Buy swamp land for $1 million, get an appraiser to value it at $8 million, and agree to never develop it by donating a “conservation easement” to an environmental group, thus reducing its value to $3 million.
Now deduct that $5 million “loss” of value from your taxable income, saving yourself $1.85 million at tax time (assuming you’re in the 37% tax bracket).
Fortune magazine reports that this loophole survived the latest tax law changes, and President Trump has himself generated $100 million in tax write-offs using conservation easements.
Of course, it’s a tax shelter that’s not too useful for those of us with more limited resources. In fact, most tax shelters are meant for the rich.
So what can we less-than-wealthy taxpayers do to shelter at least some of our income from taxes?
Here are ten strategies that might work for you even if you’re in the lowest income tax bracket.
Table of Contents
1. Live In A State With No Income Tax
The state in which you’ll pay the least in taxes depends on your personal financial situation. For example, if you have a decent middle-class income you might do well to move to one of the seven states that have no income tax:
- South Dakota
The type of income you make matters too. New Hampshire and Tennessee don’t tax earned income, but they do tax dividends and other investment income.
Assuming you can take your income with you (or easily replace your job), how much will you save by moving? That depends on where you live now.
As an example, according to an income tax estimator, if you’re single, live in California, and have $50,000 in taxable income, you currently pay about $2,100 in state income tax. Moving to a no-income-tax state would save you all of that.
But be careful when doing your calculations, especially if your income is lower. When my wife and I moved to Florida, we were happy to discover that there was no income tax, but shocked when we had to pay hundreds of dollars just to register our car.
As pointed out in a BankRate.com article, states without an income tax tend to collect taxes in ways that take a bigger bite out of the paychecks of low-income residents. Washington charges 49.5 cents per gallon in gasoline taxes, for example, and Tennessee has a 7% sales tax.
Generally, if your income is above average the savings from moving to a no-income-tax state outweigh the cost of other taxes, but if you’re in the bottom half of income earners you should probably consider other options, like our next strategy…
2. Live In A State With Low Or No Sales Tax
If your income is low enough you may not owe much in federal or state income taxes no matter where you live. In that case, sales taxes become a more important consideration. After all, you still have to buy things to survive.
There are states that have sales tax rates topping 9%, and in parts of Louisiana you’ll pay over 10%. Groceries are often fully or partially exempt, but those taxes can really add up when you’re buying clothes or appliances.
Fortunately there are five states with no sales tax:
- New Hampshire
How much can you save? Hundreds of dollars if you’re buying a car. On a more regular basis, if you spend $8,000 annually on taxable items and move from a state with a 9% sales tax to one with no sales tax, you’ll save about $720 per year.
When my wife and I moved to Montana in 2002, we were happy to discover that there was no sales tax. On the other hand, we paid $810 in annual property taxes on the house we bought for $17,500, making it the highest rate I’ve ever seen (we challenged it but lost the case), which brings us to our next strategy…
3. Live In A State With Low Property Taxes
Property taxes vary widely according to where you live. Hawaii tops the list of the best states for property taxes, with a property tax equal to 0.28% of the average home value. But it also has expensive homes and high income taxes.
That average “effective rate” of taxation is worth paying attention too, especially if you plan to spend a good chunk of your income on a house.
For example, we paid $143,000 for a home in Colorado (average effective rate: 0.52% of value) and it costs us less than $600 in property taxes annually.
But in addition to the average rate of taxation, various exemptions affect your total property tax burden. Many states have homestead exemptions, active-military exemptions, senior citizen discounts and more.
For example, when we moved to Florida we paid $89,000 for a condo. Because the Florida homestead exemption effectively eliminates taxes on the first $50,000 in value, our annual property taxes came to $350.
By comparison, when we lived in a mobile home in Michigan (worth about $30,000 at the time) we paid property tax of about $600.
Michigan is on the list of the worst states for property tax, as is New Jersey, where an $89,000 condo would have an annual property tax bill of about $2,100 — $1,750 more than we paid in Florida.
Property tax exemptions benefit most those who can afford only modest homes (a rarity among tax shelters).
If you can find a house in Florida for under $50,000 (a mobile home on a lot, for example), you’ll pay almost nothing in property taxes (you’ll still pay something, because the second $25,000 of the $50,000 exemption does not apply to school taxes).
4. Live In A State That Doesn’t Tax Social Security Benefits
According to Kiplinger.com, there are 37 states that don’t tax social security benefits. If you collect social security, then, it makes sense to consider moving to one of those states.
Of course, you have to balance that benefit with the other taxes you’ll pay, but if you start with states that leave your social security checks untaxed, you can still find one that also meets your other criteria. For example, Delaware does not tax social security benefits and is on the list of the best states for low property taxes.
5. Start A Business To Get Tax Write-Offs
A small business lets you take advantage of many tax-saving strategies, and anyone can start a business with no money,
The general idea is to find business tax deductions for expenditures you normally make anyhow. For example, the tax code allows a health insurance deduction for the self-employed (without itemizing). So if you’re already buying your own health insurance you can shelter income equal to your annual premium payments.
Of course it makes no sense to add expenses to your life just because they’re tax write-offs. For example, if you’re in the 12% tax bracket, buying a $1,000 computer will reduce you taxes by $120, which means it still costs you $880 — so those expenditures better make business sense.
On the other hand, if you look closely you might find valid deductions for fun activities that save you more than your marginal tax rate.
For example, when I lived in Colorado I started a treasure-hunting website. It didn’t make much money, but I loved taking trips across the state to hike and hide clues to the treasure, and I deducted 56 cents per mile for that business use of my car (the current standard mileage rate is 54.5 cents per mile).
I effectively got a 50% savings on the cost of my adventures, because I got to deduct double the actual cost and I was paying a 25% tax rate at the time.
Look over a list of small business tax deductions to see if any of your activities and expenditures can be deducted as business expenses (ask a tax specialist to be sure). And remember, starting a business can be easy. Even doing paid surveys is a business activity by IRS standards.
5. Fund Your IRA
You need to save for retirement anyhow, so you may want to do it in a way that saves money at tax time. The contribution limit for 2018 for a traditional IRA is $5,500, which, if you’re income reaches the 22% tax bracket, will knock $1,210 off your tax bill.
But talk to a tax expert to see what kind of retirement plan works for you, and whether you qualify. For example, you may not be able to deduct IRA contributions if you already have an employer-sponsored retirement plan.
6. Travel To Avoid Taxes
Here where we live, in Tucson, Arizona you’ll find many car dealerships just outside the city limits. It may have something to do with the fact that the sales tax there is 2.6% lower than in the city. That would save a car buyer over $500 on a $20,000 car purchase.
In addition to traveling across town to avoid city sales taxes, you might consider crossing state lines if you’re making a large purchase and you live close to one of the five states with no sales tax. Here’s that list again:
- New Hampshire
Also, if you live in a town on or near a state border, gasoline taxes might be far less a few miles away, so filling up on the other side might make sense. For example, a gas tax chart shows that the taxes per gallon are 30 cents lower in Ohio than in next-door Pennsylvania.
8. Flip Your Own Home For Tax Free Profits
The IRS Section 121 exclusion lets you to exclude from taxation a capital gain of up to $250,000 ($500,000 for a married couple) on the sale of your home if you’ve lived in it at least two of the five years prior to the sale. That’s a nice loophole that lets people roll their entire profit into their next home tax-free, but it can be more than that.
If you want to really take advantage of this tax loophole, buy a fixer-upper, live in it while you do repairs, and sell it for a tax-free profit two years later — then start the whole process again.
For example, my wife and I sold our condo in Florida for a tax-free profit after we had lived in it for two years. Then we bought a house for $65,000, lived in that for two years, and sold it for $85,000, again avoiding any tax on the small profit we made.
9. Claim The Earned Income Tax Credit
If your income is low enough and you have a job, you get to claim the earned income tax credit. It’s worth between $519 (no kids) and $6,431 (three qualifying children).
But what if you have a low total income at the moment, but some of that money comes from investments? Then you have to do some calculations, because the IRS says that to qualify for the credit, “Investment income must be $3,500 or less for the year.”
Perhaps you can arrange to meet that criterion.
If, for example, you would otherwise make $4,000 in investment income, stick some money in a non-interest bearing bank account to get that investment income down to $3,400. Then, with two children, you can get a credit of $5,217, meaning you net an additional $4,617 after the reduction in investment income.
10. Contribute To A Health Savings Plan
If you have high-deductible health insurance policy (deductible over $1,350) the IRS allows you to contribute to a tax-free health savings plan (HSA) which can be used for qualified healthcare expenses, like doctors, dentists, medicines, medical transportation, and much more.
The limits for 2018 are $3,450 for yourself or $6,850 for a family. You pay no taxes on the contributions, and they roll over to the next year if you don’t use all of the money. You can search online for HSA providers to find a place to open an account.
Other Tax Deductions, Shelters, And Strategies
With the standard deduction now at $12,000 ($24,000 for a married couple), most of us can’t deduct things like mortgage interest, since these require itemizing, and the deductions would have to add up to more than standard deduction.
So you want to look for “above the line deductions.” That includes self-employed insurance costs and IRA contributions, mentioned above. Here are a few more above the line deductions for which you might qualify:
Student Loan Interest – You can deduct up to $2,500 in interest paid on student loans if you’re below the current income limit.
Alimony – You can deduct payments of court-ordered alimony.
Military Moving Expenses – If you’re an active member of the military and are required to move, you can deduct the expenses of that move.
Finally, some of the best tax shelters involve income that simply isn’t taxed, like the capital gain on your home, mentioned above.
If you use tax shelters or tax-savings strategies not mentioned here, please share them with us below… and keep on frugaling!