Karl Frank's new book, "Go Tax Free," might be a hyperbole, but he says almost all taxpayers can take steps to significantly reduce the amount of money they hand over to Uncle Sam every year. "Most people pay more than we have to, and that's a shame. It doesn't take a whole lot of planning and foresight to reduce your tax burden, but you have to do the work," says Frank, a certified financial planner and president of A&I Financial Services LLC in Englewood, Colo.
Now, with plenty of time before the end of the year, is the time to figure out how. Frank says the group that's most primed to cut their taxes are professionals, which he describes as "folks who are already spending below their means and who don't need budgeting help, but who aren't so wealthy that they can hire a team of advisers."
As for the ethics of minimizing your tax burden, Frank says there's nothing wrong with simply taking advantage of the existing tax code. "You have the ability to act with your own integrity and do everything appropriately … We all want more choice and control," he says.
Frank writes about the most universally-applicable techniques, but he emphasizes that everyone's situation is different, and anyone attempting a complex tax move, like taking out an annuity, should consult a financial professional. The worst tax advice, he says, involves blanket statements. "There are no absolutes, and planning thrives in the exceptions … it's really about an expert doing a good job getting to know you," he says.
Still, there are some common areas where Frank says people tend to overpay in taxes. Here are five ways many people can reduce their tax burden:
1. Save more money for retirement.
Frank recommends using individual retirement accounts, either the traditional or Roth variety, to pay fewer taxes while squirrelling money away for retirement. With a traditional IRA, users deduct contributions from their taxes and don't pay anything on the earnings until the money is distributed. With Roth IRAs, after-tax money enjoys tax-free earnings. "I would love to see more people get their money into a Roth IRA. Almost everybody can do it, but there are some income limits," Frank says. Those income limits start at $112,000 for heads of households.
2. Take advantage of other types of savings and investment vehicles.
In general, municipal bonds enjoy a triple tax exemption at the county, state and federal levels, which leads Frank to call them a "great tax planning tool." Still, he warns that bonds will get hurt if interest rates go up (and default is also possible), so there is some risk involved.
Stocks enjoy other tax advantages, too, especially if you plan to pass them on to heirs. "You can buy a stock today, and it's growing tax-deferred, and when you die, your kids can inherit it and get a step-up in basis," which reduces their tax burden, Frank says. The step-up in basis essentially counts the asset at its value at the time of inheritance, and not original purchase.
3. Start your own business.
Frank credits his own relatively light tax burden partly to the fact that he's a business owner. "Business owners have more choice and control over their taxes than anyone else," Frank says. Business owners can keep money in the company to pay fewer taxes, he says, as well as count certain expenditures as company expenses.
4. Have kids.
"From a tax planning perspective, don't skip out on having kids," Frank says. In fact, he says his daughter, now 21, saved his finances back when she was born. At the time, her birth (and status as a dependent) allowed him to qualify for the earned income tax credit, which was $3,000. "It changed my life," says Frank, who adds that most people who qualify for the earned income tax credit don't take it. (Low- to moderate-income working taxpayers are eligible.)
Parents can also take advantage of other tax benefits, such as 529 college savings plans where money can grow tax-free and pre-tax flex spending accounts for child care costs.