Wow okay, I know, tax planning might sound even more boring or complicated than our previous “introduction to taxes”. But what’s the point knowing about taxes if you don’t use that information to your advantage? And if you think that tax planning is again for the rich and famous only, you’re wrong … Most legislations are designed is such a way to even give the ordinary man and woman some tax relief in certain areas. You should use those as that is what they are for.
Now let’s start with the single most important first requirement for this step: never, ever, not in a million years avoid paying taxes or try to mislead the tax authorities. Don’t ever even think of it. The tax authorities are smarter than you and you’ll end up in jail and that is NOT worth the extra money you might be getting or think you might be getting. Besides that, it’s morally wrong. Just don’t do it.
Good, now that is sorted, let’s have a look at some very basic tax planning principles you might be able to apply to your own life, that might help you save some bucks. Just keep an eye on that fine line between tax planning and tax evasion though as if you get carried away with it too much, you might end up on the wrong side of that line.
Please be warned that not everything mentioned below might be possible or even legal in every country so make sure to check up whether these tips are actually allowed and will even give you a tax advantage in your own country.
- If you have a partner you might be able to choose between filing your taxes together or separately which can make a difference in the total amount tax paid. In some cases it can work out better if you file them together, but this isn’t always the case, so make sure you check.
- One thing we have already spoken about are tax efficient savings account for example for pensions to which you can contribute pre-tax money and at the same time reduce your overall tax rate as (depending on the legislation) some countries or states see this as reducing your income, meaning you might end up in a lower tax band.
- Contributions to charities can in some cases offer tax advantages in two ways in that you don’t need to pay tax on them (meaning the charity of your choice gets more money) and that it might reduce your overall pre-tax income.
- In most cases taxes are charged per person and most legislations have a tax-free threshold below which there is no taxation. After an initial amount you usually have a staged tax system with tax percentages increasing when your income increases. Think about the different types of income in your household that might be tax-free or subject to less tax, depending on who is receiving this. Say you’re paying 15% tax rate on your dividends, but your partner is only paying 10% due to a lower income for example, it might make sense to put some of those dividends in your partner’s name.
- Consider making gifts to others such as your children or even to your spouse in order to lower your taxable income.
- Many countries offer tax deductions or tax relief that you might be able to use, for example for mortgage, health care costs, work related personal costs (travel), losses on assets, education costs and energy-saving investments (such as installing solar panels). Check what your countries’ legislation is with regards to these options and see if you can apply for a tax relief.
- If you’re liable to wealth tax, find out whether there is a set time that is used to measure your assets, e.g. 1st January. If you are planning on making a big purchase, that won’t get classified as an asset to tax you on, such as a car for example anyway, consider making that purchase before the tax measure date to avoid paying a wealth tax on money you’ll be spending very soon anyway.
- Consider deferring income, for example with capital gains so that it enters in a new tax year to not get into the next tax band. Or offset it against a loss that you expect to experience in the next year anyway.
- And to end with an explanation of why the rich pay less tax. Imagine you have an income of $40.000 per year. How much tax do you pay? Well that depends on what type of income that is. If it is earned income from a job, let’s say you’re paying around 25% (depending on where you live) If that money is however coming from dividends or capital gains, that percentage might be a lot lower. That is why the rich, who generally get income from assets such as property or dividends, usually pay less in taxes than ordinary people whose income come from a job.
Step 64 – Tax Planning – in detail
Unfortunately I can’t spell it all out for you as each legislation is distinct and what you can and can’t do in one country will be completely different. Hopefully I have however given you some ideas on where to save some money or think about tax.
- Go to the list above and find out whether any of these tips are applicable to you. Make sure to check:
- Differences in filing taxes together or separately as a couple
- Tax efficient savings accounts – you probably already have done your research on this from step 43 and 44.
- Whether charitable contributions can be deducted and if so what the rules are for doing so.
- Gift taxes and whether these are deductible
- Whether you can put any income or assets in your partner’s name.
- Think about when you want to or can make certain purchases or income and whether it would be interesting to speed this up or delay.
- Any other tax deductions you might be able to use.
If you want to take it to the next level and get serious about tax planning, making sure your taxes are done in the most effective way you might need to consider getting the help of a certified financial planner or tax adviser. Bear in mind that these people are expensive though, so part of the money you save on taxes will be spent on their wage. Yet if they do their job well they should be able to save you more than that they cost you of course.
Rests me nothing but reminding you just one more time to stick to the law and don’t try to avoid paying what you should be paying.
Read more about my 100 steps mission to financial independence or simply decide to take control today and join us on our step-by-step quest on how to make your finances work for you, starting with step 1.