The ultimate tax planning strategy

The taxes that are withheld from paychecks amount to about 25% of your gross pay (including federal tax, state tax, social security tax and medicare tax). But these taxes that are withheld could be working for you as investments if you employ what I call the ultimate tax strategy. This tax strategy consists of how you plan to pay no taxes just like all of the large corporations. Large businesses have teams of accountants and lawyers going over the tax code to make maximum use of legitimate deductions.

In my opinion, there is a distinct difference between an individual and a business in the U. S. tax code (others have called it the difference between the rich and the poor). Such as businesses are rewarded with tax deductions because they create jobs and engage in entrepreneurial activities that support individuals and government. But individuals are awarded few tax breaks because they don’t create jobs and don’t take risks that add substantial value to the economy. This is simply the fact and we just need to find a way to make the most of the few tax deductions that are available to wage earners as well.

When tax time comes around, the only substantial tax break most individuals have is a deduction for their home mortgage. This deduction is a social policy benefit to many people, but instead of helping people, it can motivate them to buy a larger home or higher mortgage than they would ordinarily afford. And unless you live in a neighborhood that continually appreciates, this is not a great strategy for you to target.

First, I need to make some big disclaimers about minimizing your taxes. There are many people in jail that have written books, tapes, websites and held seminars on how to never pay taxes. You can spot these people due to their focus on concepts that the IRS says are invalid; strained interpretations that haven’t held up in court, constitutional nonsense and a lot of straight fraud. Once the IRS audits these “patriotic educators”, the result is an invoice for back taxes, interest, penalties, and a jail or prison sentence. And illegal tax avoidance isn’t limited to wage earners. Nearly every month there is someone who tried to avoid taxes from a giant windfall (sold a company for millions, exercised stock options, received a large bonus) and paid some small shady offshore consulting company to create a fictitious tax loss to offset the big gain. The same thing happens; IRS files suit for back taxes, interest, penalties and possibly jail depending on the circumstances.

The ultimate tax planning strategy works when you buy investments that have a positive cash flow (before any tax consequences), and give you a legitimate tax deduction as an added bonus. Now it is just a matter of buying enough of these investments to reduce your tax liabilities close to zero. If you have too much of these investments, the IRS limits tax loss carry-forwards, and you may end up losing them.

The two legitimate deductions that I want to mention are real estate depreciation and oil well depletion. You are buying something that is going to put money in your pocket (or a very high probability of success), and because it is in alignment with government policy, they give you a tax deduction to take this risk.

To figure out how much of a deduction that you need, start with your 1040 federal tax form. Add together the Standard Deduction (which is around $3,000) and your itemized deductions from Schedule A. The difference between the number that you just calculated and your actual Adjusted Gross Income is the amount of depreciation you need to acquire for the ultimate tax strategy.

Investment real estate depreciation is calculated over 29.5 years right now, so take the amount of depreciation that you need and multiply it by 29.5 to calculate the purchase price you need to buy. (Note that depreciation is limited to $25,000 per year unless you meet the IRS qualifications as a real estate professional. The taxing authorities don’t like wage earners taking these types of deductions so there are many limits on them, including the Alternative Minimum Tax, to block you from taking excessive deductions).

Now even if you aren’t able to buy enough tax deductible investments to get your taxable income all the way down to zero, any investment that meets the IRS rules for a deduction, and is a positive cash flow investment, will increase your net worth, reduce your taxes and thus create more money available to you to spend or invest.