Finding ways to save on taxes is one of the best money moves you can make. One of the best ways to cut your tax bill is to take lessons from millionaires, many of whom have spent a fortune working with tax professionals to identify every deduction and credit they can use to reduce what they owe the IRS.
Here are eight of those federal tax savings opportunities millionaires take advantage of — and some tips on whether you could use them as well.
Donating to charity is one way wealthy people save money on their tax bills. But there are certain rules to follow.
In general, deductions to a charity are deductible only if you itemize. Itemizing means you declare deductions for specific expenditures, rather than claiming the standard deduction. The standard deductions for 2022 and 2023 are:
|Tax filing status||2022 standard deduction||2023 standard deduction|
|Head of household||$19,400||$20,800|
|Married, filing separately||$12,950||$13,850|
|Married, filing jointly||$25,900||$27,700|
Unless your charitable contributions and other deductions exceed that amount, it makes sense to claim the standard deduction instead. If you itemize and want to claim the charitable deduction, generally, you are limited to deducting no more than 60% of your adjusted gross income. However, there are some exceptions to that for qualified contributions. These include cash contributions to public charities or certain private foundations.
Property taxes are deductible, but again you will need to itemize to claim this deduction. You can deduct up to a total of $10,000 (for married joint filers) or $5,000 (for single tax filers) on your federal taxes. This $10,000 limit applies to state and local taxes, including property taxes and state income or sales taxes. Still, it could be a good way to reduce your tax burden.
If your property taxes and other deductions don't exceed the standard deduction, it probably doesn’t make sense to itemize.
Depreciation refers to the loss in value of business property that occurs over time. For example, business equipment such as machinery loses its value over time as the equipment ages. If you have a rental property, depreciation can also occur when you make improvements that stay useful for several years, such as replacing a roof.
Wealthy people who own businesses or rental properties can deduct depreciation. Unfortunately, this is a form of tax savings you can take advantage of only if you own a rental property or a business with qualifying equipment.
There are numerous methods of calculating what this deduction is worth, but the simplest is the "straight line" method, which allows you to calculate your deduction using the following equation:
(Cost of the asset - the salvage value (what it's worth at the end of its estimated useful life)) / estimated useful life
This gives you the annual depreciation expense you can deduct when you file your federal taxes. However, there are annual maximums on the amount you can deduct. For the 2022 tax year, the maximum is $1.8 million. For the 2023 tax year, it is decreasing to $1.16 million.
You could deduct necessary business expenses commonly accepted in your trade or business. For example, if you run a store, you could deduct the cost of goods sold on your federal taxes. Or if you’re a freelancer, you might be able to deduct costs related to your business website. This is something that wealthy business owners might do to reduce their tax burden.
Again, you need to have business income to take advantage of this tax savings opportunity. The best tax software can help you identify deductions for your business if you run a company of your own. The best business credit cards could also make it simpler to track your business expenses at tax time, too.
Millionaires often have investment income in addition to earned income, and this might provide certain federal tax benefits. You might be able to take advantage of these tax benefits, provided you buy investment assets and profit from them.
Investment income can have a relatively low capital gains tax rate, provided you hold the investment for over a year. The capital gains tax rates are either 0%, 15%, or 20%, depending on your income and tax filing status.
If you do not own your investments for over a year, though, you will be taxed at the short-term capital gains tax rate, which is equal to your ordinary income tax rate. This tax rate can be up to 37%, depending on your tax bracket.
You could also reduce your capital gains taxes if you sell investments at a loss. These losses can be used to offset gains, potentially reducing your tax burden.
Learn more about how to avoid capital gains taxes on stocks and avoiding capital gains tax on home sales.
The step-up basis is a fundamental way wealthy people avoid paying taxes when their investments increase in value. When an asset is sold at a profit, it's taxed. However, if the asset isn't sold but instead passed on to an heir, then the asset’s value is adjusted to its worth at the time of the death.
Say, for example, a wealthy person bought an investment for $10,000, held onto it for a very long time, and its value went up to $100,000. If the person died, someone would inherit the investment. When they do, the stepped-up basis will adjust the value of the asset to $100,000. If the person who inherited then sold the asset the next day for $100,000, no capital gains taxes would be owed on it. So $90,000 in profits would have gone untaxed.
Anyone could take advantage of this tax benefit, provided they don't sell assets that have increased in value but rather leave them to loved ones to inherit.
Trusts are a key tool if you're trying to determine how to avoid inheritance tax or estate tax. It's possible to create an irrevocable trust and transfer assets into it. The trust becomes the owner of the assets, and the person who created the trust can name their heirs as the trust’s beneficiaries when they die.
Because the assets don't pass through probate and aren't inherited in the traditional sense, no estate or inheritance tax is owed. Anyone could take advantage of this, but creating a trust can be expensive, and it involves giving up some control over property. It's also not necessary for most people because only a few states charge inheritance tax. And for the tax year 2022, estate tax at the federal level isn't charged until the estate is valued at $12.6 million or higher.
Family limited partnership
Millionaires might also use family-limited partnerships to avoid high estate taxes. A partnership is created, and ownership of assets is transferred to it. Heirs are gifted an ownership interest in the partnership, and the value of that ownership interest is discounted under estate tax rules.
This reduces the amount of assets that transfer through probate and are considered part of the taxable estate. But, again, there are costs involved with setting up a family-limited partnership. It's not normally necessary to do this unless you have a substantial estate that would be subject to tax.
Taking control of your federal tax bill is one of the best and most important things you can do when figuring out how to manage your money effectively. After all, taxes can be a huge expense. Paying more than necessary leaves you with much less in your pocket.
The good news is some of these eight opportunities for tax savings might work for you, and next year you might pay a little less when you file your tax return.
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