Friday, August 31, 2012

How Many Tax Rates Should You Have?

What is your tax rate?

Some people may be able to answer this off the top of their head. When they do, they are probably thinking about their personal effective tax rate - which is their average tax rate. It's pretty rare that someone is aware of all the tax rates available to them.

Understanding ALL of the tax rates available to you is a great way to identify opportunities to reduce your taxes.

Most successful tax strategies have several tax rates.

Individual Tax Rates
Individuals, in all countries, typically have several tax rates which usually include:

- Tax rate on earned income
- Tax rate on ordinary income
- Tax rate on investment income (such as dividend income or capital gains)

Which tax rate applies to you usually depends on the type of income you have.

In the U.S., tax rates can range from 0% to 40% and sometimes even higher. If you are able to change the type of income you have from one that is taxed at 25% to one that is taxed at 15%, you've just eliminated 10% of your tax - permanently!

This type of planning must be done before the transaction takes place - sometimes even years before.

A great example of this came up in a recent Ask Tom Live session. A real estate investor shared a deal he has had in the works for a few years. He was now at a point where he was making a decision about the direction of this investment.

I was really excited when he explained his situation because I knew there was huge opportunity with changing the type of income the deal would produce and that would lead to a much lower tax rate. I shared with him how he could reduce his tax rate on his deal by up to 25%.

Beyond Your Individual Tax Rates
To take this planning to the next level, consider not just your tax rates but the tax rates of others.

For example, some entities have their own tax rates. If the entity's tax rate is less than the individual's tax rate, there is opportunity for tax savings.

The Government Wants You to Reduce Your Taxes
Think about all of the tax rates available to you. Are there any tax rates you should add to your tax strategy?

Remember, the government wants you to reduce your taxes and using lower tax rates is perfectly legal as long as you follow the rules.

What is your tax rate?

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