You pay taxes to federal, state and city governments based on how much money you make, how much you spend and where, where you live, what you own, how you invest your money, and ultimately, how you live your life. If you would like to reduce your taxes, it is worth your time to better understand how you are being taxed day after day. Once that is accomplished, you can start to identify ways to cut them.
Most people pay federal income taxes on their earned income. See a 2022 "real world" tax table here that includes the standard deduction. This is relatively straightforward. The more you earn, the more you pay with our progressive tax system. Everyone gets the standard deduction (a small few will itemize their deductions). We all then get taxed at 10%, 12%, 22%, 24%, 32%, 35%, and 37% as your income rises.
How do you reduce federal and when applicable, state income taxes? Contribute to a pre-tax retirement account like a 401(k) to reduce taxes now. Put more money into a Roth retirement plan like a 401(k) or IRA to reduce taxes later. See the pros and cons of those options here. Negotiate a lower paycheck to get greater benefits. Put more money into an HSA if it applies. Its about being informed as it relates to your situation!
How do you reduce a capital gains tax? Hold your non-retirement assets for more than one year (receiving the lower long term capital gains tax vs. the higher short term capital gains tax). When selecting investments to hold in a brokerage, focus on tax efficient investments like a broad market stock index fund that produces little to no short term capital gains on a yearly basis. Consider a 1031 exchange when applicable.
What about sales tax by state? Most can avoid sales tax on groceries and prescriptions. Everything else pretty much has a sales tax. You reduce your sales tax by eating out less often and buying more groceries. You further reduce your sales tax by buying less stuff and being happy with what you got. You also reduce sales tax by living in a state with lower sales tax while rejecting the idea of being a constant consumer.
How do you reduce the 7.65% payroll tax (Social Security and Medicare, also called the FICA tax)? That tax is assessed on all of your earned income, not passive income. You can reduce this tax by living on less earned income and living on more passive income that does not assess the 7.65% tax. Save and invest wisely to gradually build up your passive income over time so one day it can take care of YOU.
What about reducing property taxes by state? You can buy smaller, less expensive homes. You rent instead of buy (yes, some of that property tax gets passed on to you from the landlord). You challenge county assessments when hit with a number that seems higher than it should be. You may choose to live in a different state at some point in your life based on how they tax your housing.
How do you reduce the 18.4 cent federal gas tax and the various state rates. You drive less often as you are more mindful of each trip you take. You select a more efficient vehicle that gets better gas mileage. You consider a hybrid or electric vehicle if it works based on your situation. You live in a state that taxes you less (state gas tax can be as low as 9 cents or as high as 53 cents per gallon). Learn more here.
How do you reduce vehicle registration taxes? You buy less often. In most states the first year tax (they may call it something else, but don't be fooled, it's a tax) on the purchase a newer vehicle is high. Iowa will charge you 7% in that first year. You reduce the tax by owning that vehicle you already own for longer periods. Iowa charges you $50 for a 12 year old vehicle. Learn more about your state here.
How do you reduce the dreaded sin tax? Each state taxes your "sin" differently, but they are usually quite high and added on to the sales tax. You reduce your sin tax by getting rid of the cigarettes. Drinking beer and liquor less often. Gambling less often. And now, in some states, partaking in marijuana less often. Governments make you pay more if you want to enjoy the "sins." The less you do, the less tax you will pay.
How do you reduce the lodging tax by state? Yep, the majority of states add a lodging tax to the sales tax. Politicians know it is much easier passing a tax on to visitors to a state rather than tax their residents more. This is easy. Go buy a 12-year old bus and live down by the river! Just in case that does not appeal to you, another option is to be more selective in where you vacation as you look at the lodging rates per state.
Now What? The ball is in your court. Take the time to understand how your life is being taxed and then figure out ways that you want to reduce your tax burden. Each situation is unique and that means you need to look at your life and carefully break down how you can reduce your tax burden one life event at a time. Ultimately, you are deciding how you can save and invest more of your money. Financial Freedom to follow!
