Warren Buffett paid a lower tax rate than most of us because the majority of his income comes from investments creating capital gains (long-term) and dividends. This is income on money he already earned (and presumably paid a higher tax on previously). Income generated from buying and selling stocks or from stock dividends is generally taxed at 15 percent. Additionally, Buffett doesn't have to pay a payroll tax (currently 4.2 percent).
Buffett has said his effective tax rate is 17.4 percent. You can estimate your effective tax rate here.
How can you plan for a future where you create income that is more like Warren's? It starts with setting aside investable savings. Perhaps that means saving your tax refund this year. You'll need to invest that savings and hold it for over a year. If your investment grows, that growth will be taxed at 15 percent. This is in contrast to the short-term capital gains rate (on investments held for less than one year), which is taxed like regular earnings. Once you've saved more on your tax bill, that savings can be invested too! Here are a few ways to do it...
Commonly overlooked tax savings opportunities include:
1. Child Care Credit -- Can reduce your tax bill dollar for dollar
2. Earned Income Tax Credit -- For low-income workers
3. Student Loan Interest paid by Mom and Dad -- It's treated like a gift so you can deduct it
4. IRA or 401k deductions -- You receive a deduction now, plus growth in these accounts is not taxed
4. State Sales Tax -- Applicable for those living in a state with no income tax
5. Reinvested Dividends -- Should be included in your cost basis so that when you sell (at a gain) they aren't taxed
It is important to keep track of bills, receipts, and other items all year long so that you can work with your tax professional to make smart tax decisions in December of the year you are being taxed. If you wait until April, often times it is too late. Examples include offsetting capital gains with capital losses (known as tax harvesting) and coordinating your charitable giving to best suit your tax situation. Additionally, some tax advantages require you to carry forward items several years, so you want to be sure you have records in place. If you are audited, these records will come in handy and make it a less hectic process.
You don't want the tax climate to dictate your financial decisions. When you're making decisions to lower your taxes, you want them to make good financial sense as well. (For example, you could reduce your income to get into the low income tax bracket and pay below 15 percent, but that wouldn't make any financial sense).
Bottom line, every penny you save can be invested (and taxed) at a long-term capital gains rate so that you can be more like Warren!
At SaveUp, we encourage you to do just that. At SaveUp we offer rewards for your good financial actions -- including saving money and filing your taxes on time! One of the many prizes you can win is a TurboTax sponsored prize to double your refund. This year you could bring yourself one step closer to being in Warren's tax bracket.