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These Households Earned Huge in 2020 and Avoided Taxes; Here's How They Did It

For 30% of these taxpayers, the exclusion of interest income from municipal bonds was one of the primary secrets that helped them dodge taxes.

BY KRITIKA BHATIA

PUBLISHED MAR 12, 2024

Cover Image Source: Federal tax forms | Photo Illustration by Scott Ols | Getty Images

Earning an income without having to pay taxes on it is still a dream for many. People are always concerned about reducing some amount of taxes from their ITRs and getting refunds. Some of the legal tactics used by people include smart investments, leveraging tax deductions, or mentioning special investments with the help of a CA. As per a report published by the IRS, in 2020, a small group of taxpayers with huge incomes managed to save all of it without paying any taxes. From over 160 million tax returns filed during the pandemic year, around 9,300 tax returns showed at least $200,000 in income but no federal income tax to pay. This was done by using various credits, deductions, and exemptions, as per the Internal Revenue System department.

Employees work relentlessly to make their incomes tax-free. Image Source: Pexels|Photo by Nataliya Vaitkevich — Employees work relentlessly to make their incomes tax-free (representative image) | Pexels | Photo by Nataliya Vaitkevich

But how can one do that as many people are going crazy on savings taxes? One such way is investing in government-issued municipal bonds. The investment bonds are provided by the state and local government and are aimed at funding big public projects. The catch here is that the interest on such bonds is exempted from federal as well as state taxes. For 30% of these taxpayers, the exclusion of interest income from municipal bonds was one of the primary secrets that helped them dodge the taxes. However, if the investors wish to sell their bonds, they might have to pay capital gains taxes.

Federal Reserve increased its interest rate benchmark to the highest level in twenty years and the taxpayers are wondering when the rates will see downtime again and how it will impact their portfolios. For example, in October 2024, the investment-grade corporate bonds profit reached almost 5.3%. Besides this, the maximum you could make from the tax-free municipal bonds was 3.39%. Currently, many investors are putting their money into bonds to get fruitful returns. They can either buy them directly or invest in municipal bond mutual funds and ETFs (exchange-traded funds). By the end of January, there were about $759.6 billion in capital invested in municipal bond mutual funds. On the other hand, municipal bond ETFs had about $123 billion in assets by January 2024, showing an increase of almost 46% from March 2022. The tax regimes and their impact on the general public can be determined a lot by the Presidential elections.

Profits on municipal and corporate bonds tend to follow the Treasury's (treasury bonds) revenue patterns. Investors can turn to several online calculators to determine whether or not bonds are a wise investment option for them. Investment in taxable and tax-exempt bonds majorly depends on the rates they provide and for this reason, people who fall into the 32% tax bracket are usually inclined towards investing in municipal bonds instead of taxable corporate bonds. Municipal bonds are generally more beneficial for individuals and families in higher tax brackets because they provide better returns after taxes compared to taxable bonds.