How To Avoid Paying Taxes (Legally)

If you have ever wondered how to avoid paying taxes without breaking the law, you are not alone, and yes, it is absolutely possible.

While tax evasion is illegal, tax avoidance is a smart, legal strategy to reduce tax bills dramatically.

Unfortunately, most people miss out.

Over 90% of taxpayers fail to take advantage of all the legal tax strategies available, leaving thousands of dollars on the table.

The right tax reduction strategies can unlock massive savings if you are a high-income earner. 

In this article, we will break down three legal ways to avoid paying taxes so you can keep more of your money and build the wealth you deserve.

1. Use Tax-Advantaged Accounts to Avoid Taxes

Utilizing tax-advantaged accounts is the easiest and most traditional way to avoid paying taxes. 

Tax-advantaged accounts are investment accounts that offer tax benefits to help individuals save more efficiently for specific goals like retirement, healthcare, or education. 

These benefits can come in the form of tax-free growth, tax deferrals, or deductions, making these accounts a valuable tool for effective tax planning.

Tax-Free Accounts

Tax-free accounts are investment accounts where both the growth of your investments and withdrawals are tax-free as long as certain conditions are met.

This means that once you deposit money into these accounts, you will not pay taxes on the income generated by those investments.

These accounts include:

Roth IRA (Individual Retirement Account)

Contributions into a Roth IRA are made with after-tax dollars, meaning they are not tax-deductible.

Withdrawals of contributions and earnings are tax-free after age 59½, provided the account has been open for at least five years.

This account is useful for individuals who expect to be in a higher tax bracket in retirement, as it locks in the tax rate at the time of contribution.

Roth 401(k)

Similar to a Roth IRA, contributions to a Roth 401(k) are made with after-tax dollars.

The account offers tax-free growth and tax-free withdrawals after retirement, adhering to the same age and timing rules as the Roth IRA.

A Roth 401(k) is often offered as an option through employer-sponsored retirement plans.

529 Plan

A 529 plan is designed for saving for education expenses.

Contributions are not federally tax-deductible, though many states offer tax deductions or credits.

Distributions can be used for qualified education expenses, including tuition, books, and room and board, which are tax-free.

Tax-Deferred Accounts

Tax-deferred accounts are those where contributions are tax-deductible, reducing your taxable income in the contribution year. 

Taxes on investment gains are deferred until money is withdrawn, typically during retirement.

These accounts include: 

Traditional IRA

Contributions to this account may be fully or partially tax-deductible depending on your income and whether you or your spouse have an employer-sponsored retirement plan.

Taxes are paid on withdrawals, ideally at a lower tax rate in retirement.

Traditional 401(k)

Contributions are made pre-tax, reducing taxable income during the contributing years.

Like the Traditional IRA, withdrawals are taxed as regular income in retirement, potentially at a lower tax bracket.

Health Savings Account (HSA)

An HSA is available to those enrolled in high-deductible health plans.

Contributions to this account are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free.

Donor-Advised Fund

This allows donors to make charitable contributions, receive an immediate tax deduction, and recommend grants from the fund over time.

Investments grow tax-free within the fund.

When to Use Each Account Type

Tax bracket above 30%: Consider using tax-deferred accounts to defer taxes until a time when you may be in a lower tax bracket.

Tax bracket between 20-30%: It can be beneficial to use either tax-free or tax-deferred accounts, depending on your future income expectations and financial needs.

Tax bracket below 20%: Tax-free accounts are typically more advantageous as they lock in your current lower tax rate on contributions and offer tax-free growth.

Now, how much money you can put into these accounts will vary based on many factors, like your age, income, filing status, and the type of plan you use.

There are several creative ways to get tens of thousands into these accounts every year, so be sure to talk to a trusted CPA about this.

2. Maximize Tax Write-Offs

Most people pay taxes before they get paid and use what is left to pay their expenses.

But there is a way to flip this – you can get paid first, write off your expenses, and only pay tax on the leftover income. 

To do this, you only have to earn non-employment income. Or, in other words, earn income outside a traditional W-2 job. 

This may include income from a side gig, freelance contract, trade, or business. When you earn this type of income, the IRS considers you to be self-employed.

And self-employed individuals are entitled to additional tax benefits. The government wants people to start businesses, create jobs, spur innovation, and grow the economy.

So, to foster this, they give tax breaks to people who do these things to incentivize more of this behavior.

For starters, the IRS lets self-employed individuals deduct all ordinary and necessary expenses for your operation.

This means if the expense is common in your industry and helps you run your business, it can likely be written off.

For example, if you are a photographer, you can deduct camera gear, editing software, and studio rent.

If you are a consultant, you can deduct your laptop, office space, and travel to meet clients.

These deductions lower your business income, meaning you pay less taxes.

The more expenses you can legally deduct, the lower your taxable income, which helps you save on your tax bill.

Tax Deductions for Business Owners vs. W2 Earners

Business owners have access to far more tax deductions than regular W-2 employees. 

W-2 taxpayers are generally limited to the standard or itemized deduction, along with the tax advantaged accounts mentioned above.

These taxpayers typically have minimal options for deducting work-related expenses, while business owners can write off a wide range of costs considered ordinary and necessary to run their business.

This difference is one of the biggest advantages when learning how to avoid paying taxes legally and effectively.

Business owners can have significantly more opportunities to reduce their taxable income and, ultimately, pay less in taxes.

Here are some examples of what business owners can potentially write-off: 

Home expenses

Business owners can deduct a portion of their housing costs if they use part of their home regularly and exclusively for business purposes.

Car expenses

Expenses related to the business use of a vehicle, including mileage, maintenance, and other costs, can be deducted.

Travel expenses

Costs incurred while traveling for business, such as lodging, airfare, and other transportation costs, are deductible.

Meals

Around 50% to 100% of meal costs during business travel or entertainment directly related to the business can be deducted.

Health insurance

Premiums paid for health insurance can often be fully deductible if you are self-employed and not eligible for an employer-sponsored health plan.

Other expenses

Various other expenses that are ordinary and necessary for the operation of the business, such as advertising, supplies, and professional fees, are also deductible.

3. Optimize Your Investments for Tax-Efficiency

When you invest directly into assets like stocks, bonds, and real estate, there are several ways to sidestep paying taxes and enhance the growth of your investments.

Do Not Sell Investments Unless You Have To

The simplest strategy is to just hold onto your investments. 

In other words, you only pay taxes on assets when you sell them at a profit. 

If you never sell, you never trigger capital gains tax, no matter how much the value may appreciate. 

Holding your assets defers taxes and allows them to potentially increase in value over time.

Avoid Short-Term Capital Gains

If selling becomes necessary, it is wise to consider the timing of your sale. 

Assets held for less than a year fall into the short-term capital gains category and are taxed at your regular income tax rate, which is typically higher. 

This can be anywhere from 10% to 37%.

By holding assets for longer than a year, you benefit from reduced long-term capital gains tax rates, saving a significant amount in taxes.

Time Your Long-Term Capital Gains for Low Tax Treatment

By planning the sale of your investments when you expect to be in a lower tax bracket—perhaps in retirement, you can take advantage of lower long-term capital gains tax rates. 

Long-term capital gains apply to assets held for more than a year before selling. 

These benefit from lower tax rates, which are 0%, 15%, or 20% based on your income level.

This strategic timing can substantially decrease the tax burden on your investment gains.

Invest for Appreciation Over Dividends

Consider focusing on assets that are likely to appreciate in value rather than those that yield high dividends. 

Appreciation is not taxed until you sell the asset. 

Dividends, on the other hand, are taxed annually according to your income bracket, which could lead to higher tax liabilities each year.

Liquidate Your Most Tax-Efficient Investments

When it comes to liquidating assets, prioritize those that are most tax efficient. 

This means selling investments that are either not subject to high taxes or those that qualify for favorable tax treatments, such as long-term capital gains. 

Using this approach can preserve more capital, maximizing the money available for reinvestment or spending.

Bottom Line

These legal tips can help you pay less taxes and keep more money in your pocket. 

Of course, tax laws can be complicated, so it is always a good idea to consult with a qualified CPA or tax professional. 

They can review your specific situation and ensure you are maximizing all the deductions and strategies available to you within the law. 

With careful tax planning and a solid understanding of how to avoid paying taxes legally, you can save a considerable amount and build wealth more efficiently.