Ways to Earn Tax Advantaged or Tax Free Income

Have you ever wondered how the super rich can get away with earning millions of dollars, but they hardly pay anything in taxes? They aren’t cheating or breaking the law, those who earn that much are at a high risk of being audited. Instead, they are taking advantage of a system that is put in place for everyone to use, but most choose not to. There are a number of ways to earn reduced tax or tax free income, and if you make use of these methods, hiring an accountant in Billings, Montana to prepare your tax return will be a no brainer.

Municipal Bonds Provide Tax Free Income

In order to raise money to pay for large ticket items, local governments issue what are called municipal bonds (for instance, when Dehler Park was built in Billings, a large portion was funded through bonds). These bonds are exempt from federal income taxes, and often they are exempt from state and local taxes as well (usually the caveat is that you must live in the area).

The trade-off, however, is that municipal bonds don’t pay nearly as much interest as a corporate bond. Suppose a low-risk corporate bond (one issued by General Electric for example) is paying 6% interest, then a municipal bond may only be paying 3% or 4%. That is the price to pay for something safe and tax free.

Suppose you buy $10,000 worth of bonds that will mature in 15 years and they have a 4% yield on them. Now there is a lot that goes into bonds about par value, and buying at a discount, and all of that. So let’s just say you paid a flat $10k. Every year (usually distributed quarterly), you will earn $400 from the interest on the bond. You keep 100% of that, it is all tax free income. At the end of 15 years you get your $10,000 back as well.

Invest Outside of your IRA For Tax Advantaged Income

Many people have been told to invest in an IRA since that is the best tax advantaged vehicle you can get. But there are times when you will want to invest in a non-qualified account (qualified means tax advantaged, non-qualified means your earnings are taxed). The math works like this if you are in the 25% tax bracket:

Suppose you invest $100 in your IRA. Suppose it grows to $200 and then you withdraw it. You then pay taxes. Total taxes paid: $50.

Now let’s suppose you put $100 into some stocks. After it has been in more than one year, it grows to $200, so you take it out. You owe 15% capital gains tax on the growth, and you already paid 25% tax on the initial money. Total taxes paid: $40.

Now this isn’t tax free income, but it is tax advantaged. Sometimes it makes more sense to invest outside of your IRA than to invest inside of it (however, if you have access to a Roth IRA, then it is best to max that out before trying this method).

Other Tax Free Income

There are some other ways to earn tax free income, or at least reduced tax income. Your accountant in Billings, Montana can help you with those ways. When you call Practical Taxes to set up your tax return preparation, keep these methods in mind. When you visit with Mike, then you can discuss their feasibility with him.

Practical Taxes is a full service accounting firm in Billings, Montana. That means we do everything that an accountant does including payroll, online payroll, tax preparation, business consulting, and much more.