How to PAY ZERO TAXES How to
PAY ZERO
TAXES
(Money Magazine) -- You've tried staring your computer down, but it's not blinking. No matter how many times you go over the figures, you get the same answer. That number on your screen - what you're paying the IRS this year - is more than your dad earned in his five best years. You can't help thinking, Why am I such a chump when other people must be getting off scot-free?
Brace yourself. Last year 49.2 million U.S. households filed returns that obligated them to pay absolutely no federal income taxes - and they didn't necessarily do anything illegal. Before you start gnashing your teeth at the injustice, however, you should know that there are many reasons to be happy that you're not one of the tax escapees.
For starters, avoiding U.S. income taxes isn't easy. Citizens can't wriggle out of their bills by moving to another country because, almost alone among nations, the U.S. taxes all income, no matter where on earth it's earned. And although the tax code offers plenty of deductions and exemptions, if you take too many you'll be skewered by the alternative minimum tax (AMT).
Almost all the tax shelters of yesteryear disappeared when Congress closed loopholes in 1986. Even running your own business is not the shelter it was when you could deduct yourself down to zero by saddling your company with bills for luxurious travel, cars and meals out.
"Those days are over," says Charles Hayes, a C.P.A. and financial planner in Coronado, Calif. "Expenses have to be necessary and reasonable." If they aren't, the IRS will likely disallow them.
So how do the 49.2 million do it? That's what Money Magazine set out to learn. What we found offers a glimpse into the workings of the immensely complicated U.S. tax system, as well as valuable lessons in the dos and don'ts of cutting your own taxes.
Among them: Do whatever you can to shave income from your 1040 but, perhaps most important, don't cut off your tax nose to spite your financial face. You can find plenty of ways to collect tax-free income, but you'd likely find unacceptable the trade-offs it takes to get all the way to zero.
How we got here
From its beginnings in 1913, the income tax system was designed to be progressive; the more you make, the more you pay. The top bracket then was 7%, and it applied only to those who earned above $500,000 a year, which is about $10.6 million in today's dollars. Congress also recognized that some were too poor to pay taxes, so it exempted the first $3,000 in income. In 1913 that exclusion liberated all but 1% of the population from taxes.
Those principles still hold today. "Our tax system still is progressive," says Len Burman, director of the Tax Policy Center in Washington, D.C. In 2005 the 10% of taxpayers with the highest incomes provided 70% of income-tax revenue, which cost them on average 25% of their income, more than any other group, according to the IRS.
That's not to say that many wealthy people don't shelter immense chunks of money, but getting to zero is difficult even for them. Fewer than 2% of earners in the top 20% (average income: $99,500) escape taxes altogether. That comes to about 400,000 filers. (Plus, even those who sidestep federal income taxes may have to pay Social Security and Medicare taxes, state and local levies, property taxes and sales tax.)
The vast majority of the members of the zero-tax club are on the opposite end of the income spectrum. Some 92% of zero-tax filers earn less than $30,000 a year, according to the Tax Foundation, a non-partisan research group in Washington, D.C. That doesn't include another 15 million who earn too little to file in the first place.
Your annual income wouldn't have to be quite as low as you'd imagine for you to be free of the income tax. Because of deductions, credits and exemptions, a family of four can earn about $43,000 and pay nothing. For a single person without kids, that threshold is $10,300.
Over the past decade, Congress has removed more and more people from the tax rolls by increasing the size of those adjustments. The personal exemption, for example, rose from $1,000 in 1980 to $3,400 in 2007. Additionally, low-income families receive a $1,000-per-child credit and a special credit for the working poor.
Few among us would want to settle for a drastically lower income just to avoid taxes. But David Gross did just that. After the 2003 invasion of Iraq, the 39-year-old technical writer decided that he didn't want his tax dollars funding the war. Only by earning less, he realized, could he stay within the law.
At the time his salary came to about $100,000 a year. He asked his employer to pay him far less - some $70,000 less - but was turned down. So he quit and launched a business from his apartment, strictly limiting his earnings.
In 2007 his income was $29,000. He put $2,850 in a health savings account, $4,500 in a simplified employee pension (SEP) and $4,000 in an IRA. Since he works freelance, he can deduct half of his self-employment tax ($1,850) and his health insurance premium ($1,200), leaving him with an adjusted gross income (AGI) of $14,600.
After taking the standard deduction and one exemption, his taxable income neared $6,000 and his tax was $493. Low-income earners like Gross are also entitled to a credit for retirement plan contributions. His came to $500 and - poof! - no tax bill.
Because he's saving so much, Gross has to pinch every penny. But even though he lives in San Francisco, one of the nation's most expensive cities, he says, "it turned out to be a lot easier than I thought." Most places he goes are within walking distance, working at home gives him time to cook, and he and his girlfriend (who does pay taxes) rely on Netflix-rented movies for entertainment.
Gross believes in the government's right to levy taxes - he still pays California taxes - but he's satisfied, he says, that he hasn't been financing what he calls "the hugely bloated military."
Can You Do This? You probably don't want to emulate Gross' ascetic lifestyle. Face it: Earning less is a great plan - unless you like to eat dinner out, go to the movies once in a while and own a car. But don't ignore his example of grabbing every retirement tax break you can find. You can reduce your income and enhance your financial security by funding a 401(k), an IRA, a SEP or a health savings account.
Over the past two decades, Congress has eliminated most exotic tax shelters. But you can still find a handful of government-approved ways to collect certain kinds of income-and keep every last cent of it!
Strategies
Invest in Municipal Bonds
>The income is exempt from the federal taxes and sometimes also free of state income taxes; income taxes; most bonds aren’t subject to AMT (alternative minimum tax)
>On the flip side: You wouldn’t have earned 5-7% a year on average in a muni fund over the past 20 years VS. 10.80% for the S&P 500.
Open A 529 College Savings Plan
>Earnings grow tax-free.
>Withdrawals are tax-free when the money is used for college.
>Anybody, even an adult, can be a beneficiary.
>>On the Flip side: You can’t deduct your contributions on your 1040.
>>You’ll owe a 10% penalty plus taxes if you tap your 529 for anything other than school.
Go to your Final Reward
>Leave behind stocks and your heirs owe taxes only on the subsequent gains. If your heirs sell immediately, there’s no tax bill.
>>On the Flip side: You won’t be around to enjoy beating the IRS.
Sell your House:
>You pay no capital-gains tax on 250,000 of the profits for singles, 500,000 for married couples.
>>On the Flip Side: Houses aren’t soaring in value right now, ergo, not much tax-free income.
Be a Life Insurance Beneficiary:
>The proceeds are Tax-free.
>>On the Flip side: Someone had to die-but at least it’s not you. (No disrespect)
Ask Someone to Give you Money:
A gift of up to 12,000 a year is Free of Taxes.
Your spouse and each child in the family can collect 12,
>>On the Flip side: There is no flip side. It’s all Good!
>>>Put your retirement fund in a ROTH! >All Withdrawals are tax-Free after age 591/2. >>On the Flip Side: You had to pay taxes at some point, either when you opened the Roth or when you converted your traditional IRA to a Roth.
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Magazine Title: Money Subtitle: Smart Moves in a Mean Economy Author: Marlys Harris, (Money Magazine Senior Editor)
Article Title: How To Pay ZERO TAXES. Pg(98-104) Date found information: April 15, 2008 Published: March 27, 2008 4:37 A.M. EDT
