Five (legal!) tax shelters anyone can use
For the middle-class, building wealth for your family can be like constructing a house — the biggest challenge is setting the foundation. And it starts with keeping your taxes as low as possible. This can sometimes result in relocating to an area where the cost of living and taxes are more affordable, trading high-cost districts in areas like New York City and San Francisco for a more sustainable lifestyle in an area where the job market is strong, like in Houston or Dallas.
But there are other smart, easy ways to reduce your tax burden, too. Read on to familiarize yourself with a few.
1. Avoid Personal and Business Income Tax
You won't have to worry about paying personal state income tax if you live in one of these nine U.S. states: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. And you will avoid corporate income tax if you do business in the states of Nevada, South Dakota, Texas, or Wyoming.
2. Take Advantage of Retirement Plans
Most people start saving for retirement once they land their first "real" job by contributing to employer-sponsored plans. Some employers will match as much as 100% of your 401(k) contributions up to 3% of your salary. That's a guaranteed 100% return of your investment! So, let's say you've contributed $3,500 — your employer will put in another $3,500. There isn't another investment that can guarantee this type of return. Plus, if historical average stock market returns are any indication, your money will likely grow an average 8%–12% per year tax-free or tax-deferred. Meanwhile, investing in your 401(k) will reduce your annual income and possibly your tax bracket, further reducing your tax burden.
3. Contribute to a 529 College Savings Plan
Qualified Tuition Programs (QTPs), often referred to as 529 Plans, are tax shelters that allow you to save for higher education expenses. In many ways, they resemble retirement plans, offering tax-deferred growth on contributions. Plans vary and have different lifetime contribution limits — generally around $200,000 — but there is no federal tax on earnings, and often no state tax if your plan's beneficiary chooses an in-state college.
4. Avoid Estate and Inheritance Tax
The estate and inheritance tax doesn't affect many people, because you're not required to file an estate tax return unless your estate is valued at $5,430,000 or more as of 2015 — and only six states levy their own inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. And the transfer of property through an estate or inheritance is taxed only in Nebraska and Pennsylvania. Consider yourself lucky — unless you've got a very sizeable estate, your progeny will probably be spared this tax blow.
5. Buy a Home
When you purchase a home, you can deduct interest paid on your mortgage, a percentage of your real estate taxes and depreciation, and receive credits for certain home improvements. Not a bad deal. But if you're in the business of flipping real estate, it gets even better, because when you sell a property, any profit of under $250,000 (for single tax filers) is tax-free. That amount doubles to $500,000 if you're married and filing jointly. The only requirement the IRS has is that you occupy the home as your principal residence for at least two years before you sell.
What other easy tax shelters do you employ?
This article is from Qiana Chavaia of Wise Bread, an award-winning personal finance and credit card comparison website.
