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Sa ve Money with These Tax Stra tegies

Tax-free income is exactly that—tax free. It’s smart to know the ways you
can achieve tax-free income. Let’s say you are beginning to earn more income.
That’s great, but now you’ll have to pay more tax; 35 percent in federal taxes,
and 7 percent in state, for a total of 42 percent. You shop long and hard for a
good money market rate, and find one that pays 6 percent. Unfortunately,

much of that interest income—about 40 percent—is lost in income taxes, and
you end up with an effective gain of 3.6 percent, a little more than half of
what you had hoped to yield. Tax-free investments may yield lower returns,
but at a higher tax rate than many after-tax investments. One example most
working Americans are familiar with is the onetime break they get from
the federal government when they sell their personal residence. If you use a
home as your main, or principal, residence for any two out of the preceding

five years, any gain is tax-free, up to the first $250,000 for single fi lers, or

$500,000 for married filers. Adding a few thousand or more tax-free dollars
to your portfolio from the sale of your house is a smart move that can gener-
ate wealth at an amazing clip.
In giving you this quick overview on the different types of income, my
purpose is to help you begin to understand that you can change the amount of
taxes you pay by changing the way you earn income. You have no control over
the type of tax you pay, or the amount of tax, when you work for an employer,
but you can dramatically lower your tax bill by changing the nature of the
income you receive. Look at Fred and Wilma. They earned the same amount
of income in Examples 2, 3, and 4, but their taxes varied dramatically. I con-
stantly challenge my clients to look for ways to generate types of income that
will yield preferential tax treatment for them. I want to help you do the same.

Making Tax Changes Means Making More Money

By now, I hope that you’re starting to realize that you must make some
changes if you want to improve your tax situation. In the previous section, we
discussed how different types of income can benefi t you. Now I want to talk
about how changing your taxpayer status can benefi t you.
A working knowledge of this subject can help you map out a plan to cut
your tax bill signifi cantly.

Individuals

We’re used to being individual taxpayers; that’s our default status. If you do
nothing to change this status, however, you will be taxed at your full income

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