It’s no secret that many wealthy people manage to pay a lower percentage in taxes despite their high earnings. In fact, a 2021 White House study found that the country’s 400 wealthiest families paid an average income tax rate of just 8.2%.
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So, what tax strategies do the rich use that might be able to reduce your own tax burden? Here’s what financial experts recommend.
Put More Money Toward Retirement
Many people underutilize their retirement accounts, said Jason Escamilla, CFA and CEO of Impact Labs. This can be an expensive mistake, especially for moderate earners in high income tax brackets. Consider increasing your retirement contributions or moving funds from a taxable account to a Roth account. With Roth IRAs, you can withdraw contributions (not earnings) without paying taxes or a penalty.
“For example, if you’re over 50 and only putting in $20,000 of your income, you leave behind the chance to move $10,000 more into the 401(k) and convert $10,000 in a pre-tax IRA into your Roth IRA,” Escamilla said. “The combination of those steps can be tax neutral and the net effect is moving $10,000 of your wealth into a Roth IRA where all earnings are tax free.”
Buy Tax-Advantaged Investments
One way the wealthy reduce their taxes is by buying assets that either earn tax-free income or increase their deductions. Here are a few common assets that work this way.
Municipal Bonds
These government-issued debt securities are generally considered safer income-producing investments.
“The income you make from interest on them is generally exempt from federal income tax and, in some cases, state and local taxes,” said Varsha Subramanian, a CPA at FlyFin.
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Donor-Advised Funds
If you want to give to a worthy cause, consider putting the money in a donor-advised fund (DAF), which lets you invest dollars tax free that you can later donate to charity.
“You can take an immediate tax deduction when you make a charitable contribution to your DAF, reducing your tax liability,” said Adam Nash, co-founder and CEO of Daffy.
Real Estate
Armine Alajian, a CPA and founder of the Alajian Group, said buying properties is one of the best tax-advantaged investment strategies.
“You can write off depreciation and all related expenses if you list the property for rent,” she said. “Deciding when the best time is to buy an investment property is up to you, but if it’s purchased at the beginning of the year, you can utilize the full year for deductions.”
In certain cases, you can defer taxes after selling a property by using a 1031 exchange, said Subramanian. You’ll need to designate a replacement property within 45 days and close within 180 days of the original sale.
Sell Declining Investments
Another helpful strategy is called “tax-loss harvesting,” said Richard Lavina, a CPA and CEO of Taxfyle. This involves selling declining investments at a loss to offset the taxes you owe on profitable investments.
“For example, a wealthy individual may sell a stock that has lost value, allowing them to offset capital gains from other stocks they’ve traded,” he said. “This can be a smart move as it reduces their tax bill and helps them rebalance their portfolio.”
Reduce Taxes With Business-Related Expenses
Wealthy people often own multiple companies and use their business-related expenses to offset taxes, said Alajian.
“They’re buying things that will be beneficial to the business so they don’t have to pay taxes on the purchases,” she said. “It’s a win-win situation for the business owner and the business itself.”
You might not own multiple companies, but small-business owners and freelancers can also reduce their tax burden by deducting business-related expenses like marketing and advertising, accounting and legal fees, business use of their cellphone and internet, office rent or mortgage interest, supplies and business use of their vehicle. If you work from home, you may also be able to take a home office deduction.
Take Advantage of Tax Credits
Be sure to take as many tax credits as you can, recommended Lavina. The Earned Income Tax Credit (EITC) offers a tax break to people who work and earn under $59,187 per year.
You can also claim the Child Tax Credit to reduce your taxes by $1,000 for each of your children under 17 — as long as they qualify. If you paid for child care so you could work or go to school, you may be eligible for the Child and Dependent Care Credit. And if you adopted a child, you might be able to take advantage of the Adoption Credit and Adoption Assistance Programs.
Lastly, people pursuing higher education should look into the American Opportunity Tax Credit and the Lifetime Learning Credit to see if they’re eligible.
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This article originally appeared on GOBankingRates.com: Do Your Taxes Like a Rich Person: Here’s How
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