Tax-Free Day

It’s over, it’s over, it’s finally over.  Yes, if you live in the United States, you should have finished up and mailed out all your income tax forms by now.  (Unless you filed for an extension, in which case you’ll have to deal with your taxes by October, but at least you have some more time.)  And to celebrate the conclusion of Tax Day, why not consider ways you can avoid taxes altogether next year?

With that in mind, let’s declare April 16th Tax-Free Day, and devote our energy to finding (legal) ways to avoid forking over so much of our sweet, sweet money to the IRS next year.  There are several techniques you can use, albeit none that are completely perfect.  Let’s consider some ways you can tell the IRS to bother someone else next year:

1) Municipal Bonds – One of the classic ways to reduce your taxable income, municipal bond (or muni) income is exempt from all federal income taxes (including, in most cases, the Alternate Minimum Tax).  Many munis are also exempt from state taxes for the issuing states, a handy bonus if you live in a state with high income tax rates.  To make things even more convenient, most mutual fund companies offer both federal tax-free muni funds and tax-exempt funds for specific states, making it easy to find one that will maximize your tax avoidance.

The Catch: Munis have many of the same risks as other bonds, such as the chance of default by the issuing municipality.  (One famous example is the default by Orange County in the mid-nineties.)  Furthermore, attempting to dodge taxes by loading up your portfolio with munis will lead to poor performance; over time, munis will under-perform compared to stocks or other growth investments.

2) Selling your home – If you sell a house you’ve lived in for at least two of the last five years, you can keep up to $250,000 in profits without paying any income tax, or up to $500,000 for married couples.  You can then do whatever you want with the money, such as rolling it over into another home purchase or putting the money into other investments.

The Catch: Your house needs to have increased in value since you purchased it in order to get any benefit from this rule.  And given the current housing decline, that’s a bit of a stretch.  Also, in order to gain the maximum benefit from this rule, you need to move fairly frequently.

3) Gift GivingAccording to the IRS, you can give (or more importantly for our purposes, get) $13,000 in gifts without having to pay taxes on it.  The limit applies to each gift receipient; if you have four people in your household, a wealthy relative could give the maximum to each person, for a total of $52,000 this year (with rates likely to increase in the future).

The Catch: Finding a relative (or wealthy, benevolent stranger) who can afford to give you money, and will actually do it.  If you can do that, you can take full advantage of this tax break.

4) Roth IRAs – Roth IRAs allow you to withdraw your proceeds tax-free once you turn 59 1/2.  (You can pull your contributions out at any time, though.)   You also are not taxed on the growth of your funds once they have been deposited.

The Catch: Roth IRA contributions aren’t tax deductable, so you will have had to pay taxes at some point.  (Unless you use another tax-exempt method, such as receiving gifts, to generate funds for the Roth.)  Also, you do need to wait until you reach 59 1/2 in order to have full access to your money.

5) Earn less money – Probably the simplest method to cut your taxes.  The progressive nature of the tax system, as well as deductions, tax credits, and exemptions (like the personal exemption for those of who don’t itemize our tax returns), creates a situation where lower income people can dodge taxes altogether.

The Catch: The amount of money you can earn and still dodge taxes is fairly low.  An individual can only earn about $11,000 before he or she would need to start paying income taxes.  (However, a family of four, thanks to higher tax brackets for joint filers and increased deductions (such as a per-child credit), could earn over $40,000 before they would need to pay taxes.  It’s not enough to make Warren Buffet jealous, but that’s still a decent income.)  Also, as with all earned income, there are Social Security taxes, occupational taxes, and other non-income-tax taxes which will be still be taken out of your pay.

There you have it, five legal and ethical ways to owe no taxes next year.  Mix, match, and combine these methods, and you can spend next April 15th relaxing and laughing as everyone else goes nuts preparing their tax returns.  (Kudos also to Money Magazine, who published an article on this subject around tax time last year (which unfortunately is not available online).)

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