“I thought only corporations could do that”. Not quite. Reducing taxes is perhaps not so easy though, especially if you are against the idea of moving abroad. We look at some viable ideas.
DISCLAIMER: Keep in mind that taxation is not a universal matter and highly depends on where you live and work. This article should only serve as an appetiser for you to make your own research on the topic. For reliable information, consult a local tax advisor. It is also worth mentioning that you should always try to minimise taxation by complying with the law. Tax fraud can result in heavy fines and sentences. We strongly discourage it.
- Learn about tax deduction with debt
You might not be aware of this, but debt is tax-deductible. This means that as you take on debt, you effectively reduce your taxable basis. There lies the ultimate wealth trick of the rich. They use debt to avoid taxes. In addition to seeking cash-flow positive investments, the rich use a large amount of debt to cover such investments. They borrow money to buy income-producing assets. Debt then allows them to “cancel” their profits from their taxable income, leaving them with close to no tax to pay.
A word of caution should be addressed, however. Taking on debt should be done in the right way in order to grow your wealth. Taking on consumer loans to buy rapidly depreciating assets like cars is possibly the worst you could do just to deduct taxable income. The goal is obviously to increase your wealth and not to destroy it. This is why you should always consider using debt for cash-flow positive investments. In other words, buying an asset that yields more than it costs you in interests. Buying a home does not quite fit in that description if you do not rent it out. Or at least partially. However, it is a much more valuable asset than buying a car or a brand new TV. It is not quite a cash-flow positive investment per se, but won’t hurt your wealth quite as much as when you buy depreciating assets.
2. Using a business structure
In some cases, it might be wise for you to use a company structure of some sort. If you are self-employed, you have probably at least considered the move. However, even if you are not doing business on your own, companies can have their perks. They can offer more attractive accounting possibilities for some aspects. For instance, having a company allows you to reinvest profits before they are taxed. This can be extremely practical for building wealth. Another perk is that you can divide a company into shares and thus give it to family more efficiently.
If you manage rental real estate or if you manage a decent asset portfolio, it might also justify looking at incorporating. In those cases, a company, a trust or a fund could help you reduce taxes. As always, this highly depends on your geography and the options that are available to you. It is often a matter of taxation ratio that determines if such a strategy would reduce or increase your taxable income. Unfortunately, there is no rule of thumb.
3. Some purchases are tax-deductible
Depending on your professional status and where you live, some purchases might be tax-deductible. As a self-employed, you might be able to enjoy tax deductions on insurance premiums, internet and phone bills, meals, travel, subscriptions, etc. If you are an employee, there might also be a range of expenses that can be covered by your employer or that would reduce your taxable income. It’s always worth finding out. Those can make a huge difference in the long run!
4. Minimise capital gains
If you have experience with investing, you know how painful capital gains can be. Some countries really crackdown more than others on investment profits. For some, it has been sufficient to justify building complex wealth structures to try to reduce capital gains taxes as well as wealth taxes.
It is very hard to escape the capital gain tax, at least legally. If you are subject to it–regardless of the size–you should try reasoning accordingly when investing. Simply put, the more you profit-taking, the more you owe in taxes. Since you will not be taxed on your gains until you realize your profit (i.e. you sell your asset), it might be wise to pool your profit-taking. You can do that by minimising the number of transactions. If you invest in cryptocurrencies, for instance, one way of avoiding capital gain taxes is to swap cryptocurrencies, rather than sell for fiat currency. Stablecoins are an effective way to achieve the desired effect.
Other factors are at stake to try to minimise your capital gain taxes. In fact, you should seek to reduce your opportunity cost and maximise the compounding return of your investments. By deciding to take your profits, you give up what is taxed that could have generated even more return. Even if you decided to reinvest the proceeds, a part of your profits would still be foregone. This is why it is a matter that requires more thought process.
Another solution used by the rich is to not sell the asset. This means not incurring a capital gain tax to rather borrow against it if ever in need of liquidity. Rather than selling a rental house, you could seek to refinance it for instance. This is easily made possible in cryptocurrency as well. With this, you both minimise capital gains and deduce taxes through debt.
5. Consider moving your company abroad
Again, this is a tip that would not suit everyone. However, it is worth mentioning that by company, we also englobe self-employed workers such as freelancers. For instance, Baltic countries like Estonia–and soon Lithuania–attract digital nomads and freelancers with their e-residency program. It offers great advantages to their e-residents, although it has nothing to do with traditional residency or nationality programs. Perks such as easy and fast digital business administration allows one to launch an Estonian company in an instant. The tax rate can be attractive, although it will always be lower elsewhere.
Whether you have use of moving your company off-shore depends on your own situation. You as a freelancer, business owner as well as your current country. It highly depends on how you deliver services. In general, there is a strong chance that you find a suitable opportunity if you research off-shore taxation. Not everything is the Cayman Islands or Panama related.
6. Home office deductions
Some countries offer tax deductions if you have set up your company office at home. Finally, a nice gesture from governments, recognizing the difficulty for small business owners to keep up with start-up costs. You might be in a position to take advantage of it. With the pandemic, however, it is unclear as to if this will be sustained or rather inversed given the increased tendency to work from home.
7. Consider moving abroad
In line with the previous tip, how about you would actually move abroad for a wealthier life? Fair enough, we know that most people will instantly pass on this one. However, we take great inspiration from Nomad Capitalist’s Andrew Henderson who preaches the “go where you are treated best” mentality. If you feel crushed by the tax burden of your country, if you feel that it does not reward you near enough for your efforts, then you should probably at least consider it. It is so easy to obtain information on the global tax rates by simply screening search engines. Once you do that, if you feel an appetite for what you read, it’s probably a good sign!
Regardless of the experience that moving abroad can be, it is often the case that countries require 6 months of yearly stay to ensure that you are based there. This still leaves half of the year free to either live someplace else. Basically anywhere. Some countries offer incredibly attractive tax rates, just think of the UAE who offer close to no taxation (if we exclude VAT and taxation on oil proceeds). Investors also have an incentive to look abroad as many countries tax as much as 30% on capital gains. This is why we are seeing a generational wave of crypto investors moving abroad. As always, this is will always be according to your personal preference.
8. Research potential tax credits
As presented in our “All you need to know about Personal Finance” ebook (available for free here): It is important to understand the difference between tax deductions and tax credits.
Tax credits are the amount of money a taxpayer is permitted to extract from his or her taxes. Tax deductions on the other hand reduce the amount you are to be taxed on. Tax credits actually reduce the amount of tax you owe, while tax deductions reduce the amount on which your taxes are computed. This means that a 1,000€ tax credit will save you much more than a 1,000€ deduction.
As you would imagine, tax credits are more seldom found than tax deductions. However, we invite you to research what is part of the tax credits that your country offers. You might find out that some of the things we have presented as tax deductions are in fact available as tax credits in your home country.
Another type of tax-deductible expenses is… charitable donations. In some countries such as Canada, they are even subject to tax credits. Up to you to work out if the math of giving money away to “have it back” in some other sort. Let’s not forget that the real thing at stake here is to help the ones in need. However, if tax deductions can facilitate the giving, then it’s a win-win.