. Investors, they get treated the best. Like Warren Buffett famously said that he pays a less income tax rate than his secretary. And that's because his income gets taxed differently because he's technically an investor. He gets taxed at capital gains rates. Different than what the secretary who's getting a W-2 paycheck gets taxed at. So I'm going to go through these three different things. And then I'm also going to tell you how I personally changed the course of my life just starting a few years ago when I saw how much I was paying in taxes. And when my employer started moving me over from being a W-2 employee over to being a 1099 contract worker for a majority of my income. And I started to really dig in and learn about this stuff. I'll go through the changes that I personally made to dramatically reduce my tax bill. And not only that, but in the last year I had over $30,000 of income that I paid zero taxes on. So I'll tell you how I did that as well. So now if you're a W-2 employee, like I mentioned before you're pretty limited as to how you could reduce your taxable income. Let's go through the options real quick. And hopefully there'll be a couple in here that you aren't currently using that you haven't thought of before. But the first one is very well known and that's contributing to your retirement plan through work. So like a 401k, a 403b or a 457 plan. In 2020, you could contribute $19,500 if you're under 50 years old into those accounts. And it's a tax deduction that will save you a lot of taxes in this year. But all you're really doing is you're deferring the taxes to retirement. So you will end up paying taxes on that money. It's just later on down the road. But that is a good option to reduce your taxes in this year. Another way is through IRA accounts. So you have Roth IRA and traditional IRA. Now, if you're making a lot of money, you might not qualify for a deduction of a traditional IRA. And maybe you could just do a Roth IRA. But if you do qualify for the deduction on a traditional IRA, you could contribute up to $6,000 and that will reduce your taxable income in this year as well. Now, the third way is through an HSA account, a health savings account. And now you can only contribute to a health savings account if you have a high deductible health plan. So if you don't have a high deductible plan, then you are not eligible for an HSA. But I encourage you to research it, to look into getting a high deductible health plan. I personally have one and I think it's a great way to go, especially if you're young and healthy because you'll pay a lower premium month in and month out. Yes, you have to pay more out of pocket if you have doctor visits, if you're sick, if you go to the hospital. But ordinary visits like a physical once a year is gonna be covered under the high deductible health plan. And the advantage of having that is that you now have a health savings account that's available to you. If you're single, you can contribute up to $3,550. If you're married, you can contribute up to $7,100. And these plans, they have the triple tax, the trifecta. They're the best tax type of advantaged account that is out there. When you make the contribution, you get a tax deduction. The money in the account, it grows tax deferred. And then when you take it out, it could be years down the road or it could be in the current year. As long as it's used for health expenses, it comes out tax free. You don't have to take the money out. So if you have a health expense that comes up, you can decide to pay out of pocket and let the money continue to grow in there. Save your receipts and then later on down the road, if you wanna take money out, you're able to take it out tax free. And then the fourth way is through a 529 plan if you have kids. So if you have children and you're saving for college, putting money into a 529 plan, a lot of states give you a state tax deduction. Like in New York, we get a state tax deduction up to a certain limit for contributing to a 529 plan. But even if you don't have the state deduction, it could still make sense because the money that goes in, it grows tax deferred and it comes out tax free as long as it's used for higher education purposes. And they keep expanding what the definition of that is. So who knows, by the time our kids go to college, what it will look like, if there will even be room and board or if everything's gonna be online. But I'm sure at some point in the future, you're gonna end up paying for your kids some kind of education and 529 plans are a good way to do that. And then the last way to save on your taxes is through donations. So now you have to itemize your deductions in order to get a tax break by making donations. If you just take the standard deduction, then by donating money, it actually doesn't give you any tax benefit. But if you itemize, then you do get the deductions for charitable donations. So that's another great way to reduce your earned income, especially if you're a very high income earner. All right, so the next type of person I'm gonna talk about are those self-employed people out there. You know, a few years ago, my wife left her teaching job, her W2 job, and she started her own business, paisleydoodle.com. We have a clothing boutique that she runs out of our house. It's all online. We ship all over the country. It's an awesome business. Go check it out. If you haven't yet, go buy you or your significant other something nice. But anyway, she moved over from W2 to being self-employed. For me, I used to be a W2 employee. And like I said earlier, they started slowly switching me over to be a contract employee where most of my income was 1099. And then finally, I actually sold my business as a financial advisor and a couple years later, I went independent and started my own financial planning firm, School of Personal Finance. So now both of us are self-employed. So five years ago, we were both W2, and now we are both self-employed. And it does make a tremendous difference as far as your deductions go, as far as the amount that you pay in taxes. So let's get into some of the benefits of being self-employed. The first big advantage to being self-employed is you could deduct your business expenses right off the top. And then you're gonna pay taxes on what's left over. When you're an employee, you just don't have those deductions available to you. So like some examples would be, me and my wife both work from home. So we have home offices that are deductible. We both have cars that we use for business. So our cars, they become deductible. The phone that I'm using to record this video, I use it for business. It's a tax deduction. My MacBook, tax deduction. The internet that I'm using to upload this video, tax deduction. All the books and articles and things that I subscribe to for my business, because I enjoy reading them, tax deduction. My wife, her phone, her computer, things that she subscribes to. She sells clothing. So what about a trade show out in California? My high deductible health plan, the premiums, it's deductible. Pre-COVID, we were going out to dinner and having business meetings at least once a month, right? We both own our own businesses. If we go out to dinner, what do you think we're talking about? We're talking business strategy. Those dinners, that's tax deductible. And now another advantage is we have higher contribution limits for our retirement accounts. So like with a solo 401k, we can each contribute up to $57,000 a year into our 401k, depending on how much money we make in the year. And now another big benefit, if you have children, is hiring them to work in the family business. So my son is about to turn 13 and he's perfect for my wife's boutique. He can do the inventory. He can make sure that everything is in the right spot that it's gonna be. He can pack up orders, do the shipping. And then we get to work with our son, which could be good or bad. But the money that we pay him, it's tax deductible to us. And what's great is your kids have their own tax bracket. So like my son, he has a standard deduction the same way we do of up to $12,200. So that means on the first $12,200 that he earns, he's not gonna owe any income tax on it. And then you could take that even a step further. He'll be able to contribute to a Roth IRA at 13 years old. Imagine starting that early. Go back and watch my last video that I did about compound interest. That could make a huge difference. So it's a big tax advantage to be able to have your children work in your business. And then the last tax benefit is that when you sell your business, you get taxed at a capital gains rate. So that is at a lower tax rate than ordinary income, than earned income that you would have. So that's another advantage of building a business and then eventually selling it and cashing out of it. And now I know that you might be thinking, well, I have a W-2 job. I've been there for a while. I'm not going anywhere. I'm not quitting and starting my own business. And I'm not telling you to do that at all. But what you can do is start dabbling. You could start, find a passion, find a hobby, and just start trying to sell stuff. And you could start selling stuff on eBay, and that would be considered your own business. You would be a sole proprietor. And you could start slowly transitioning over and seeing if you could grow that business and then start researching all these things that are available to you. It's very easy to start your own side hustle, your own business where you can make some money and start benefiting from some of these tax breaks that self-employed people get. Remember, the government wants you to employ people, to start a business, to add to the economy. They give you legal tax incentives to do so. Start looking into it. It's not that hard to get started. So now the last group we're gonna talk about is an investor. And now I want you to understand that you don't have to choose one or the other. You could be in all three of these groups. You could be a W-2 employee who has a side business, who also invests in things. You could fit into all three of these categories and take advantage of the tax breaks in all of them. But investors, they get treated the best. So if you invest in developments, if you build buildings, if you invest in real estate, if you provide housing to people, if you invest in oil and gas exploration, if you invest in municipalities, the tax code is in your favor. So now the first benefit for investors, which most people are aware of, is the capital gains rates. So if you hold an asset, this could be a stock, a bond, a mutual fund, a house, any asset, if you hold it for a year or longer, then it gets taxed at long-term capital gains rates, which are gonna be lower than your ordinary income tax rates. If you hold it for less than a year, then it gets taxed at your ordinary income rates. If you invest in municipalities, if you buy municipal bonds, then the interest is going to be tax-free from that. So you won't have to pay any taxes on the interest income that you receive from those bonds. Oil and gas exploration, if you invest in that, the deductions are through the roof. Sometimes you could deduct all the way up to 100% of your investment. Now, I mentioned earlier in this video that I made over $30,000 last year and I paid zero tax on it, and that was through owning rental real estate. So the way that it works is through a magical word called depreciation. So now, if you buy a, let's just say a single-family rental property, and let's say you pay $140,000 for the house. Now, let's say the land is worth $30,000, so the actual structure is worth $110,000. The IRS, they allow you to depreciate that on your income tax return over 27 1⁄2 years. So you do an even amount, so you get to zero over those 27 1⁄2 years. So if we divide that into the $110,000 cost of the structure, that would be $4,000 a year that you could depreciate, that you could deduct off of your taxes, even though the value of the house is not actually going down. Hopefully, it's going up. But let's say you own one house, and after your mortgage and your taxes and your property manager and any maintenance and vacancy and all your expenses that come up through owning a rental property, you receive an income of $3,500 for that year. Let's say $3,600. Let's say you get $300 a month for that house in income after all of your expenses are done, actual cash in your pocket. At the end of the year, when you do your taxes, you could deduct that $4,000 of depreciation against that $3,600 of income. So even though $3,600 would go into your pocket, you would actually show a $400 loss on your tax return. That is how people invest in, this is on a small scale. People do it on a huge scale where they invest in tons of real estate, and they actually show a loss on their tax return even though they have all this money going into their pockets. And that's not the only benefit with real estate. There are other things like a 1031 exchange. When you sell that house, as long as you take it and you parlay it into a bigger house, then you could defer the taxes. You don't have to pay the taxes when you sell the house as long as you're rolling it into another house. And you could keep on doing that actually until you die. They call it defer till you die. You could keep doing that, and then when you pass away, you leave the house to your kids, they get what's called a step up in the cost basis. So they get a step up all the way up to the current value of the house. So if they were to sell it the day after you die, they would owe zero taxes on it. It's really a great way to invest to earn tax-free income and to leave a legacy if that's something that's important to you. All right, so I went through a lot of stuff in this video. And this is just the tip of the iceberg. This was really meant to really pique your interest, to help you to understand that there are things that you could be doing. It takes planning. So I hope that this was helpful to you. Please make sure to hit that subscribe button if you've not done so already. Make sure to like this video. Make it turn blue. It helps the YouTube algorithm so much. Helps show it to more and more people. I appreciate you being here, and I will see you again in the next video. Thanks.