Did your last tax bill have too many zeros on the end? Learn how to invest money to save tax dollars by reducing your overall tax liability. These investment strategies are commonly used by financial professionals and the wealthy to legally and effectively lower their tax burden and increase their returns.
By implementing a few tax-efficient investing strategies, you can lower your taxable income and save thousands of dollars. This allows you to maximize your returns and live the lifestyle to which you’d like to become accustomed.
Read on to learn how to invest money to avoid taxes and maximize your returns.
Keep It In the Family
When you need help running your business, one of the best tax-saving strategies for high-income earners is to hire your spouse. When you hire your spouse, you can put most of their paycheck into a 401(k), allowing you to save exponentially more for retirement.
As with any other job, neither you nor your spouse will have to pay taxes on the money invested in a 401(k). You can contribute up to $19,500 a year, which can significantly lower your joint income taxes. If this number is enough to bump you into the next lowest tax bracket, you could be looking at thousands in tax savings.
In addition to these savings, your company can also match your spouse's contributions up to a certain amount. This expenditure can be deducted from your business tax return for savings as your business as well—a win-win!
If you have employees aside from your spouse, offer them a 401(k). While their contributions won't affect your taxes, any amount you match can help lower your business's taxable profits.
Another option for tax-reducing investments is to hire your children. While not an investment per se, hiring your kids offers similar benefits to hiring your spouse.
Deposit some of the money you pay your kids into a 529 college savings plan. As they get older, you can contribute to their 401(k) by matching their contributions. This leaves them set up for college and retirement early while also lowering your tax burden.
If you need more than one employee, hiring your kids can be a great option. It’s important to remember that as long as your business is nonagricultural, you can hire your children under the age of 16 to work any time of day for any number of hours—so long as it is for the family business.
For instance, Your 15-year-old could do data entry while your 11-year-old packs boxes or files documents. The type of work doesn’t matter. This will teach them responsibility while also preparing them for their financial future.
Choose Your Business Structure Strategically
When you started your business, you may have started as a sole proprietor. That business structure can be nice because you pay taxes on your personal return, meaning your business doesn’t pay extra taxes.
However, a sole proprietorship may not be the best structure as you start earning more and expanding. Once you earn enough money to start investing in your business or other investments, starting an S corporation is likely the best option.
An S corporation allows you to take part of your business income as a salary. You'll have to pay self-employment taxes on that amount, so the more you earn that way, the more you'll pay in taxes.
The money you don't take as part of your salary you can take as a distribution. As long as the distribution doesn't exceed your stock basis, you won't have to pay taxes on that money. If it does exceed your stock basis, it’s still cheaper to pay the disbursement taxes than it is to pay full employment taxes.
Use an HSA
Another one of the best tax-deductible investments 2021 has to offer is contributions to a health savings account (HSA). Please note that you'll need to have a qualifying high-deductible health plan to use this strategy.
If you have an eligible health insurance plan, you can contribute up to a certain amount each year tax-free. As a single person, you can contribute up to $3,600 a year, while family HSAs have a maximum of $7,200 a year.
An HSA can be an excellent option if you're fairly healthy and don't have many medical expenses. You can save a lot of money on your premiums, which you may also be able to deduct.
And when you contribute to your HSA, you won't have to pay taxes on the money you use. Additionally, the money will roll over to the next year, so you can always access it if you need it.
Invest Your Money
You should also think about how to invest business profits to avoid taxes. Investing your profits is a perfect strategy for people who don't need to hire employees or who are already maxing out on those 401(k) benefits.
If you earn a return on the investment of your business profits, you have to pay capital gains tax. However, that rate is much lower than the standard income tax rate.
The current capital gains tax rates reach up to 20%, while the highest income tax bracket is 37%. If you invest a significant amount of your earnings, you may be able to bump down to the next tax bracket and save a significant amount of money.
Review Your Travel Expenses
If you travel a lot, deducting travel costs is one of the best tax-saving strategies for high-income earners. You can deduct the cost of your business travel on your tax return, which adds up fast when you travel frequently.
Tax deductions related to travel can include:
- Plane, train, bus ticket
- Rental car
- Hotel reservation
- Baggage fees
You can also deduct half of the cost of meals for your business during your trip. As long as you have documentation that the trip was planned well in advance and that the travel was necessary, you should be able to deduct it.
While you won't be able to deduct the cost of personal travel, you might be able to if part of the trip is for business. Be sure to talk to an accountant to determine how much you can deduct from each particular trip.
For instance, maybe you and your business partner are going to Italy on a vacation. But while you’re there you hold several business meetings or do some strategic planning. The portion of the trip that is business should be deductible.
Focus on Benefits
When it comes to building a team of employees, you should do what you can to attract and retain the best people. You may want to offer a raise to someone who has done good work for you.
But before you offer a significant raise, consider other benefits you can provide. When you increase salaries, it increases the amount your company owes in payroll taxes.
However, offering better benefits, such as high-quality health insurance, dental, life insurance, vision insurance, etc. doesn’t have the same effect. Instead, these are listed as expenses, lowering your profit and therefore your tax liability.
Implement an Accountable Plan
Do any of your employees travel for your business? If so, you can use an accountable plan to reimburse employees for their travel expenses.
You'll use the plan to pay employees back for the money they spend out of pocket. However, an accountable plan means you don't have to report that reimbursement as income for your employees. This means you don’t have to pay as much in taxes.
As the end of the year gets closer, think about when you will bill your clients. Of course, you can bill them all at the beginning of December to give your business an extra boost of revenue.
However, you may want to wait until the following January to bill those clients if possible. Then, you can count that income toward your taxes for the next year.
If you won't have time to invest that money by the end of December, waiting can be a good strategy. You'll have plenty of time to find good investments for that money so that you can keep from paying taxes later on.
Just make sure this is alright with your clients, who have to worry about their own taxable income and accounting statements!
File on Time
You can also save money by filing your taxes before the deadline. Paying taxes may not seem like an investment, but paying late fees and interest can be an unexpectedly large expense.
Depending on how late you pay your taxes, you might have to pay a penalty. Avoiding that means you'll have more money to invest.
Be sure to pay your taxes on time at the end of the year as well as quarterly. This gives you room to invest more of your profits elsewhere.
Cost segregation allows real estate owners to use accelerated depreciation deductions to reduce federal and state income taxes on their rental income. This tactic identifies certain building costs that would normally be depreciated over the standard 27.5 or 39-year schedule, and reclassifies those costs for an accelerated depreciation schedule.
For instance, if you own a rental home, you can either depreciate the entire property over the usual 27.5 or 39-year schedule, or you can choose to separately depreciate specific, non-structural elements of the property like:
- Sidewalks and other exterior improvements
- Portions of the electrical system
When you use cost segregation, you can depreciate these elements of your property on a 5, 7, or 15-year schedule instead. This maximizes your tax savings, reduces your real estate tax liability, and can even provide you with retroactive tax deductions.
Cost segregation can be used for buildings that were built, purchased, or remodeled after 1987. It’s most effective with newer construction, but it’s worth looking into for any building that meets eligibility in case you uncover retroactive tax deductions.
Move Your Business
Trying to invest money to avoid taxes? Consider moving your business. If you currently live in a state with high operating costs, such as California, moving to a different state can help you save a lot of money on your taxes.
For instance, California charges up to 13.3% in state income tax. Moving to a state with a lower tax rate or no income tax at all can save you a lot of money, especially when your income increases.
Consider moving to states such as Nevada, Florida, or Tennessee. These states have no state income tax, so you may be able to reduce your overall tax liability by a significant amount.
If you have a corporation or LLC, you might even be able to deduct the cost of your move. While that won't be an ongoing deduction, it can be an excellent way to invest your profits.
The Best Investment Tax Strategies to Consider
If you want to reduce your business’s taxes, you should consider a few investment tax strategies. As your business makes more money, your savings should increase with your profits. This gives you more money to keep growing your business and continue your success.
Are you ready to learn about how to invest money to avoid taxes? Download our eBook Make More, Keep More.