How to Increase Income While Paying Less Taxes

A side effect of increasing income is paying more taxes. It is amazing that Amazon paid zero taxes in year 2018. A higher income typically catapults an individual to a higher income tax bracket. With this, there are cases were the tax liability could be reduced. Let us review them below.
Municipal Bonds
Interest received from Municipal Bonds are tax-free meaning you pay no taxes on any income you receive from this type of bond. Municipal Bonds are debt instruments issue by a local government. These debts are used to finance public projects such are roads, schools, parks, and other repairs within a city. There are two types of Muni Bonds – General Obligation and Revenue Bonds. The principal and interest for a General Obligation bond is secured by taxing power of the bond issuer while just like the name sounds, a Revenue Bond is secured by revenues derived from the project. The reason I only purchase newly issued Muni Bonds are the ability to purchase it at no cost, its relative risk, good returns and tax-free nature. Muni Bonds typically generate 5-6.5% in stable income when accounting for the impact of taxation. Taxes can eat into the returns we realize from different investment vehicles. Long term capital gains tax rate is around 15% and short term capital gains are taxed at the ordinary income tax bracket which can vary from 10-37% depending on annual income. The interest earned from Muni Bonds are exempt from taxes boosting the net returns achieved. Just like other investment vehicles, there is some associated risk and Municipal Bonds are no different. However, Muni Bonds have a relatively lower risk when compared to corporate bonds or the stock market. It is possible to purchase risk-free Muni Bonds that are insured and although, not very common, they do exist and I do own some insured Muni Bonds in my portfolio. Each Municipal Bond has a credit rating that helps assess the amount of risk involved. The Moody ratings range from Aaa bonds (strongest category of creditworthiness) to C bonds (weakest with a relatively higher risk). It makes sense to only purchase Aa and Aaa bonds to minimize risk.
Capital Gains
This is the classic “buy low, sell high” asset class. Capitals gains usually occurs when there is a profit due to the sale of a property or an investment. The investment can take various forms including selling a share of a stock to selling a property. It is important to be aware of the impact of time on capital gains tax rate as long-term capital gains (usually a security held for at least a year) are usually taxed at a lower tax rate. The return on capital gains can vary widely as that depends on market conditions. Below is a table with the capital gains tax rate for 2018. You will notice that single filers with an income less than $38,600 get to keep 100% of the return from the sale of a security. You can purchase securities for free on M1 Finance.
Real Estate
Traditional Real Estate offers tax benefits due to the ability of claiming deductions such as depreciation of property. Traditional real estate is one of the oldest forms of investment and it has been around for a while. Traditional real estate typically requires a high initial capital but it can be well worth it if the property is managed properly. Recent real estate vehicles such as eREIT (electronic real estate investment trusts) pioneered by Fundrise offers investors a new way to invest in the industry for a low minimum. You can read about my review of Fundrise. You can also purchase REIT stocks on the M1 Finance platform to get some exposure to the real estate market. REITs are required to pay out 90% of its taxable income to shareholders so the yield of REITs are typically much higher compared to regular dividend stocks. The yields from REITs can range from 3-12%.
Traditional IRA
An IRA is an individual retirement account that allows an individual to save for retirement. The benefit of an IRA is mainly the tax advantage it provides which will be discussed in detail. The IRA contribution limit for year 2018 is $5,500 (and $6,500 if you are age 50 or older) while the new limit for year 2019 is $6,000 for those below age 50. The deadline to contribute to an IRA for the previous year is April 15 of the current year. IRAs can be opened in pre-tax (Traditional IRAs being the popular one) and after-tax accounts (Roth IRAs being the popular one). An IRA can contain stocks, bonds, index funds, mutual fund, and REITs. I do not recommend high cost funds as the fees could hurt your earnings in the long run. Now, let us get into the meat of today’s discussion “Roth vs. Traditional IRA – which is optimal from a taxation point of view.” A Roth IRA is taxed today but the earnings will grow tax-free. This makes a lot of sense for those who expect to be in a higher tax bracket when they take distributions from their Roth accounts. As opposed to the Roth IRA, a traditional IRA is not taxed today (you take deductions when preparing your taxes), however, you will be taxed in the future. Hence the traditional IRA offers an up-front tax break. Now, there are rules to the traditional IRA to be aware of, especially those with higher incomes. If you are covered by a retirement plan at work there is a limit on the amount of deduction you can claim when filing taxes. Below is a snapshot from the website of the IRS with the IRA deduction limits for year 2019 based on your modified adjusted gross income.
Bottom line
There are ways to decrease tax liability based on the current rules. For further reading into the rules governing 2019 taxes. You can grab a copy of the U.S. Master Tax Guide on Amazon.


Recent Posts