Since this is the stage of maximum development and the one with higher income, you also will have to accept that it is also the one with higher taxes. Collecting entities will be very aware of your financial progress. You will have to make use of all the strategies you know in order to minimize taxes.
Is it legal to apply strategies to avoid or reduce the amount of income tax?
It is perfectly legal. However, at this point, it is important to establish the difference between the avoidance of paying taxes and evading taxes. The first one is a legal procedure, whereas the second one isn’t. In the first case, you act before tax is charged, but in the second case, the potential offender of the law tries to find tricks to avoid paying taxes which he has already incurred. The strategy to avoid or reduce taxes consists of foreseeing and preventing them before they are generated and trying to find ways to avoid them or reduce them as legally possible. Let’s illustrate this strategy through an example: Suppose that you need $50,000 to invest in a business. You have a beach home to enjoy during your vacation. This is valued at $100,000, but its real market value is $250,000. You have thought of selling it to get the money, but you know that if you do, you will have to pay property valuation taxes. You accountant lets you know that there is going to be a tax reform and taxes on property’s return can be reduced significantly for next year. Then, you decide to put the sale off until next year and use it as a loan guarantee to invest in a business. With this strategy, you’ll be saving an important amount in taxes when selling your property in the future.
Which strategies could be used to avoid or reduce the amount of income tax?
The following are general strategies that may or may not be applicable to your case, depending to the current tax law of your country of residence. When dealing with taxes you should consult with your accountant before taking any decision.
A. Reducing the amount of taxes on your income
When reducing the taxable part of your income, you will be paying fewer taxes and, therefore, taking more money home. Here, you will find some ideas on how to do it:
Salary in kind. If you generate a high income, you can reduce taxes with the help of your employer. Ask him to pay your salary as traveling expenses or with tax-exempt benefits such as: insurances, retirement plan contribution, educational assistance, etc. By doing this, the taxable part of your income will be considerably reduced.
Gift or transfer of income-generating properties. If part of your income is made up of properties that generate income and you are in the highest level tax bracket, you could move down a few levels by transferring those assets, with their income, to your children or family members that are in lower levels. Therefore, you could reduce the total rate of taxes and at the same time, you could take advantage of deductions.
Investing in interests-exempt instruments. If you receive income from financial investments, there are investment instruments in many countries whose returns are tax free. For example, municipal bonds are exempt in the United States. In other countries, interests on governmental bonds, savings accounts or some dividends could be exempt. However, you should keep in mind that, in general, these investments pay lower interests than similar instruments with taxable returns. You should make your own calculations before investing and determine if, in your case, what you are avoiding paying in taxes compensates the lower yield of a non-exempt investment. This kind of investment is more applicable for people who are in the highest tax brackets.
B. Deferring some taxable income
In this case, it’s about reducing the amount of taxes that, sooner or later, you will have to pay, but on which you have control over. For example, if you realize that this year your income will place you in a higher level in the tax scale, but you estimate that next year or in the upcoming ones the level of your income will be lower and, therefore, you’ll be in a lower tax level, you might want to defer some taxable income. Let’s see some ideas:
Deferring income for special bonus or any other concept. If your employer will give you a bonus in December, you could ask him to give it to you in January next year. If you receive money from a rented property, you could ask the tenant to postpone the December payment until next January. If you perform a service in December, you could get the money in January.
Deferring profit taken. Your investment in stocks has risen substantially and you believe it’s time to take profits. If your total income level is very high and you think that next year’s might be lower, you could postpone the profit-taken until next year when your total income could be minor and you can be in a lower level of the tax table. Long-term postponement (retirement plan). Some legislations authorize residents to invest –tax free- an amount of their income. While the money remains invested, the yield will grow tax free until the person reaches a certain age. IRA (Individual Retirement Account) is a typical example in the US. When the accumulated capital is required, usually many years later, the total income is generally lower which places the person in a much lower tax level.
C. Anticipating deductible expenses
Medical and dental expenses. For example, if you have a scheduled surgery or a consultation with a dentist for January next year, you could move it so that it can be done the current year and be deducted from your taxes.
Charitable contributions. If you usually include within your budget any charitable contributions, you could make it December the one that you have planned for next year. As you may have noticed, the proper tax planning will let you manage your payment in a way that it is more favorable to you. There might be other specific strategies in each country, which I’m sure are well-known by your accountant. The strategies that we mentioned before are ideas of a
general nature and shouldn’t be followed to the tee but as suggestions. If you want to make use of any of these strategies, we advise you to check first the taxes legislation of your own country to be sure that they are applicable
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