Dear Field Notes reader,
Death and taxes.
The only things that are certain in life. Or so Benjamin Franklin famously asserted in a 1789 letter, when he wrote “Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.”
Franklin may have penned that sentiment 232 years ago, but it is as true today as it was then. There is no way to escape taxes, especially as an American. You can, however, reduce your bill dramatically. And doing so is one of the best, smartest investments you can make.
One of the core reasons I write these letters to you is because I firmly believe that nowadays we all need to take personal responsibility for our finances…to learn about and implement strategies to protect and grow our nest eggs.
Many people shun this responsibility…and I completely understand why. They are following the rulebook of a different era—our parents’ era—when you could simply rely on your corporate pension or stroll down to your local bank and lock in a 5% or 8% return on a certificate of deposit. Funding your retirement…well, it just wasn’t something you had to spend a lot of time thinking about.
Obviously, that era ended many years ago. The practice of companies sending monthly retirement checks to former workers is a footstep away from extinction. Savings accounts, meanwhile, are about as relevant to modern life as Walkmans, Ataris, and parachute pants. Today, the national average interest rate on savings accounts is a pathetic 0.04%, according to the Federal Deposit Insurance Corporation.
So, we are left with two choices: watch as inflation erodes the value of our hard-earned scratch (and inflation is set to return big time this year, likely reaching 4% to 5% or more), or take the necessary steps to protect and grow our nest eggs.
There are a number of ways to achieve the latter. I often write to you about how to invest in stocks, gold, cryptos, and other assets. These strategies are essential. But we also need to think about how to decrease the money going out, and one of the best ways to achieve this is to legally reduce our taxes.
The bottom line: There is no better risk-adjusted return than slashing your tax bill.
To achieve a 20% or 30% return on stocks or alternative assets, you have to be willing to take significant risks. But there are effective, and completely legal, ways to reduce your tax bill by this amount…risk free.
One of the most effective is to move overseas. This strategy is increasingly viable in this age of remote working, and it’s the one I’ve pursued by moving to Prague in the Czech Republic.
Living overseas, you’re eligible for the Foreign Earned Income Exclusion. This allows you to exclude up to $108,700 in earned income from your personal income tax in 2021. As an expat, you can also claim foreign tax credits from Uncle Sam, meaning whatever taxes you pay to the local government you can generally deduct from the taxes you owe in the U.S., dollar for dollar. Plus, you get a foreign housing cost exclusion that can knock off as much as $15,218 from your taxes, based on where you live overseas.
For my taxes to the Czech government, I write off 60% of my income and then pay taxes at a 15% personal rate on the remaining amount. Every month, I also pay just under 15% into the local Social Security system and 6.75% for the state health system.
So all in, even though I’m filing taxes in the U.S. and the Czech Republic, I’m paying markedly less than when I was living and working back home.
While taking off overseas worked for me, I recognize that relocating to another continent is not for everyone. But there is a way you can remain in the U.S. and reduce your tax bill even more than I have—move to Puerto Rico.
Sunny, culture-rich Puerto Rico offers significant tax incentives.
Puerto Rico is a U.S. Commonwealth. That means some things fall under U.S. law, like customs and immigration (so you don’t need a passport to visit), while other things are independent, such as the tax system.
Puerto Rico has used this autonomy to extend generous tax incentives to attract business owners, contractors, and self-employed people. These include zero federal income tax, a 4% corporate tax, and zero tax on capital gains and dividends.
Under these incentives, if you move to Puerto Rico, incorporate a business there that’s providing a service, and that service is being sold to people outside of Puerto Rico, you’ll pay a meager 4% corporate tax and zero dividend tax, instead of the 21% corporate tax in the mainland U.S., plus another 20% dividend tax.
These incentives do not apply to remote employees. However, if you can arrange to work remotely full time, and you transition to being an independent contractor based in Puerto Rico, then you’re exporting your services—so you can qualify for the tax incentives.
Similarly, if you’re an investor based in the U.S., you’re paying a top 20% tax on dividends and capital gains and a host of state and local taxes. But if you move to sunny Puerto Rico, then all your future capital gains on stocks, bonds, and cryptos become tax free, so the IRS can’t touch any of your investment income.
Of course, there are caveats to all of this. You must be a bona fide resident of Puerto Rico to avail of these incentives.
Moreover, in order to qualify for zero capital gains tax, you need to make an annual donation to official charities in Puerto Rico of $10,000. Also, you need to pay a yearly filing fee of $5,000, and within two years of obtaining your capital gains tax exemption you will need to buy a property in Puerto Rico and use it as your primary residence.
Still, the broader point here is to look seriously at your tax options. In this emerging work-from-home, work-from-anywhere era, many of us have far greater freedom to choose where we live…which means we have far greater freedom to escape excessive local, state, and federal taxes.
As U.S. debt soars to unprecedented levels, this is a good time to consider how you can keep more of your wealth in your pocket.
