Since ancient civilizations, governments have used taxes as an important revenue. With this long history, taxes keep funding public services and infrastructure worldwide. Sometimes, paying taxes might be complicated, and it is not easy to catch up with the details of the law. In this article, we explained some of the key points that can help you legally avoid paying taxes and reduce your tax burden.
Tax deductions, tax credits, and some investment options can help you legally reduce how much tax you should pay. Eventually, you may have more money left from your earnings. Let’s explore the legal strategies to pay less tax legally.
What are Income Taxes?
Even if you do not see yourself informed enough about taxes, you must be familiar with income taxes. It is your individual or personal income tax that is levied on your wages, salaries, dividends, interest, or other income you might earn during the year. The calculation of the income tax is dependent on the state in which you earn your income. On the other hand, some states avoid double taxation by letting your earned income be taxed in your state of residence in case that state has reciprocity agreements with other states.
Law says that as a taxpayer, you must file an income tax return annually that will, in the end, determine your tax obligations.
What Does Taxable Income Mean?
Taxable income means the portion of your gross income. The reason it is used is to calculate how much tax you owe in the given tax year. It can also be called adjusted gross income, AGI, that is minus allowable itemized or standard deductions.
Remember that most income is taxable if there is no specific exemption by law. Your income can be your money, property, goods, or services. You do not need to wait to receive a form to report your income. In any case, you are expected to report your income on your tax return.
Federal Income Taxes
The Internal Revenue Service (IRS) imposes federal income tax on the yearly income of individuals, corporations, trusts, and other legal entities. All sorts of earnings, including commissions, bonuses, tips, wages, salaries, investment income, and some unearned income, are subject to federal income taxes and constitute a taxpayer’s taxable income.
Individual federal income tax rates in the United States are progressive, which means that they rise in line with taxable income. As of 2024, the federal income tax rate ranges from 10% to 37%, with rates applied at certain income thresholds. Tax brackets are the ranges of income to which the rates apply. Every income bracket’s associated tax rate is applied to income falling inside it.
Healthy Saving Account
A particular kind of savings account that permits you to deposit funds for qualified medical costs before taxes. You may be able to reduce your out-of-pocket medical expenses by utilizing untaxed cash in an HSA to cover certain additional charges such as coinsurance, copayments, and deductibles. Generally speaking, premiums cannot be paid with HSA funds.
You can contribute to an HSA if you have an HSA-eligible plan, also known as a High Deductible Health Plan (HDHP), which is typically a health plan (including a Marketplace plan). It only covers preventive services before the deductible. However, it is possible for you to use the funds in an HSA at any time to pay for qualified medical expenses.
Tax Deduction
Every year, taxpayers can claim several credits and deductions on their taxes that might help them pay less in taxes or even get a refund from the IRS.
Tax Avoidance vs. Tax Evasion
As we mentioned before, tax is not a generally easy topic. So, it is normal that there are a lot of misconceptions. For instance, tax avoidance may be confused with tax evasion. But both are very different concepts; while tax avoidance is a legal way of reducing taxes, tax evasion totally illegal.
In order to make the difference between the two more understandable, please see the distinctions between them and have a clear view of the legal way you will follow.
Legality: While tax avoidance operates within the restrictions of the law by employing legal strategies to lower tax liability, tax evasion is unlawful and entails purposeful misrepresentation to trick tax officials.
Transparency: Using legal tax breaks and exemptions is a common component of tax evasion, which is usually apparent. Tax evasion, on the other hand, is opaque and involves dishonest methods like underreporting income or fabricating documentation.
Penalties: Because tax evasion is unlawful, it can result in harsh punishments, such as lengthy jail terms and substantial fines. On the other hand, there are no penalties associated with tax avoidance; nonetheless, authorities may contest excessively active avoidance strategies.
Ethics: Tax evasion is excessively aggressive, and ethical concerns may arise.
Impact on Public Finance: Although tax evasion is illegal, extensive use of tax avoidance by wealthy individuals or businesses can put a burden on public finances. It lowers the revenue base that is required to pay for public services.
Tax Avoidance
After the comparison, let us get you through more detailed information about tax avoidance and what it means for your budget control.
Tax avoidance is legal. It simply means taking advantage of any tax deductions, tax credits, or other tax-reducing incentives that are available through a tax system.
Tax avoidance can be a legal way to avoid paying taxes. For instance, you can avoid paying taxes by using tax credits, deductions, exclusions, and loopholes to your advantage. Corporations often use different legal strategies to avoid paying taxes. These include offshoring their profits, using accelerated depreciation, and taking deductions for employee stock options.
Tax avoidance can be illegal, though, when taxpayers make it a point to ignore tax laws as they apply to them deliberately. Doing so can result in fines, penalties, levies, and even legal action.
Tax Evasion
It is an illegal activity that happens when someone avoids paying a true tax liability. If this person is caught when evading taxes, it is general that this person is subject to criminal charges and substantial penalties.
Tax evasion may involve the following:
- Dishonest tax reporting
- Overstating the deductions
- Profits, or gains rather than the amounts actually earned
Top Personal Income Tax Rates in Europe in 2024
| Country | Top Statutory Personal Income Tax Rate |
| Austria | 55.0% |
| Belgium | 53.5% |
| Bulgaria | 10.0% |
| Croatia | 35.4% |
| Cyprus | 35.0% |
| Czech Republic | 23.0% |
| Denmark | 55.9% |
| Estonia | 20.0% |
| Finland | 51.4% |
| France | 55.4% |
| Georgia | 20.0% |
| Germany | 47.5% |
| Greece | 44.0% |
| Hungary | 15.0% |
| Iceland | 46.3% |
| Ireland | 48.0% |
| Italy | 47.3% |
| Latvia | 31.0% |
| Lithuania | 32.0% |
| Luxembourg | 45.8% |
| Malta | 35.0% |
| Moldova | 12.0% |
| Netherlands | 49.5% |
| Norway | 39.6% |
| Poland | 36.0% |
| Portugal | 53.0% |
| Romania | 10.0% |
| Slovakia | 25.0% |
| Slovenia | 50.0% |
| Spain | 54.0% |
| Sweden | 52.3% |
| Switzerland | 39.5% |
| Turkey | 40.8% |
| Ukraine | 19.5% |
| United Kingdom | 45.0% |
Source: PwC Worldwide Tax Summaries
How to Legally Avoid Paying Taxes for Freelancers
By choosing to reside in countries with advantageous tax policies or those that do not impose income taxes, digital nomads can lawfully lower their tax obligations. They frequently use international tax treaties to their advantage and establish their companies in low-tax jurisdictions.
Generally speaking, digital nomads who live in a state for a certain amount of time throughout the tax year and get income there are required to file state taxes. Still, some US states tax their former citizens as well. After they move out, these states have the authority to tax digital nomads if they provide ID cards or driver’s licenses.
Self-employment tax deduction
The typical self-employment tax for independent contractors, freelancers, and business owners is 5.3% of net profits, calculated after business expenditures. So, this percentage covers your social security and medical contributions.
Making the most of a self-employment tax deduction program is one of the simplest methods to lower tax obligations and pay no taxes at all. If your self-employed income meets certain permissible expenses, you can deduct a portion of it from your taxable profit in the United States.
To be eligible for the tax deduction on self-employment, you need to be:
- An individual business owner
- An associate within a collaboration
- An LLC’s (limited liability company) member
- Submitter of a tax return together with a Schedule C or Schedule C-EZ (Form 1040)
Deduction for business expenses
Savvy entrepreneurs make the most of the opportunity to claim business expenses as a tax deduction when they file their taxes. This covers expenses for your home office, phone and internet fees, supplies for your craft, marketing and advertising, client meetings, business travel, industry-related education, and more.
You must maintain documentation of all your yearly deductions for company expenses and ensure that you are aware of the goods that qualify for tax exemptions. Additionally, you must make sure that you only deduct business-related expenses in accordance with tax rules. If not, the Internal Revenue Service or another federal tax body may impose harsh fines on you.
The standard mileage deduction can be utilized as an additional method of deducting business expenses. You can deduct a specific amount using this strategy for each mile you drive on business travel. Given that it remains an expense for any business owner, that makes sense in the long run. While commuting to and from work, this may not always be applicable; nevertheless, it can be applied when attending business meetings.
Just be sure to abide by the tax laws in your nation and to use the appropriate tax code on all of your filings.
Contribution to a retirement plan
As a freelancer, you can contribute to a retirement plan in a few different ways. This is also one of the easiest ways to legally avoid paying too much or too little in taxes. If you’re an American citizen, there are two typical methods to accomplish this. These are the following:
- Put money into an Individual Retirement Account (IRA)
- Make a Roth IRA contribution
Contribution to an HSA
The first step is opening a health savings account, or HSA for short. It functions similarly to a medical IRA in that it helps pay for medical costs in the event of illness.
You must visit a bank or other financial institution that offers HSA accounts in order to open an HSA.
Just remember that in addition to a high-deductible health insurance plan, you also need to get one, as these policies have cheaper premiums than those with lower deductibles.
When tax season arrives, how can an HSA assist you?
The annual cash restrictions indicated below apply to the annual HSA contributions that you are able to deduct from your income taxes each year.
- The money in your HSA is not subject to taxes on any income it may receive.
- Withdrawals made to cover medical costs will not be subject to taxes. Withdrawals made for non-medical costs will incur penalties and taxes.
- You are not charged a fee if you take money out of your HSA for any reason at all once you turn 65 or become incapacitated. Additionally, you only have to pay ordinary income tax on withdrawals made for non-medical costs.
Donation to a Charity
In 2024, charitable contributions will need to be claimed by taxpayers as itemized deductions on Schedule A of IRS Form 1040 under the heading “Gifts to Charity.” Because they are all tax deductible, it’s crucial to request a tax receipt if you donate clothing, make an online donation, or go to an in-person or virtual charity event. You can include even the costs of volunteering, such as automobile mileage.
You can lower your income, which is taxable if you donate as a freelancer. You may contribute to a private foundation or registered charity and receive a tax receipt.
Here are a few things to be mindful of:
- Contributing to a recognized charity
- Maintaining a record of all your donations
- Making sure to disclose your donations when submitting your taxes
Claim of Child Tax Credit
The Child Tax Credit (CTC) offers an additional way for business owners with children to lower their taxes. The starting amount tax credit for your 2023 taxes is $2,000 for each eligible child. In order to be eligible for the tax credit, your kid must also be younger than age 17 at the conclusion of the calendar year.
For parents who pay taxes and have dependent children under the age of 17, there is a tax credit called the Child Tax Credit. Each child is eligible for a refundable tax credit of up to $2,000, which can be claimed each year when filing taxes.
Time year-end income and expenses
The tax year for almost all freelancers is the calendar year, and they all file on a cash basis.
Cash basis refers to the practice of only counting income in the year of receipt. Additionally, you write off a cost in the year that it was purchased.
It is significant because it enables you to do some astute year-end tax planning. You can reduce your annual tax burden. You could expedite the payment of deductible expenses while deferring income.
Waiting to bill consumers until the next year is one strategy to postpone income. Remember that just waiting until the next year to cash a cheque won’t save you from having taxable income. When you receive a check, rather than when you cash it, it counts as income.
Purchasing items for your company before the end of the year is another way to choose to raise your deductible expenses for the year. The best news is that you can benefit from the deduction even if you don’t need to pay cash by December 31. You can use your credit card in its place and fully deduct the cost.
The Wrap Up
The most important outcome of this article may be to remember that you need to pay all that you legally owe to tax authorities. However, we highlight that nobody has to pay extra. By discovering the legal methods in this article, you can find options to minimize tax liabilities.
With proactive management of your finances focusing on tax efficiency, you can safeguard more of your hard-earned money. And you do everything according to the law. In the end, you have the chance to contribute your fair share to public coffers, and you also protect your financial health and future at the same time.
Frequently Asked Questions
How can I reduce my taxable income legally?
You can reduce your taxable income legally. Your method can be saving for retirement through tax-deductible contributions, investing in tax-exempt bonds, and utilizing flexible spending plans that employers offer.
Is avoiding taxes legal?
Tax avoidance, which involves using legal methods like claiming allowed deductions and credits to reduce your taxable income, is legal.
How do you calculate taxable income?
To calculate taxable income, you add up all sources of taxable income and subtract any deductions to find your taxable income amount.
What are the tax avoidance examples?
Tax avoidance examples include claiming allowed tax deductions and credits, making tax-advantaged investments, and receiving income as directors’ loans.
Which European countries offer the lowest tax rates?
European countries with the lowest tax rates include Bulgaria, Malta, and Gibraltar.
Which European countries offer the highest tax rates?
Denmark, France, and Austria have the highest top personal income tax rates in Europe.
Which Golden Visas have Tax Reductions for non-citizens?
Golden Visas that offer tax reductions for non-citizens include those from Italy, Greece, and Portugal.
How do I pay taxes in the US as a non-citizen?
Non-citizens living and working in the U.S. may be required to file a federal tax return.
How do I pay property taxes in Europe?
Property taxes in Europe are levied on assets like real estate and paid on a recurrent basis by individuals or legal entities.
