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How to Pay Zero Income Taxes Legal Tax Angles: How to Save Taxes Without Going to Jail A lot of people would like to be able to stop paying income taxes. If your tax advisors have told you that it's not possible, they were probably making a value judgment that the available methods were not worth while or suitable for you. Just to satisfy your curiosity, here are some legal ways to pay zero income taxes. But first, I need to emphasize that there are many tax scams and schemes to avoid taxes that are not legal and will not stand up to a challenge by the IRS in any U.S. court. Some of these illegal tax schemes and scams are described in the Offshore Press web site. If you want to avoid income taxes then you must find a legal way to avoid having any income that is subject to tax. There are quite a few types of income that are not subject to tax. The following are a few examples that are described in an extremely simplified and abbreviated manner. Expatriation One way to avoid income taxes, estate taxes and even the social security tax is to give up your U.S. citizenship (expatriate) and move to a tax haven. The reason you have to give up your citizenship is because the U.S. imposes taxes on the world-wide income of a citizen, regardless of where they live. After you expatriate, all future income from non U.S. sources will not be subject to U.S. taxes. But ... to avoid having to pay even higher taxes in another country, you would need to locate a country with no income or estate taxes on its residents. Such countries are often referred to as "tax havens". And ... because you need to have a passport to travel and you must be a citizen of some country in order to have a passport, you might want to become a citizen of another major country (like Canada) before you give up your U.S. citizenship. The USA is the only major country in the world that asserts the authority to tax the income of its citizens no matter where they live. In other high tax countries, if you move to another country you are no longer subject to the taxes imposed by the former country. IN most English countries, you don't have to give up your citizenship and passport in order to do that. Thus, you could move to Canada or Australia long enough to become a citizen and you could then move to a low tax country like the Bahamas or Bermuda. But if you are a U.S. citizen or permanent resident, you must formally give up your citizenship or resident status. However, this is not a simple procedure and you could be subject to U.S. taxes on any tax deferred income for up to ten years after you expatriate. For those with modest assets (under $600,000), the process is not as difficult and it may be possible to avoid any U.S. tax immediately after giving up your U.S. citizenship. Further details about the tax rules for expatriation are included in the Offshore Tax Manual. Foreign Earned Income A less extreme variation of this previous strategy is useful for those whose income is from a trade or business that can be operated any where in the world. If a U.S. citizen moves to a foreign country and becomes a legal resident of that country and operates a business in that country, up to $160,000 of income could be taken from the business tax free (by a couple) using the foreign earned income exclusion in tax code section 911. If the business were organized as a foreign corporation, and if there was no investment income earned by the foreign corporation, then it would be possible for any excess profits to accumulate in the foreign corporation without being subject to U.S. income taxes. However, if this couple has a large estate, a part of the estate could still be subject to U.S. estate taxes. Further information about the foreign earned income exclusion is in the Offshore Tax Manual Further information about the U.S. tax rules for foreign corporations owned by U.S. persons is available in both the Offshore Tax Manual and the Controlled Foreign Corporation Tax Guide. Tax Exempt Bonds A somewhat less extreme method of avoiding income taxes is to invest exclusively in tax exempt bonds. Admittedly, this is an option that is only available to those who have already accumulated a very substantial net worth. For example, if you have investments worth about $2 million and invest them in tax exempt bonds that yield 4% per year, you could make $80,000 a year without any federal income tax. If the bonds were issued in a state where you live or if you live in a state without an income tax, then you would owe no state income tax on this income. Nor would you be subject to any social security taxes on this income. However, you could be subject to potential estate taxes -- but that would affect your heirs. Rental Real Estate Real estate is a tax favored business because owners of income producing real estate can utilize an assortment of tax deferral methods. In addition to the tax deferral, when the real estate is sold, a substantial part of the gain may be eligible for the 15% maximum rate on long term capital gains. The principal tax device used by real estate owners to avoid taxes is the tax deferred exchange in code section 1041. In addition, the real estate owner gets to claim a depreciation deduction for property that may not actually decrease in value over the years. When the property is sold at a gain, the gain can be deferred with an installment sale that spreads the gain over many years. Interest paid to finance loans to purchase the real estate is also tax deductible and can be used to reduce the amount of taxable income. $250,00 a Year Tax Free The tax law permits homeowners to avoid income tax (and social security taxes) on up to $250,000 of gain from the sale of a principal residence. A married couple can get up to $500,000 in tax free gain. However, the exempt gain is only available when the taxpayer has used the home as their principal residence for at least two of the past five years. Thus, the maximum benefit from this tax break is $250,000 per year for a married couple or $125,000 a year for a single person. And, there is the practical problem of finding a residence that can be improved so much that it will produce such a large gain. But for those with more modest objectives, any amount of gain on the sale of a residence is exempt -- up to the limit. One way to increase the amount of gain is to learn how to buy and sell real estate without having to use the services of a real estate broker. The broker fees on real estate often take as much as 6% of the total price. Clearly, you must find a property that is in dire need of being restored -- both inside and out. Then you must be willing and able to do nearly all of the repairs and restoration yourself. While you are doing this you will need sufficient capital to pay for the supplies to fix up the home and to pay for your personal expenses such as food, clothing and other personal necessities. If you use a loan to get leverage on the property, you will need to be able to generate enough gain to offset the interest rate on the loan. Other Forms of Tax Free Income The ideas discussed above are not an exhaustive list of the various methods of legal tax avoidance. I will add additional topics as my work schedule permits. Vern Jacobs Copyright, 2003
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Books and Services by Vern Jacobs
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