“I want to lower my taxes” is a stupid goal

By James M. Dahle, MD
The White Coat Investor

Editor: Being a high income earner also comes with a pretty hefty tax bill. Dr. Dahle shares tips for how to think smarter about our tax goals and actions that will impact your bottom line in this Saturday Selection, originally posted on White Coat Investor. 

I keep running into people who want to know how to lower their tax bill. This is seriously an important financial goal for them. I suspect many of them are just tax illiterate, but I bet some just haven’t really thought through this goal. The problem with this goal is it leads people to do stupid stuff and be vulnerable to people selling bad financial products. To be honest, I WANT TO PAY MORE TAXES because it usually means I made more money and in the end, I’m still coming out ahead even after paying those taxes.

8 Ways to Lower Your Tax Bill

So today, I’m going to rant a bit and actually answer their question. Then, at the end of the post, I’ll answer the questions they should have asked.

#1 – Vote

If your tax bill is a very important issue for you, then I would suggest you make it very important when you vote for local, state, and federal politicians. In nearly every general election, one candidate supports lowering your tax bill and the other supports raising it. You will probably also notice differences in primary elections. If lowering your taxes is your most important political issue, then I would suggest voting for the candidate most likely to lower your bill. If it is not an important political issue for you, and perhaps isn’t even in the top 10 most important issues for you, then quit whining about your tax bill.

#2 – Work Less

Want to instantaneously lower your tax bill? Work less. Yup, that’ll do it. In fact, thanks to our progressive tax code, if you stop working, your tax bill will go down by a larger percentage than your income went down. Let me demonstrate a simple tax situation:

  • Gross income: $400K
  • MFJ Standard deduction: $25,100 (2021)
  • Taxable income: $374,900
  • Marginal tax rate: 32%
  • Tax due: =$19,900*10%+($81,050-$19,900)*12%+($172,750-$81,050)*22%+($329,850-$172,750)*24%+($374,900-$329,850)*32%+0.9%($400,000-$250,000)* = $82,972 (2021)
  • Effective tax rate: =$82,972/$400,000= 21%

how to lower taxes

Note that I am ignoring state and local income taxes, payroll taxes, property taxes, and sales taxes for the sake of simplicity.
*PPACA tax on income over $200K ($250K MFJ)

Now, what if you worked half as much and made half the money?

  • Gross income: $200K
  • MFJ Standard deduction: $25,100 (2021)
  • Taxable income: $174,900
  • Marginal tax rate: 24%
  • Tax due: =$19,900*10%+($81,050-$19,900)*12%+($172,750-$81,050)*22%+($174,900-$172,750)*24% = $30,018 (2021)
  • Effective tax rate: =$30,018/$200,000= 15%

As you can see, your gross income went down by 50%, but your taxes went down by 63%.

#3 – Give Your Money Away to Charity

You know what else lowers your tax bill? Charitable deductions. You can donate up to 50% of your adjusted gross income and take a tax deduction for it. No, giving away $1,000 in order to lower your tax bill by $320 is not a winning strategy if your goal is to have more money after taxes. But if your goal is to lower your tax bill, it works great.

#4 – Spend Money in IRS Approved Ways

Want an even lower tax bill? Spend your money on stuff the IRS approves of like child care, college education, mortgage interest, and health care expenses. Again, at best you’re spending $1,000 in order to get $320 off your tax bill so you won’t have more money after tax, but you will lower your tax bill.

#5 – Get Married (to a Non-Earner) and Have Kids

When you get married, you get to use the married filing jointly tax brackets, which are much better than the single tax brackets. Of course, if you marry a radiologist you may find that the overall tax bill goes up, not down! Having kids may also qualify you for a lower tax bill. The child tax deduction doesn’t start phasing out until $200,000 ($400,000 married). It isn’t indexed to inflation, unfortunately.

#6 – Save for Retirement

If you aren’t maxing out your tax-deferred accounts such as the 403(b), 457(b), and 401(a) at your regular job, doing so will lower your tax bill (and you even get to keep the money this time). If you have a 1099 side gig, add on an individual 401(k). You might even want to look into a defined benefit/cash balance plan for your employer or partnership (or yourself if an independent contractor).

#7 – Save for Health Care

If you are using a High Deductible Health Plan, then fund a Health Savings Account (HSA) each year. For a family, that’s a $7,200 (2021) tax deduction and like a retirement account, you get to keep the money!

#8 – Stop Being Tax Illiterate

Most people think they’re leaving a lot of money on the table due to filling out their tax returns improperly. The truth is they probably aren’t leaving all that much. But if you’re making dumb tax decisions like not deducting all of the business expenses you are eligible for, choosing high-turnover tax-inefficient mutual funds for your non-qualified (taxable) investing account, or not tax-loss harvesting investment losses, then stop doing that. Besides retirement accounts and an HSA, that’s really the only free lunch.

The Questions You Should Have Asked Instead of “How Can I Lower My Taxes?”

Now that I’m done ranting, let’s talk a bit about the questions you should have asked instead of “How can I lower my tax bill?” Here are a few good ones:

Q. “Are there any tax deductions I should be claiming but am not?”

A. Read through the instructions for Schedule A and Schedule C and have your return looked over by a tax accountant or two with many clients like you.

Q. “How can I rearrange my financial affairs such that I am not dramatically inconvenienced and have more money to spend after paying taxes?”

A. If you are a business owner, consider becoming an S Corp to save on Medicare taxes and figure out if there is a way you can qualify for or increase the 199A (pass-thru business) deduction. Make sure you know about and use all of the tax-protected accounts available to you. If you give to charity, make sure you are doing so in the most tax-advantaged way.

Q. “How can I end up with more money after-tax?”

A. The answer here is usually to invest for the long-term. All of your investment income will at a minimum be free of payroll taxes, but when investing in a non-qualified (taxable) account, you may also wish to consider municipal bonds (the yield is usually federal and sometimes state tax-free), total market index funds (minimal distributed capital gains, dividends mostly qualified, possibly a foreign tax credit), and equity real estate (where depreciation shelters some or all of the income).

The answer is not to buy whole life insurance, because the returns are so low (and likely to get lower given regulatory changes in early 2021) that you would have ended up with more money after-tax if you had used a more traditional investment and just paid any taxes due. Nor is the answer some other complex, high-fee, tax-sheltering investment. You can’t give up a lot of return for additional tax benefits and expect to still come out ahead when there are options like muni bonds, index funds, and real estate out there.

Don’t be tax illiterate. Know enough about our tax system that you can at least make sure you’re asking the right questions. It’s hard to find the right answers until you know how to ask the right questions.

What do you think? What have you done to increase the amount of money you have left after paying taxes? Comment below!

1 Comment

  1. Accidentally Retired

    Yes, the question should be, am I being as tax efficient as possible? Once you can answer that question as yes, the amount you are paying doesn’t really matter. You know your doing the best you can given your income/allowed deductions.


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