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Being an employee, you have to pay taxes on several levels and there is very little that you can write off or show as an expense. Owning a business is an advantage here but not the only way you can save taxes.
If you’re a 9-to-5er and thinking that you’re already paying a lot of money in taxes and wanna save some, then stick with us for this blog, and we’re going to tell you how to avoid taxes legally as an employee.
Now since we’re more into the stock market & investing, and less into accounting and taxes, we’ve got Preston Anderson with us to tell us about his 5 best ways to avoid taxes as an employee. Preston is a Certified Public Accountant (CPA) and provides custom tax deduction solutions to individuals and businesses. If you’re interested in his services, you can book a free assessment with Preston on Anderson.tax
Now, let’s get into it!
5 Ways How to Avoid Taxes as an Employee
Ok, so before we begin with our list, you should know that not every method will work for everyone, and not all five ways will be a fit for you. Everyone’s tax situations are different, and you should seek your accountant’s advice to see what works for you and what doesn’t.
1. Health Savings Account (HSA)
An HSA is a separate savings account where you can contribute pre-tax dollars for qualified medical expenses. It generally comes with a High Deductible Health Plan (HDHP).
HSAs are great to cover your medical expenses and for retirement savings, but not only that, they’re a great tool to do some tax savings too.
HSAs provide you multiple layers of tax benefits because all your contributions to it are tax-free, the growth within your HSA is also tax-free, and withdrawals are tax-free as well. Three layers of tax protection there.
Also, you get to write it off this year. Even if you don’t incur any medical expenses for the year, you can still deduct it. Some employers also provide an HSA, and they also provide a match just like a 401k, but not everybody does it, so you should check with your employer.
Remember that you need to have an HDHP in order to make this work because an HSA only comes with an HDHP.
A disclaimer here, it is Preston’s absolute best method for tax savings for 9-to-5ers, and he recommends everyone to max out their HSA.
2. Real Estate
Preston teaches his clients how to use real estate to grow their net worth. He has got two strategies for you on how to use real estate to avoid taxes as an employee.
The first strategy is using your primary residence for real estate investing. How this works is, if you buy a piece of property, and live in it for 2 years, and then sell it. All of your gains in this transaction is tax-free up to $250000.
You don’t have to buy another house or reinvest that money, all of your gains upto $250000 are 100% tax-free, and you can do this every 2 years.
Now obviously this strategy doesn’t work for everyone. It works best for 2 primary groups of people, first one is really young people who don’t have a family because it’s easy for them to move every 2 years, and the second one is retirees, people whose kids have already moved out, and now they’re open to adventure.
This probably doesn’t work if you have a family, especially with young kids, because then it becomes very hard to move out every 2 years.
The second way you can use real estate to avoid taxes is depreciation. Depreciation is a non-cash expense that you get to write off your investment properties, and you can use it to reduce your taxable income.
For residential properties, the useful life, according to the IRS, is 27.5 years. Meaning you get to write off depreciation on them for 27.5 years.
So, let’s say you buy a property for $300000, you get to deduct $10000 on it every year from your taxable income in the form of depreciation.
Now, this method is also not for everyone because there are some income limits. If your income is more than $150000 a year, this will not work for you. However, for those under the limit, it’s a wonderful method to increase your cash while reducing your tax liability.
3. Roth IRA vs Traditional IRA
A lot of people save for their retirement using an IRA, but most of them don’t understand which one, out of the two, they should choose for maximum tax benefits.
The basic difference between the two is, with a traditional IRA, you get to deduct it from your taxable income today, but when you pull the money out after retirement, it is taxed as current income.
With a Roth IRA, there are no deductions today because you contribute with after-tax dollars, but when you pull the money out at retirement, it’s 100% tax-free.
If you’re in the 24% tax bracket or less, then Preston will always advise you to go with Roth IRA without a second thought. If you’re in the 33% tax bracket or higher, then it might make sense for you to get the deduction now.
A piece of advice that Preston gives is if you already have a decent amount of money in a traditional IRA, and it’s still gonna grow significantly more in the future, then it’s best for you to liquidate it today, pay the taxes on that decent amount right now, and put that amount into a Roth IRA, so the rest of your growth can be tax-free.
4. Long-term Capital Gains
It is the easiest and most straightforward way to avoid tax as an employee or a business owner. When you hold on to an asset for more than 12 months, it drops from your top tax bracket, whatever that is, to one bracket lower.
So, for example, say you’re in the 24% tax bracket, and you hold an asset for more than 12 months, it’ll drop from the 24% to 22% bracket. Similarly, if you’re in the 32% bracket, then it drops to 24%, and so on.
If you’re anything lower than the 22% bracket, then the long-term capital gain rate for you is zero. So it makes perfect sense for you to maximize long-term capital gains to minimize your tax bills.
What Preston does with some of his clients and what you can do too if you fall in that below 22% category is reset your basis. What that means is selling some asset to realize the gains and then buying it right back to reset your position.
The benefit of doing this is you realize some gains, don’t pay taxes on them because the tax rate is zero, and then buy it back immediately to keep holding onto your position.
5. Opportunity Zones
So if you have long-term capital gains that you wanna save taxes on, then you can reinvest those dollars into an opportunity zone fund, and you can defer those gains for 10 years. If you hold it in for the entire period, those gains completely disappear, and you pay zero taxes on them.
An opportunity zone is basically an economically backward area. They were created under the 2017 Tax Cuts and Jobs Act to incentivize people to invest in lower-income areas around the country.
You can either invest in an opportunity fund to defer your tax from the current year or if you hold on to your investment for 10 years, then you can realize all your gains tax-free.
The Act will stay till 2047, so until then, you can redo this strategy every 10 years and save a ton on your capital gains.
Obviously, you don’t have to do this if you fall in below 22% tax brackets because long-term capital gains are already tax-free for you.
So there you have it, 5 ways how to avoid taxes without owning a business or doing anything shady. If you’re interested in learning the 3 steps to financial freedom, then make sure you attend the free on-demand masterclass now 👇