6 Strategies to Protect Income From Taxes
6 Strategies to Protect Income From Taxes
By Barbara A. Friedberg Updated Jan 29, 2020
These tips can help you preserve the income you earn
Earned income gets taxed in many ways: at the federal and state levels, and by Social Security and Medicare, to name a few. Taxes are difficult to avoid, but there are many strategies to help ward them off. Here are six ways to protect your income from taxes.
Key Takeaways
Contributing to qualified accounts with pretax dollars can defer or exempt some income from taxation.
Business ownership includes several work-related tax breaks, as does owning a home or being a student.
Tax-sheltered income from eligible municipal bonds can also help taxpayers save.
1. Invest in Municipal Bonds
Buying a municipal bond essentially means lending money to a state or local entity for a set number of interest payments over a predetermined period. Once the bond reaches its maturity date, the full amount of the original investment is repaid to the buyer.
Municipal bonds are exempt from federal taxes, and may be tax exempt at the state and local level as well, depending on where you live. Tax-free interest payments are what make municipal bonds attractive to investors.
Municipal bonds historically have lower default rates than their corporate bond counterparts (for investment grade securities, the default rate is 0.1% for municipal bonds versus 2.28% for corporate). However, municipals typically pay lower interest rates. Because of the tax benefits, bondholders must understand their tax equivalent yield. The higher your tax bracket, the higher your tax equivalent yield.
2. Shoot for Long-Term Capital Gains
Investing can be an important tool in growing wealth. An additional benefit from investing in stocks, mutual funds, bonds, and real estate is the favorable tax treatment for long-term capital gains.
An investor holding an asset for longer than one year enjoys a preferential tax rate of 0%, 15%, or 20% on the capital gain, depending on your income level. If the asset is held for less than a year before selling, the capital gain is taxed at ordinary income rates.
Understanding long-term versus short-term capital gains rates is important to growing wealth. A married couple filing jointly would pay 0% on their long-term capital gains if their income falls below $78,750.
A tax planner and investment advisor can help determine when and how to sell appreciated or depreciated securities to minimize gains and maximize losses. Tax-loss harvesting can also offset a capital gains tax liability by selling securities at a loss.
3. Start a Business
In addition to creating additional income, a side business offers many tax advantages.
When used in the course of daily business, for instance, many expenses can be deducted from income, reducing the total tax obligation. Especially important tax deductions are health insurance premiums.
To continue reading, please go to the original article here: