The Goal is to Pay No Income Taxes, Legally

Taxes. They come in many forms. Some are hidden: corporate taxes are built into the cost of goods and services you buy; excise taxes are included into products like gasoline. 

Others are more visible like sales and property taxes. And then we come to the most visible and dreaded tax of all: income tax. When people complain about taxes they are usually talking about income taxes.

Avoiding income taxes should be easy considering the size of the tax code and the millions of loopholes available. And that is the problem. The tax code is so big that it is daunting so most people have their eyes roll back in their head when they should be facing the tax code head on.

We will discuss several avenues to a zero out your income tax, but first some ground rules.

  1. Keeping your income low is not eliminating taxes; it is eliminating income at a 100% tax rate. Our discussion will focus on ways to eliminate income taxes at any income level, with only a slight nod to lower incomes where incomes taxes rarely apply.
  2. Tax credits can cut your taxes significantly. I’ll point out a few of these obvious gems, but will not hang my hat on mainstream tax credits to eliminate your income tax.
  3. No using cheap gimmicks like “have three kids” to eliminate your income taxes. I will assume no children in most of my strategies here.
  4. Debt is not tax-free income. Borrowing more money is NOT a tax strategy! No universal life craziness on this blog, either.
  5. Our inquiry will focus on tax strategies available to a large number of people and legal ways of converting taxable income into tax-free income.

Before we begin our analysis I want to point you to an excellent article on this topic published by the Root of Good blog in 2013. The Tax Cuts and Jobs Act of 2017 (TCJA) changed many of the rules the Root of Good blog post used. Still, it is a good place to get ideas for the flavor of strategies available.

I also discussed 10 Ways to Legally Stop Paying Taxes in a prior post on this blog. You may wish to review that post as well if you are serious about reducing or eliminating your income tax.

 

Income Tax on Income Under $100,000

A short nod to readers with a five-figure income. 

There are so many tools for eliminating incomes taxes on incomes under $100,000 that I will only scratch a few. 

  1. Social Security benefits can be partially or totally tax-free. This link provides more details.
  2. The TCJA eliminated exemptions, but jacked the standard deduction. In 2017 the standard deduction on a joint return was $12,700. In 2021 the standard deduction is $25,100 on a MFJ return; $12,550 for MFS and single taxpayers; and $18,800 for heads of household. This means a married couple filing a joint return gets a $25,100 deduction right out of the gate. 
  3. Long-term capital gains enjoy a large 0% tax bracket. In 2021, the 0% tax rate for LTCGs income threshold is $80, 800 for married couples filing a joint return; $54,100 for heads of household; and $40,400 for single and MFS taxpayers. The easiest way to look at this is to add all your taxable income together and stack the LTCGs and qualified dividends on top. The portion below $80,800 for a MFJ return is taxed at 0%. Add this to the standard deduction and a married couple filing a joint return can enjoy $105,900 of income without an income tax with this one strategy alone in 2021. This is an incredible tax opportunity for those retiring early. 

A plethora of tax credits are available for low incomers. Your facts and circumstances will prevail. 

The Child Tax Credit (CTC) is a bit more complex in 2021 than in prior years. Portions of the CTC phase out well into the six-figures

Other common credits that can reduce your income taxes are:

  1. Earned Income Credit
  2. Saver’s Credit
  3. Education Credits
  4. Child and Dependent Care Credit

There is also a small credit for nonbusiness energy improvements for homeowners. Then there is the Premium Tax Credit. This is a big credit for those with lower incomes. You can do more research on the PTC here.

There is another new massive temporary tax-free employee benefit made available under the CARES Act. Employers can pay to the employee or the student loan provider up to $5,250 for student loan repayments. This break is available for tax years ending December 31, 2025 or before. That means you have several years to accumulate this tax-free income.

Note: You can’t take the student loan interest deduction if your employer provided the tax-free funds. However, if you made additional student loan payment you may get an additional deduction there as well. Example:

  • Student loan interest: $2,000
  • Employer paid $5,250 of your student loans
  • You paid an additional $2,000 of your student loans.

In this scenario you could also qualify for a $2,000 student loan interest deduction as long as you are below the income threshold. What is less clear to this accountant is if you need to pay the interest out of your funds and the principle from employer funds or not, and how that would be segregated.

One last gift from Congress for those with a modest income. If you have a health savings account qualified health insurance plan you need to fill that HSA savings account. Contributions are deductible, earnings grow tax-free and the whole thing comes back to you outside income taxes if used for qualified medical expenses or Medicare premiums once you turn 65.

Eliminating your income tax requires planning. The government erects obstacles you need to navigate. It is worth the effort. No need to succumb to anti-social behavior.

The Easy Income Tax Deductions

Now we turn to taxpayers with higher income. Some of these strategies apply to people with lower income as well, but the focus in the remainder of this article is on eliminating income taxes for taxpayers with a six-figure or higher income. 

Let’s start with some low hanging fruit. Here are several sources of tax-free income:

  1. Some alimony. Use the link for more details.
  2. Child support payments are always tax-free.
  3. Inheritances, gifts and bequests.
  4. Cash rebates
  5. Most employer provided healthcare benefits.
  6. Foster care stipends
  7. Worker’s Compensation benefits
  8. Disability benefits if you paid for the premiums.
  9. §121 exclusion of up to $250,000 of gains from the sale of your primary residence per person.
  10. Foreign Income Exclusion
  11. Death benefit from a life insurance policy

A source of income I do not consider tax-free income is employer matching in retirement funds because the employer contribution always goes to the traditional part of the retirement plan, even if you elect to have your 401(k) contributions treated as Roth contributions. The income is not tax-free; it is tax-deferred. This is where I disagree with the Root of Good blog post. That post suggested deductions for the current year eliminated income taxes when all it did was push them into the future where tax rates on retirement plan distributions are uncertain.

The same can be said about souped-up retirement plans like cash balance accounts. A lot of money can be deducted currently with these plans and investments grow tax-deferred. But somebody at some point is going to pay the national uncle on the east coast. 

 

Two Unique Sources of Tax-free Income

Now I want to share what I consider two very powerful tools for generating massive amounts of tax-free income.

The first involves the cash rebates listed above. Most credit and debit cards provide some kind of cash-back these days. Some offer airline or travel rewards. In either case, these rewards are tax-free. 

We need to delineate what is a rebate and what isn’t before continuing. When you get a bonus on a bank account that is interest income. Selling tradelines are also income. What I’m talking about is sign-on bonuses and the continuing cash-back rewards offered by the myriad credit card companies.

This leads to an interesting situation. The sign-on bonuses can be large, say, $500 for $3,000 of spending in the first 90 days, plus the regular cash-back the card offers. Churning cards and manufacturing spending can turn no real spending into large amounts of cash-back fast, which is still tax-free. 

There are so many ways to game the system with cash-back rewards. I suggest a deep dive into Doctor of Credit (DoC) if this interests you. Be warned, this is a rabbit hole. The number of ways to get a steady stream of small incomes is nearly endless. DoC provides a nice ongoing list of opportunities to profit. Subscribing to their mailing list is a must in such situations. (Note: I am in no way related or connected to DoC. This is NOT an affiliate link of any sort.)

Eliminating your income tax requires planning. The government erects obstacles you need to navigate. It is worth the effort.

A Billion Dollars Tax-free

A common complain in my email is that I focus too much on people with higher income. That isn’t true! I spend plenty of time outlining tax strategies for people with lower levels of income. The ones I tend to avoid helping (until now) are the uber-rich! (Except when consulting. Most consulting clients tend to be very high earners.)

One of the most powerful tools for generating tax-free income is the Roth IRA. The mechanics are as such: Money going in is after -tax (meaning it has been taxed already) and money coming out, including profits, are not included in income once you reach age 59½. (In most cases your basis is available for distribution at any age.) 

Most people don’t see the massive loophole. Any asset placed into the Roth grows tax-free. What asset could you possible own that grows really fast, turning a small amount into a really big amount in a short order of time?

Let me give you a hint. There is at least one guy (it is a guy) who placed less than $2,000 into his Roth IRA and turned it into $5  billion! Think about that for a minute: $4,999,998,000 tax-free. Sure beats winning the lottery and anybody can use the same strategy. One particular accountant in the room did, only to a much, much smaller degree.

Peter Thiel, a co-founder of PayPal, started with less than $2,000 in his Roth IRA and parlayed it into $5 billion. So how did he do it? And more important, can you?

Well, let me give you a hint. I have done it, only with a lot smaller balance.

It started many years ago when I ran a small hedge fund. Using my Roth I was able to turn a small amount into a much larger amount, all tax-free. In less than two years I can touch those gains and never pay a penny in income tax ever! Until then I can keep investing and growing the pile more. (The basis is currently available.)

What about you? How can you super charge your tax-free income? Simple. You can either invest in market securities or index funds and enjoy those returns, or, invest in your own company, placed inside a Roth. Cryptocurrencies can also be placed inside a Roth. 

It is the early years of business growth that pound returns north fast. Peter Thiel invests and continues investing in start-ups. You can do that to a lesser extent, but you can easily start a business with the shares held by the Roth. The biggest obstacle is finding an IRA administrator that allows such investments inside Roth IRAs. You may have a local firm that handles such Roth IRAs if you look. You can also check Equity Trust. (Not an affiliate.) Be sure to do your due diligence before moving money.

 

There are so many opportunities available to eliminate your federal income tax. You can mix and match the strategies listed above and more in an endless number of ways. I spend most days at the office consulting with clients on just such issues. Sometimes my hands are tied and the benefits are limited (still profitable for the client, but limited). Most of the time we crush the tax beast. 

One word of caution before I leave you to your cup of coffee. Never fall for the old trick of lower taxes for the current year only. That is a very easy game to play that ultimately screws the client (that is you, my taxpaying reader). When I work with clients I consider “all years involved”. That means investments into a traditional retirement account requires consideration for the tax consequences when the money comes out.

Now, get creative, but stay legal. You want to keep your money and enjoy it too.

 

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here.

Blockfi is currently paying 7.5%.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Why Cheating on Your Taxes Costs More

This past week an old story returned to the surface. A tax office that handles mostly simple tax returns for a very low price and gets paid mostly cash might not be claiming all that income. A previous employee of that firm informed me over $300,000 in cash was kept in a safe in the money cage. 

The final response (and I was thinking the same thing) was, “And I’m sure all that cash was reported.

Cheating on your taxes is as American as apple pie, but a whole lot dumber. If this other tax firm really has that much cash on hand and does not report all their income they lose a lot more than most people expect. 

First, if they get audited and the unreported money is found you can expect more audits. This is a tax on your time and I can’t think of a more usurious tax.

Next are the penalties. Here is a sampling of the penalties that could apply:

1.) Accuracy related penalty (§6662): 20% of the assessment.

2.) Fraud (§6663): 75% of the amount attributable to fraud.

3.) Willful attempt to evade or defeat tax (§7201): Up to a $100,000 fine, five years in prison, or both. This is a felony! If they are a corporation the fine can climb to $500,000.

4.) Willfully making and subscribing to a false return (§7206): Also a felony with a fine up to $100,000, three years in prison, or both. Corporations face fines up to $500,000.

Even worse, with underreported income at those levels it is likely the IRS will seek to bar the owners from ever preparing taxes again. And my guess is they would find a few more penalties to apply to make the financial pain even worse. 

He would probably make the local evening news. Clients would bolt. Clients would face greater scrutiny. There isn’t anything I find acceptable about the risk of underreporting income in their situation.

The odds of getting caught are small, however. And even if they get audited, the IRS may not find the underreported income. 

And none of that matters because there is another cost to cheating on your taxes that costs more than the taxes saved even if you don’t get caught.

S&P 500 10-year chart

Why Cheating on Your Taxes Costs More Than the Tax Avoided

The first time I heard the rumor was at least a decade ago. The firm files a lot of returns. I mean a lot. 

Their fee is the lowest of any firm in their service area of any size. I imagine a few guys working out of their home might do a return for less, but this firm is the lowest fee of any major player locally.

Probably 80% of the firm’s revenues are in cash with the firm pulling around seven figures of revenue annually. The owner could siphon a cool $100k off the top with no problem. 

Cheating on your taxes has a hidden cost. You can’t just deposit the unreported cash into a financial institution. The IRS might be slow, but they ain’t stupid. They will find that quicker than a starving mule finds a load of oats.

If you can’t deposit the money you are left with spending it. (You could launder the money, but that has a cost, too, which is nothing more than a tax paid to a different entity.) And when you spend it you can’t look like you are spending that much. Buy a car with cash and the IRS gets a report. 

I guess you could save it up for retirement, spending some here and there as not to look conspicuous. 

Yet, that isn’t the real problem. The real problem is lost opportunity cost! 

Let’s say the tax on this $100,000 is 40%, federal and state taxes combined. That would leave the business owner with $60,000 after tax.

Yet, if that $60,000 was invested 10 years ago in an S&P 500 index fund it would now be worth nearly three times as much! Even if we take a bit off the top for spending we still have more than $120,000 and in reality closer to $150,000! The best the unreported income can do is maintain $100,000, unless you want to risk some prison time.

Cheating on your taxes never pays! It always costs you more in the long run with serious risks in the short run. If you underreport income by up to 25% the IRS can audit you on that return for up to seven years after you file or from the due date, whichever is longer. This is up from three years when you play it straight. If the underreported income is over 25% that tax return is open for audit forever!

Cheating Uncle Sam costs more than the tax even if you don’t get caught.

Wink, Wink

There is a way to profit from people who do cheat on their taxes. 

When a client offers to pay cash they sometimes do so with a wink. I assume they mean that since they paid me cash I will not report it. Unfortunately, I invoice each client separately so I create a paper trail. It all gets reported. It is how a real business operates. (I’m a real business.)

It has been a long time since I was asked for a discount if I am paid cash. When I was the answer was always no. I use the Seth Godin plan: full price or free.

When purchasing a good or service I might ask for a discount if I pay cash. I remind the business owner they don’t have to pay bank transaction fees. It is a win/win for all parties involved. I never make it a tax cheating issue

Several years ago I was coming home from the office during tax season when a deer attacked my car. Hit the from wheel well. A rural body shop quoted me $800 to fix the damage. It was a really good deal.

I brought cash when I picked up my car, concerned he might not want to accept a check. Without asking, the business owner offered me a $200 discount for cash.

That was a whopping $200 discount; 25%! It was accompanied by the ol’ wink-wink. I took that to mean he would not be reporting the income. (Hey, I’m not here to judge.) 

He traded his tax bracket for a 25% tax paid to me. And my savings were tax free!!! (You don’t pay tax on money you didn’t spend on a service.) By the looks of the place I don’t think his tax bracket was much higher. I enjoyed the discount, but it was still foolish on the business owner’s part if he did so just to not report a small amount of income.

The choice is clear. Cheating on your taxes destroys your wealth even if not caught. Honest pays better!

Tax season is heading into the final stretch as I write this. I hope I made the case for not cheating on your taxes. It isn’t too late to file a superseding return if you left something important off your tax return, like some income.

The risks are too high for anyone serious about accumulating wealth. The math doesn’t add up. Cheating on your taxes will bite you in the tail regardless the outcome. Audits waste a lot of time and are not fun. (You can make more money, but ya can’t make more time.)

The lost opportunity cost of wasted time hiding money from the government and the lack of ability to invest all your money optimally make it real clear: cheating will always cost you.

Worse, you could have enjoyed a few posts around this blog and saved as much or more legally than you potentially saved cheating. (What are the chances traffic to this blog will spike now?)

I know you will do the right thing.

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.