Monday, September 26, 2011

Simple, Legal Ways The Rich (or Anyone Else) Pay Lower Taxes

Amid all the current "tax the rich" debates, most Americans don't seem to understand how the rich are able to pay lower tax rates. They are able to do so because our tax laws are written to "encourage" them to do so. Here's some of the simple ways they lower their tax burden and how many middle class Americans can save money on their own tax bills:

1. Tax Free Municipal Bonds and Bond Funds. When a community or state wants to build new roads, schools, or perform other expensive building activities, it often spreads the cost of those projects over a period of 30 years by selling debt instruments known as Municipal bonds (aka: Muni's). In order to encourage investors to buy these bonds and, at the same time, keep the payable interest rates low for the states and communities issuing them, the Federal tax laws allow interest income from these bonds to be free of any Federal taxation. Depending on a person's tax status and level of risk aversion, this can be a very effective means to avoid Federal taxes.

2. Charitable Contributions. Generally, speaking, a person can deduct charitable contributions to up to 50% of their adjusted gross income as long as other 20% and 30% deduction rules are adhered to. In other words, if properly done, charitable contributions can lower someone's tax rate by as much as 50%. Actually, more if the the charitable contribution pushes someone into a lower tax bracket. Again, these allowable deductions are intentional to spur charitable giving to help fellow citizens who are less fortunate.

3. Capital Gains and Losses. For the purpose of tax laws, certain buy/sell activities are defined as capital gains or capital losses. Typically, we know these activities to be the buying and selling of stocks and bonds; but other buy/sell activities are also defined as "capital" transactions. In any event, if a capital trading activity results in a net gain; the IRS will tax the entire gain at the current capital gains tax rate which is substantially lower than the normal high-income tax rates. On the other hand, if there is a loss, the taxpayer can only claim $3,000 of that loss in the current tax year and the balance must be carried forward to be applied in the next and, sometimes, succeeding tax years. Therefore, if a taxpayer has a loss or a carried over loss, his/her marginal tax rate will be lowered. The bottom line is that we have advantageous tax laws associated with capital buy/sell activities because we want Americans to invest in America's corporations.

4. Tax Deferred Income. Under the current tax laws, certain types of income are shielded from taxation. For most of us, this is contributions and income generated by Individual Retirement Accounts and other qualified tax deferred retirement accounts such as 401k's. Rich or poor, the maximum contribution that can be made to a traditional IRA is $5,000. However, coupled with some or all of the above tax saving activities, retirement funding and other tax deferred activities can help lower the overall tax rate; especially for the rich.

None of these tax saving techniques are loopholes. They were all intentionally made part of our tax laws to help America grow; build new roads and schools; aid our neediest citizens; and help most of us save for our retirement. While it is true that the rich greatly benefit from these tax deductions, it is also true that these deductions strongly help our country as a whole. Yet, our President continues to demonize the rich for having taken advantage of the very tax breaks that Congress, in the past, has always found to benefit society.

Please Note: No one should get involved with any of the above tax lowering methods without advice from a tax or investment consultant.

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