The primary aim is to learn strategies you can employ to legally avoid or reduce the taxes you ought to pay. In the process, you will learn the distinction between legal and illegal ways of reducing your tax obligations.
If you still need help navigating the tax system even after reading this, or you need even more robust ways to reduce your taxes, give us a call for expert help in tax planning.
Tax evasion and tax avoidance may sound similar but are worlds apart. One is a legal approach to minimize tax liability, while the other may get you into serious trouble with the tax collector.
Knowing the difference between the two terms is the first step in legally reducing your tax payments. We at Wealthy Expat do not condone tax evasion but only encourage tax avoidance per the law.
Tax evasion occurs when individuals underreport or fail to report earned income or revenue to a taxing authority, such as the IRS. If a business or individual is guilty of tax evasion, they could face jail time, heavy penalties, or both.
Examples of tax evasion include:
On the other hand, tax avoidance refers to minimizing one’s taxable income or tax liability by utilizing legal ways to ensure you pay the least tax possible.
These are the best strategies for avoiding or minimizing taxes in your home country:
Moving outside of the US to a country with a more advantageous tax structure is one of the most effective ways to avoid paying taxes. Many countries have low/no capital gains or income taxes and offer other tax benefits that might save you money.
The Foreign Earned Income Exclusion (FEIE) allows US citizens living and working abroad to avoid paying US taxes on their worldwide income up to a specific limit and meet other eligibility requirements.
You can qualify for FEIE if you are an expat:
The FEIE earnings limit increases annually to account for inflation. For 2023, the FEIE limit is $120,000, the highest rise in recent years from the previous year’s maximum of $112,000.
There are a few caveats and exceptions to the FEIE, so it is in your best interest to discuss your situation with a US expat tax professional.
Renouncing citizenship is a drastic step some people are willing to take. If you give up your citizenship, you can potentially lower your tax burden if the country you are moving to has tax advantages.
However, before giving up your citizenship, you should consider the long-term ramifications, such as being restricted in your ability to travel and use domestic services.
Additionally, if you renounce your citizenship, you must pay an exit tax on unrealized capital gains, which could be a major setback.
Even if you made timely income tax payments until your renunciation, the IRS might require you to pay exit tax if your net worth is less than $2 million. You may still have access to US banks and, in some situations, receive government benefits.
Though it is not the best choice for everyone, renouncing citizenship is an option for some who want to escape the crushing weight of US income tax.
The US has several territories, including American Samoa, Guam, Puerto Rico, and the US Virgin Islands. Tax rates in these jurisdictions are often more advantageous than those in the US.
For instance, Puerto Rico has no income tax for those who meet specific residency requirements, making it a popular choice for wealthy people who want to lower their tax burden.
It has implemented Act 20, or the Export Service Act, to encourage businesses to move to the island to take advantage of tax breaks for exporting their services. The incentives include a 4% export income tax and no tax on earnings or profits.
Act 22, the Individual Investors Act, offers tax-free dividends, interest, and capital gains, focused primarily on high-net-worth investors. However, there is one catch: spending at least 183 days in Puerto Rico per year.
There is also a similar program in the US Virgin Islands, and like Puerto Rico, you must spend at least a half year in the country.
These programs are most attractive to high-income earners who aren’t satisfied with the FEIE and would like to maximize their potential benefits.
If you do not wish to move outside the US or renounce your citizenship, you can still avoid paying taxes by establishing a residence elsewhere. However, only a few types of residencies are acceptable.
You can do this by spending a specified period of time in the country, buying property, or doing business there. Individuals who prefer the flexibility of working in multiple countries while retaining their US citizenships will find this the ideal strategy.
Expats must stay in the US for up to four months to pass the residency test. When deciding where to establish a residence, it is essential you consider the safety, legal system, business climate, and accessibility of the local government.
Contributing to a retirement account is a simple and effective way to reduce your taxable income. You can contribute to a retirement account through 401(k) and IRA accounts.
Your contributions to a 401(k) plan and IRA accounts are tax-deferred until you withdraw the money in retirement.
The maximum IRA contribution for qualified individuals in 2023 is $6,500, a rise from the previous year’s limit of $6,000. For 401(k), you can pay up to $22,500 pre-tax contributions.
Additionally, several employers might offer a matching contribution to your retirement savings, effectively doubling the tax-free amount you can put away.
You could also go for a Roth account, which you fund with after-tax money. Income on these contributions and any withdrawals made in retirement are also free of taxation.
If you qualify for a high-deductible health plan, you can reduce your taxable income by contributing to a health savings account (HSA).
In 2023, people with qualified health insurance plans can deduct up to $3,850 for an individual and $7,700 for a family for contributions to their HSA.
As long as you use the funds for qualified medical expenses, HSA contributions are tax-deductible, and withdrawals are tax-free. Like funds in a retirement account, any unused balance at the end of the year carries over indefinitely.
The IRS allows taxpayers to deduct charitable contributions amounting to $2 or more to an eligible nonprofit or charitable organization as long as they receive no benefit from the donation.
In theory, you can deduct up to 60% of their annual gross income, but the IRS might limit that to 20%-50% after considering the organization and type of contribution.
You can donate to charities through payroll deductions, checks, cash, or in-kind donations like used clothing and household items.
Alternatively, you can establish a donor-advised fund. Unlike traditional charitable donations, you can deduct the contributions to these funds in the year you made them, although you can distribute them to charities over a longer period.
Donations made over several years can be rolled into one tax year, allowing you to itemize your deductions.
You can choose from several tax credits, so it is essential to apply for all the benefits you are eligible for. The federal government provides a variety of tax credits, including:
Business owners and the self-employed have a more comprehensive selection of tax deductions than individual taxpayers.
You can reduce your income tax and self-employment tax liability by taking advantage of tax deductions available for business owners and deducting a percentage of your self-employment tax obligations from personal tax returns.
Some of these deductions can include:
Although the federal tax reform law abolished various deductions, several states still permit them or may have lower limits for claiming them. You might be eligible for tax breaks in your state or local government if you pay income taxes to them.
In California, for instance, low-income taxpayers can take advantage of the state’s earned income tax credits.
More than 30 states also offer pass-through entity tax deductions to business owners, which could significantly lower their tax burden.
By having their businesses pay state taxes, business owners who choose to use pass-through entities can effectively reduce the portion of their income subject to federal taxation.
If you sell investments at a loss due to a decline in value, you can use the money saved to offset other taxable income. You can deduct up to $3,000 from your yearly taxable income if you have any capital losses and use them to offset any capital gains you may have made.
You can contribute to a 529 plan to save for your children’s or your own higher education if you have any plans to return to school. Although federal law does not provide any tax benefits for the contributions, some states permit residents to deduct contributions on state income taxes.
Although paying taxes is necessary for modern society, most people would rather have more of their hard-earned money in their pockets. Understandably, reducing the tax burden would be a top priority for any number of people.
The good news is that several legal ways help you avoid or reduce your tax liability. Contact us today if you want to avoid paying taxes in your country or need help formulating tax strategies.
No, it is illegal to stop paying taxes in most countries or states unless directly allowed by the tax collector. The penalties for tax evasion are severe and may include crippling fines as well as jail time.
To minimize your taxes, you are better off seeking expert tax management help to avoid legal trouble.
Tax avoidance is the process of minimizing tax payable. It is entirely legal and possible in various ways, including but not limited to tax credits, retirement account contributions, or business deductions.
The maximum foreign-earned income exclusion is adjusted yearly to keep up with inflation. The maximum exclusion for tax year 2023 is $120,000 per individual.
Yes, there are legal methods to avoid taxation. They include:
Yes, you can live without paying taxes by living in tax haven countries. These countries do not impose any taxes on personal income or assets.
The decision to renounce your citizenship is profoundly personal and could have serious ramifications.
Although renouncing your citizenship and moving to a tax-free country might seem a smart move, that shouldn’t be your primary motivation.