The 2 Most Common Ways to Reduce Your Taxes
- Tax Deductions (<$250,000)
- Income Distribution (>$250,000)
Tax Deductions
Reducing your taxable income by deducting variety of personal & business expenses is one of the most common ways to lower your taxes when your gross income is under $250,000. It becomes less effective as your income increases due to the Alternative Minimum Tax (AMT). If you make $250,000 or more, you should start thinking about income distribution.
Income Distribution
Generating income from passive investments do not usually require material participation. If you invest on behalf of someone who has zero ordinary income, you will save more than $30,000 on your taxes for $120,000 passive income. The potential candidates could be retired parents, stay-at-home relatives, or children. This scheme allows you to distribute your passive income among idle family members and relatives without setting up complex corporations or trusts.
$250K Base Income @CA (Married Filing Jointly)
| Tax Brackets | Rate | Tax | |
|---|---|---|---|
| Federal | $0 – $65,000 | 32% | $20,800 |
| $65,000 – $120,000 | 35% | $19,250 | |
| FICA | $0 – $120,000 | 3.8% | $4,560 |
| State | $0 – $120,000 | 9.3% | $11,160 |
| Total Tax | |||
| $250K Base Income @CA | $55,770 | ||
This is an example of adding $120,000 passive income on top of $250,000 ordinary income. Your marginal tax rates for federal income tax are 32% for the first $65,000 and 35% for the remaining $55,000. You also have to pay the 3.8% Medicare tax on the lesser of (1) net investment income, or (2) the excess of modified adjusted gross income (MAGI) above $200,000 for single, $250,000 for joint. California state income tax will be 9.3% for the entire income. Your total income tax is $55,770.
No Income @CA (Married Filing Jointly)
| Tax Brackets | Rate | Tax | |
|---|---|---|---|
| Federal | $0 – $24,000 | 0% | $0 |
| $24,000 – $43,050 | 10% | $1,905 | |
| $43,050 – $101,400 | 12% | $7,002 | |
| $101,400 – $120,000 | 22% | $4,092 | |
| FICA | $0 – $120,000 | 0% | $0 |
| State | $0 – $120,000 | 4.37% | $5,121 |
| Total Tax | |||
| No Income @CA | $18,120 | ||
If your only income is $120,000 from passive investment and there is no income from other sources, your income tax rate will be much less. Your federal income tax will be $13,000 after the $24,000 standard deduction. The effective tax rate for the California state income tax will be 4.37%, which is less than half. Your total income tax is only $18,120. That is over $37,000 in tax savings.
