Want to keep the tax man away from your money? It's easier than you think. There are lots of ways to increase your wealth without having a chunk gobbled up by the IRS.
It's not that the agency doesn't want your money. It's just that tax law prohibits the IRS from touching it. And with a bit of planning, you can start cutting your current tax bill and putting money in your pocket now.
Let's look at a few examples.
Tax-free interest
Interest earned on bonds issued by a state, territory, municipality or any political subdivision is free from federal taxes. These are generically called municipal bonds, and their tax benefit increases in value as your marginal tax rate goes higher. (In other words, the bonds are worth more to you as your overall income rises.)Assume you're in the 35% bracket, the top rate through the year 2010. A 5% tax-free rate becomes the equivalent of a taxable rate of 7.69%. In the 15% bracket, the taxable equivalent is only 5.88%. If you check out this page at investinginbonds.com, you can compare taxable and tax-free yields. Compare the after-tax rates on alternative investments of equivalent risk.
Some bonds not only may be tax-free at the federal level, but may also escape state and local taxes. If you're in a top bracket and live in New York City, this is one investment you definitely want to consider for your portfolio.
Carpool receipts
Commuting to work? Bring a friend -- and his wallet. If you form a carpool to carry passengers to and from work, any income received from these passengers isn't included in your income.Commuting costs are generally not deductible. But if you establish a carpool and you're reimbursed in amounts sufficient to cover the cost of your repairs, gas and similar items used in connection with operating your car to and from work, then you've converted personal nondeductible expenses into excludable income.
Assume you're in the 25% bracket for 2009. You have to earn $133 per month to cover a $100 monthly commuting expense. If you have a carpool arrangement with expenses being reimbursed, you've got no additional income. But you do have an additional $133 per month in wealth!
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Sell your house
Under a tax law enacted in 1997, if your house was your principal residence for two of the last five years, you can exclude as much as $250,000 in gain ($500,000 on a joint return) when you sell it.You don't have to reinvest the money, and you can claim the exclusion every two years. (If you've got $500,000 in gain every two years, I want to meet your real estate agent and go shopping!)
If you don't meet the two-year rule, you may be able to get a partial exclusion based on the time of use and ownership.
Assume you sold after only one year and had a $50,000 profit. Your exclusion is half the $250,000, not half the $50,000 profit. In this case, you'd pay zero tax on the sale.
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But this partial exclusion is valid only if the sale is required because of a change in place of employment or for health reasons or unforeseen circumstances. The IRS has been very flexible with "unforeseen circumstances." Even the birth of twins or a neighbor's hostility qualifies.
Continued: Tax-free compensation
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