Author Topic: Taxes backwards, how can I make sure I pay enough? Anyone else done this?  (Read 13132 times)

dsmexpat

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I'm in my first year of working in the US so I've not yet had to pay taxes (no income 2014) but I'm studying the tax code for fun. It's a system with a complicated set of rules but one which can be broken down and optimized. The problem I'm running into is that my wife and I don't have huge incomes and the conventional strategy of tax minimization, where you try and pay as little as possible, is far from optimal for us. We were both eligible for the retirement savings contribution match, we were eligible for EITC but we'd tax deferred too much of our income and hadn't paid enough in tax to actually use our credits.

What I think I need to do is assume that AGI is a variable, depending upon how much we defer to retirement accounts, and therefore tax owed is a variable. I need to match the taxes owed to the credits available (which also vary by AGI) to have as much as my income classified as post-tax as possible without actually paying tax due to credits. Most of the strategies in the FI community that I read about here are rules which will generally apply for incomes above a certain level (such as T IRA > ROTH IRA) but things get really weird in the low income areas where the effective tax rate can go into the negatives and a completely different set of strategies apply.

Anyone tried to solve this before? Maybe with an obscenely complicated spreadsheet?

Edit: Okay, EITC sucks if you don't have children. It's pretty good but it's basically impossible to claim in any profitable way if you're already claiming other tax credits. If your AGI is high enough to pay enough in tax to get the EITC back after already claiming the Saver's Credit then you're ineligible to pay it. There is a sweet spot at the AGI of $20,329 where you're eligible for a $503 tax credit and have owed $2141 in taxes but you're already getting $2000 of that back in the Saver's Credit so in real terms you're just getting $141 off of your taxes. At an assumed 15% tax rate that's a tax free conversion of $940 from pre-tax to post-tax which is nice but nothing special. Now if you have one or more children then it becomes way more fun but that's where I need a spreadsheet where I can input variables.
« Last Edit: April 15, 2015, 08:54:34 AM by dsmexpat »

Sibley

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Well, first the EITC (earned income tax credit) is a refundable credit. Not sure about the saver's credit. So you saying that you couldn't get the EITC doesn't make any sense to me.

There are 2 types of credits in US taxes - refundable and non-refundable. Refundable you get the money regardless of your tax liability. Non-refundable are limited to your tax liability.

In terms of playing with the numbers, it's easier to plug various scenarios into the forms. I'd use a tax software, find one of the free ones online and play around. Couple that with research into the various elements and you'll have a good start. There are people who advocate doing taxes by hand on the paper forms. That is helpful when you're trying to figure out how things flow, but it takes a lot of time and is less accurate.

If you've recently immigrated to the US, you may be falling under a completely different set of rules than what I know. I don't know any of the international taxation. If that's the case, then it's possible that some of the options I could use aren't available to you.

dsmexpat

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Well, first the EITC (earned income tax credit) is a refundable credit. Not sure about the saver's credit. So you saying that you couldn't get the EITC doesn't make any sense to me.

There are 2 types of credits in US taxes - refundable and non-refundable. Refundable you get the money regardless of your tax liability. Non-refundable are limited to your tax liability.
Where do you learn this, and which are what?

Assuming EITC is refundable and Saver's is non refundable the optimal low income solution would be an AGI of around $19,400 which would amount to $2,006 owed, qualify you for the 50% match on the Saver's Credit on up to $2,000 for both husband and wife giving you a non refundable credit of $2,000 and a tax bill of $6. You then claim the full $503 refundable credit.

If we assume a $12,600 deductible then that means we can earn $32,000 before we play around with the retirement savings at all. Under that $32,000 number any money put into a t IRA rather than a ROTH IRA would be money wasted because your tax rate would be 0 and by deferring the tax on the money so you don't pay it all you do it reduce the amount of non-refundable tax you can claim back.
« Last Edit: April 15, 2015, 09:04:55 AM by dsmexpat »

terran

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The savers credit is not refundable, so you can only use it up to the point of having no tax liability.

I think you might be misunderstanding one thing. The amount of withholding has no bearing on the amount of credits you can get. Credits subtract from the amount you owe regardless of what you've already paid. Basically owing $100 and getting a $100 credit means you now owe $0. Owing $100, which you have already paid through withholding and getting a $100 credit means you get a $100 refund. Under both circumstances you end up with $0 paid in taxes at the end of it all.

Of course, my example ignores the interest you could have been earning on that $100 during the year, and it ignores that you might have been able to use that $100 for something during the year to help with your cash flow.

On the flip side, if you end up under withholding and owe lots of taxes you can end up paying penalties. Double check on this, but I think you get a free pass the first year on this, and only pay a penalty in future years if you continue to under withhold.

So the trick to all this is getting your withholding to match your tax liability as closely as possible so you don't give an interest free loan to the government for the year, and you don't end up with a penalty. The good news is that you'll end up with basically the same amount of money in the end though, just minus whatever small amount you would have earned in interest.

dsmexpat

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The amount of withholding has no bearing on the amount of credits you can get. Credits subtract from the amount you owe regardless of what you've already paid. Basically owing $100 and getting a $100 credit means you now owe $0. Owing $100, which you have already paid through withholding and getting a $100 credit means you get a $100 refund. Under both circumstances you end up with $0 paid in taxes at the end of it all.
I'm ignoring withholding entirely for now and assuming that it was all just calculated and settled at the end of the year (for my theoretical purposes, I am actually paying taxes of course). What I'm trying to do is make my tax bill match the non-refundable credits as closely as possible so that I can move as much money from pre-tax to post-tax as possible without actually paying tax. The traditional strategies I've seen in madfientist and the like don't match my current situation at all, they start with the assumption that your taxes will be a positive number and focus on trying to make it as low as possible, in my case they're a negative number which gets rounded up to zero so I need to try and pay more tax.
« Last Edit: April 15, 2015, 09:09:14 AM by dsmexpat »

terran

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Ah, ok. Then I think the big one you want to mess around with is the savers tax credit: http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-Retirement-Savings-Contributions-Credit-(Saver%E2%80%99s-Credit)

What you want to do then is adjust your traditional/Roth contributions to get just under $36500 AGI which will result in a tax liability around $1600 which, assuming you contributed at least $3200 to any kind of retirement savings, will be entirely wiped out by the savers tax credit   

If your AGI is already under $36500 without contributing to a traditional IRA/401k then you can just make sure you adjust your retirement contributions across all retirement accounts to make sure they're twice your tax liability, and there's really no advantage to contributing to traditional accounts at all, and you should go all roth.

You might find https://turbotax.intuit.com/tax-tools/calculators/taxcaster/ useful in helping figure out your tax liability for various after income levels before credits.

You can also sign up for both turbotax and taxact for free an play around as much as you want. They only charge if you want to file. They're obviously still 2014 editions though, so standard deductions and limits for tax credits  will be slightly higher next year.

I would try to get close for next year, but leave some space in your 2015 IRA's (both traditional and roth) since you can contribute up to April 15, 2016 for the 2015 contribution year.

dsmexpat

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Can you deposit in a 401k at any time the way you can with an IRA?

Gin1984

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Can you deposit in a 401k at any time the way you can with an IRA?
No, a 401k is a plan offered by your employer and is taken out every paycheck.

dsmexpat

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So you can't ask your employer to, for example, take 100% of the pay from November and December and put it in the 401k if it looks like your AGI is going to be too high?

Cromacster

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The companies I've worked for usually cap the 401k contributions between 40-70% of your paycheck.  You can't do 100% because you still need enough in leftover to cover the payroll taxes etc, Which is probably why employers cap it around 70%.

But yes most employers would let you increase your contributions up to whatever max they have set for the last few months of the year.

dsmexpat

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Okay, next question. What is the EITC phase out formula. I've found a number of calculator tools, I know the lower and upper limits but I cannot find the actual formula they use to calculate it? I need it for my spreadsheet.

MDM

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Okay, next question. What is the EITC phase out formula. I've found a number of calculator tools, I know the lower and upper limits but I cannot find the actual formula they use to calculate it? I need it for my spreadsheet.
terran already mentioned one of these web pages that will help evaluate some "what if?" options:
http://www.paycheckcity.com/calculator/salary/ or
http://www.bankrate.com/calculators/tax-planning/1040-form-tax-calculator.aspx or
https://turbotax.intuit.com/tax-tools/calculators/taxcaster/.

You could also use the spreadsheet linked in the case study sticky to evaluate your options, and if you look in there you can find the EIC formulas for 2015.

teen persuasion

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Well, first the EITC (earned income tax credit) is a refundable credit. Not sure about the saver's credit. So you saying that you couldn't get the EITC doesn't make any sense to me.

There are 2 types of credits in US taxes - refundable and non-refundable. Refundable you get the money regardless of your tax liability. Non-refundable are limited to your tax liability.
Where do you learn this, and which are what?

Assuming EITC is refundable and Saver's is non refundable the optimal low income solution would be an AGI of around $19,400 which would amount to $2,006 owed, qualify you for the 50% match on the Saver's Credit on up to $2,000 for both husband and wife giving you a non refundable credit of $2,000 and a tax bill of $6. You then claim the full $503 refundable credit.

If we assume a $12,600 deductible then that means we can earn $32,000 before we play around with the retirement savings at all. Under that $32,000 number any money put into a t IRA rather than a ROTH IRA would be money wasted because your tax rate would be 0 and by deferring the tax on the money so you don't pay it all you do it reduce the amount of non-refundable tax you can claim back.

EITC and Saver's credit don't play nice together.  Optimizing one lowers the other, it seems.  At $19,400 AGI you would be nearly phased out of the EITC (assuming MFJ 0 kids).  We've got kids and a relatively low income, which we lower further thru contributions to DH's 401k.  We try to maximise our EITC (cash back to us), but cannot make any use of the Saver's credit, since our taxable income is already 0.  Then I turn around and put the EITC refund in Roth IRAs for both of us.

Don't forget to take state and local taxes into account, they add more layers of rules and cutoffs and cliffs.  Our state matches EITC at 30%, and the child tax credit at 33%, so even with a lower standard deduction for state we end up with a positive refund.  Once the kids are gone the calculations change dramatically.

Sibley

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Well, first the EITC (earned income tax credit) is a refundable credit. Not sure about the saver's credit. So you saying that you couldn't get the EITC doesn't make any sense to me.

There are 2 types of credits in US taxes - refundable and non-refundable. Refundable you get the money regardless of your tax liability. Non-refundable are limited to your tax liability.
Where do you learn this, and which are what?

Assuming EITC is refundable and Saver's is non refundable the optimal low income solution would be an AGI of around $19,400 which would amount to $2,006 owed, qualify you for the 50% match on the Saver's Credit on up to $2,000 for both husband and wife giving you a non refundable credit of $2,000 and a tax bill of $6. You then claim the full $503 refundable credit.

If we assume a $12,600 deductible then that means we can earn $32,000 before we play around with the retirement savings at all. Under that $32,000 number any money put into a t IRA rather than a ROTH IRA would be money wasted because your tax rate would be 0 and by deferring the tax on the money so you don't pay it all you do it reduce the amount of non-refundable tax you can claim back.

I learned a lot of it in college (accountant).

To figure out which are what, it's often easiest to review the IRS form and related instructions. If there's a limit based on tax liability then it's non-refundable.

dsmexpat

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For when my wife and I have two children I found a sweet spot with an AGI of around $19,750. This would give us $2040 in taxes owed and $2000 in non-refundable credits through the Saver's Credit getting our tax liability to $40. I was able to find the full EITC tables (but still no formula for how it is calculated) and the maximum benefit for two children filing jointly stays the same from $13,650 AGI to $23,300 at $5,460 refundable credit. That ought to get us to $5,420 positive for a total tax rate of -8% (as in the government gives you 8 cents for every dollar you earn).

The input numbers were a pre-tax income of $67,000 for a family filing jointly, the output was post-tax spending money of $37,770 for the year, $6,650 in the HSA, $17,000 in the 401k and $11,000 in the tIRA.

Jack

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The thing about the Saver's Credit is that you can "tune" it to match your tax liability exactly. In other words, make just enough traditional IRA contributions to get your tax to $0, then make Roth contributions to max it out.

dsmexpat

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Yep, I had fun with that game. The Saver's can't get your taxes below zero so the tax deferral on the tIRA was actually less good than the tax negation of the ROTH, the more tax you pay the more tax you can negate, up to the maximum the Saver's gives you.

frugalnacho

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Okay, next question. What is the EITC phase out formula. I've found a number of calculator tools, I know the lower and upper limits but I cannot find the actual formula they use to calculate it? I need it for my spreadsheet.

It's not a formula.  You fill out a worksheet, and then plug the value you calculate you look up the credit from a table. 

Here is form 1040 for 2014: http://www.irs.gov/pub/irs-pdf/i1040gi.pdf
Page 58 is the form you need to fill out, and page 61 is the table you pull the EIC value from.

Here is the draft 1040 for 2015: http://www.irs.gov/pub/irs-dft/i1040gi--dft.pdf


dsmexpat

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But the worksheet must be from a formula, surely? Like there is a worksheet which lists every potential income and how much you owe on it in taxes but it's still derived from a formula, 10% on the first X, 15% on the next Y and so forth. The worksheet is just because the IRS doesn't trust people to work it out for themselves (quite rightly).

frugalnacho

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The thing about the Saver's Credit is that you can "tune" it to match your tax liability exactly. In other words, make just enough traditional IRA contributions to get your tax to $0, then make Roth contributions to max it out.

This is what we did.  You can't really "tune" it to exactly $0 though.  I contributed to a tIRA just enough to qualify for the maximum credit, which ended up leaving several hundred dollars of credit on the table because we didn't owe enough in taxes, yet if my AGI was one dollar higher the credit would have been slashed by 60%.  So it's either leave several hundred dollars of non-refundable credits on the table, or earn a single dollar more and lose so much of the credit that you actually owe several hundred in taxes.  I did not analyze all possible situations, but that was the case for me (MFJ no kids).

MDM

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Okay, next question. What is the EITC phase out formula. I've found a number of calculator tools, I know the lower and upper limits but I cannot find the actual formula they use to calculate it? I need it for my spreadsheet.

It's not a formula.  You fill out a worksheet, and then plug the value you calculate you look up the credit from a table. 

Here is form 1040 for 2014: http://www.irs.gov/pub/irs-pdf/i1040gi.pdf
Page 58 is the form you need to fill out, and page 61 is the table you pull the EIC value from.

Here is the draft 1040 for 2015: http://www.irs.gov/pub/irs-dft/i1040gi--dft.pdf

Feel free to steal from the spreadsheet linked in the case study sticky.

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frugalnacho

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But the worksheet must be from a formula, surely? Like there is a worksheet which lists every potential income and how much you owe on it in taxes but it's still derived from a formula, 10% on the first X, 15% on the next Y and so forth. The worksheet is just because the IRS doesn't trust people to work it out for themselves (quite rightly).

I thought the same thing as you, because I wanted to just have a formula built into a spreadsheet to calculate it, but I couldn't find anything.  It would be a bitch to try to derive the formula from the table though since it's stepwise and not continuous, but you could probably create a spreadsheet that contains the data in that table and could return the value.  I'm pretty sure all the online EIC calculators do just that.  Ultimately I can't take the credit anyway so I just gave up and moved on.  Plus I got my tax bill down to $0 with the tax savers credit anyway.

Jack

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But the worksheet must be from a formula, surely? Like there is a worksheet which lists every potential income and how much you owe on it in taxes but it's still derived from a formula, 10% on the first X, 15% on the next Y and so forth. The worksheet is just because the IRS doesn't trust people to work it out for themselves (quite rightly).

Yes, in an abstract sense, but said formula may be difficult to derive from the algorithm expressed by the worksheet.

teen persuasion

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For when my wife and I have two children I found a sweet spot with an AGI of around $19,750. This would give us $2040 in taxes owed and $2000 in non-refundable credits through the Saver's Credit getting our tax liability to $40. I was able to find the full EITC tables (but still no formula for how it is calculated) and the maximum benefit for two children filing jointly stays the same from $13,650 AGI to $23,300 at $5,460 refundable credit. That ought to get us to $5,420 positive for a total tax rate of -8% (as in the government gives you 8 cents for every dollar you earn).

The input numbers were a pre-tax income of $67,000 for a family filing jointly, the output was post-tax spending money of $37,770 for the year, $6,650 in the HSA, $17,000 in the 401k and $11,000 in the tIRA.

You are confusing AGI with taxable income (after standard deductions and personal exemptions are subtracted).  An AGI under $20k MFJ would be taxable income of $0.

Also, the EITC calculations are tricky: your credit is tested on BOTH line 7 wages and AGI, and you get the smaller credit result.  So 401k and HSA thru payroll contributions are good (lower line 7 and AGI), but tIRA contributions only reduce AGI. 

One more gotcha to watch for with the EITC: investment income can make you completely ineligible.  I believe the limit is $3350 of investment income in a year.

MDM

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But the worksheet must be from a formula, surely? Like there is a worksheet which lists every potential income and how much you owe on it in taxes but it's still derived from a formula, 10% on the first X, 15% on the next Y and so forth. The worksheet is just because the IRS doesn't trust people to work it out for themselves (quite rightly).

Assuming you have the cells defined correctly:

=ROUND(IF(AC24<$AE$24,$AD$24/100*AC24,IF(AC24<$AH$24,$AF$24,MAX($AF$24-(AC24-$AH$24)*$AG$24/100,0))),0)

seattlecyclone

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The thing about the Saver's Credit is that you can "tune" it to match your tax liability exactly. In other words, make just enough traditional IRA contributions to get your tax to $0, then make Roth contributions to max it out.

This is what we did.  You can't really "tune" it to exactly $0 though.  I contributed to a tIRA just enough to qualify for the maximum credit, which ended up leaving several hundred dollars of credit on the table because we didn't owe enough in taxes, yet if my AGI was one dollar higher the credit would have been slashed by 60%.  So it's either leave several hundred dollars of non-refundable credits on the table, or earn a single dollar more and lose so much of the credit that you actually owe several hundred in taxes.  I did not analyze all possible situations, but that was the case for me (MFJ no kids).

You didn't really "leave money on the table" since the credit isn't refundable. The best you can do is get your tax down to zero. Once you have made enough traditional contributions to lower your income enough to have zero tax after the credit, pat yourself on the back. At that point if you still haven't maxed out all of your retirement accounts you might as well make Roth contributions since you aren't going to lower your taxes any more by making traditional contributions. I think that's what Jack was trying to say, but feel free to correct me if I'm wrong.

frugalnacho

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The thing about the Saver's Credit is that you can "tune" it to match your tax liability exactly. In other words, make just enough traditional IRA contributions to get your tax to $0, then make Roth contributions to max it out.

This is what we did.  You can't really "tune" it to exactly $0 though.  I contributed to a tIRA just enough to qualify for the maximum credit, which ended up leaving several hundred dollars of credit on the table because we didn't owe enough in taxes, yet if my AGI was one dollar higher the credit would have been slashed by 60%.  So it's either leave several hundred dollars of non-refundable credits on the table, or earn a single dollar more and lose so much of the credit that you actually owe several hundred in taxes.  I did not analyze all possible situations, but that was the case for me (MFJ no kids).

You didn't really "leave money on the table" since the credit isn't refundable. The best you can do is get your tax down to zero. Once you have made enough traditional contributions to lower your income enough to have zero tax after the credit, pat yourself on the back. At that point if you still haven't maxed out all of your retirement accounts you might as well make Roth contributions since you aren't going to lower your taxes any more by making traditional contributions. I think that's what Jack was trying to say, but feel free to correct me if I'm wrong.

Yea I know.  My point was that I owed like $1500 in taxes, and got a $2000 non refundable credit, essentially "leaving credits on the table".  Logic would dictate that I should change my tIRA contributions into roth up to the point that my tax=my credit, but I can't really do that.  It's a cliff where a single dollar more in AGI increased my tax bill by 10 cents, but reduced my credit to only $800, making a real swing of about $700.  There is no way to actually fine tune it to zero.  I either have more credit than I can use, or not enough to reduce my taxes to $0. 

dsmexpat

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For when my wife and I have two children I found a sweet spot with an AGI of around $19,750. This would give us $2040 in taxes owed and $2000 in non-refundable credits through the Saver's Credit getting our tax liability to $40. I was able to find the full EITC tables (but still no formula for how it is calculated) and the maximum benefit for two children filing jointly stays the same from $13,650 AGI to $23,300 at $5,460 refundable credit. That ought to get us to $5,420 positive for a total tax rate of -8% (as in the government gives you 8 cents for every dollar you earn).

The input numbers were a pre-tax income of $67,000 for a family filing jointly, the output was post-tax spending money of $37,770 for the year, $6,650 in the HSA, $17,000 in the 401k and $11,000 in the tIRA.

You are confusing AGI with taxable income (after standard deductions and personal exemptions are subtracted).  An AGI under $20k MFJ would be taxable income of $0.

Also, the EITC calculations are tricky: your credit is tested on BOTH line 7 wages and AGI, and you get the smaller credit result.  So 401k and HSA thru payroll contributions are good (lower line 7 and AGI), but tIRA contributions only reduce AGI. 

One more gotcha to watch for with the EITC: investment income can make you completely ineligible.  I believe the limit is $3350 of investment income in a year.
To clarify, gross minus things like retirement deductions is AGI, AGI minus your standard deduction is taxable income? So if we take the very basic example of a $20,000 gross income, a $5000 tIRA contribution and a $6300 standard deduction then AGI would be $15000 and taxable income would be $8700?

frugalnacho

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For when my wife and I have two children I found a sweet spot with an AGI of around $19,750. This would give us $2040 in taxes owed and $2000 in non-refundable credits through the Saver's Credit getting our tax liability to $40. I was able to find the full EITC tables (but still no formula for how it is calculated) and the maximum benefit for two children filing jointly stays the same from $13,650 AGI to $23,300 at $5,460 refundable credit. That ought to get us to $5,420 positive for a total tax rate of -8% (as in the government gives you 8 cents for every dollar you earn).

The input numbers were a pre-tax income of $67,000 for a family filing jointly, the output was post-tax spending money of $37,770 for the year, $6,650 in the HSA, $17,000 in the 401k and $11,000 in the tIRA.

You are confusing AGI with taxable income (after standard deductions and personal exemptions are subtracted).  An AGI under $20k MFJ would be taxable income of $0.

Also, the EITC calculations are tricky: your credit is tested on BOTH line 7 wages and AGI, and you get the smaller credit result.  So 401k and HSA thru payroll contributions are good (lower line 7 and AGI), but tIRA contributions only reduce AGI. 

One more gotcha to watch for with the EITC: investment income can make you completely ineligible.  I believe the limit is $3350 of investment income in a year.
To clarify, gross minus things like retirement deductions is AGI, AGI minus your standard deduction is taxable income? So if we take the very basic example of a $20,000 gross income, a $5000 tIRA contribution and a $6300 standard deduction then AGI would be $15000 and taxable income would be $8700?

Almost, but you also addsubtract personal exemptions.  Gross minus retirement contributions minus standard deduction minus exemptions = taxable.

Almost.  The standard deduction is double if you are married filing jointly (since you said you are married).  $20k gross, minus $5k tIRA, minus $12.6k standard deduction, minus 2x $4k personal exemptions (you and your wife each get a $4k personal exemption). = $0 taxable (actually if you math it out it's less than $0, but it's no different than $0).  You could actually earn $25.6k, put $5k in tIRA, $12.6k standard deduction, $8k exemptions = $0 taxable income

EDIT: because yellow was impossible to read

dsmexpat

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Less than zero is bad because then you'd be deferring tax which you wouldn't owe at all if you put it in the present day. How to plan out your income by putting money in the right places to get your non-refundable to be as close to 0 as possible is the point of this topic.

What exactly is the difference between the standard deduction and the exemption? Because in the UK the way we do it is we have a 0% tax bracket from 0-10,000GBP (roughly) and my thinking was that the US had more or less the same through the standard deduction (the first $6,300 you earn isn't taxed). A standard deduction of $6,300 is effectively a 0% tax bracket that pushes the brackets above is all up by $6,300. So we each have a $4,000 exemption (lower your taxable salary by $4,000 as that $4,000 is effectively taxed at 0%, move the $4,000 from pre-tax to post-tax), a $6,300 standard deductible (do the exact same thing as the exemption)?

Gin1984

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Less than zero is bad because then you'd be deferring tax which you wouldn't owe at all if you put it in the present day. How to plan out your income by putting money in the right places to get your non-refundable to be as close to 0 as possible is the point of this topic.

What exactly is the difference between the standard deduction and the exemption? Because in the UK the way we do it is we have a 0% tax bracket from 0-10,000GBP (roughly) and my thinking was that the US had more or less the same through the standard deduction (the first $6,300 you earn isn't taxed). A standard deduction of $6,300 is effectively a 0% tax bracket that pushes the brackets above is all up by $6,300. So we each have a $4,000 exemption (lower your taxable salary by $4,000 as that $4,000 is effectively taxed at 0%, move the $4,000 from pre-tax to post-tax), a $6,300 standard deductible (do the exact same thing as the exemption)?
So you can either chose a standard deduction or itemize, depending on which gives you the highest amount but everyone gets $4000 at 0% for every member of your family.  The standard deduction depends on your filling status, personal exemptions depend on how many people are within that family.

seattlecyclone

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What exactly is the difference between the standard deduction and the exemption? Because in the UK the way we do it is we have a 0% tax bracket from 0-10,000GBP (roughly) and my thinking was that the US had more or less the same through the standard deduction (the first $6,300 you earn isn't taxed). A standard deduction of $6,300 is effectively a 0% tax bracket that pushes the brackets above is all up by $6,300. So we each have a $4,000 exemption (lower your taxable salary by $4,000 as that $4,000 is effectively taxed at 0%, move the $4,000 from pre-tax to post-tax), a $6,300 standard deductible (do the exact same thing as the exemption)?

These are just two different numbers that you get to subtract from your income before you calculate your tax. The standard deduction is based on your filing status ($6,300 single, $12,600 married filing jointly, etc.). The personal exemption is based on how many people are in your family ($4,000 per person including yourself). A single person then gets a total of $10,300 of tax-free income, a married couple with no kids gets $20,600 tax-free, and a married couple with four kids gets $36,600 tax-free.

frugalnacho

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Less than zero is bad because then you'd be deferring tax which you wouldn't owe at all if you put it in the present day. How to plan out your income by putting money in the right places to get your non-refundable to be as close to 0 as possible is the point of this topic.

What exactly is the difference between the standard deduction and the exemption? Because in the UK the way we do it is we have a 0% tax bracket from 0-10,000GBP (roughly) and my thinking was that the US had more or less the same through the standard deduction (the first $6,300 you earn isn't taxed). A standard deduction of $6,300 is effectively a 0% tax bracket that pushes the brackets above is all up by $6,300. So we each have a $4,000 exemption (lower your taxable salary by $4,000 as that $4,000 is effectively taxed at 0%, move the $4,000 from pre-tax to post-tax), a $6,300 standard deductible (do the exact same thing as the exemption)?


The exemption is basically like an extra person deduction.  So if you are married and filing jointly you get a $12.6k standard deduction, and 2 exemptions of $4k each, for a total of $20.6k.  If you have 1 child you get the $12.6k deduction, and 3 exemptions of $4k each, for a total of $24.6k.

And yes you are right, you wouldn't want a negative taxable income simultaneous with contributing to a tax deferred account (401k or tIRA).  In that first example you would change your tIRA contribution into a roth since the tax deferment gives you no benefit. 

dsmexpat

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So before we even count EITC we're looking at a tax free income of $20,300 per person in a childless household as long as they contributed at least $2,000 to a retirement plan ($6,300 at 0%, $4,000 at 0%, $10,000 at 10%, 50% match non refundable tax credit on up to $2,000), right?

So if you earn $22,300 then you can tIRA $2,000, live on $20,300 and not pay a cent in tax, before we even count EITC paying you back some.
If you can live on $18,300 then you can earn $20,300, ROTH $2000 and still not pay a cent in tax.

Why the hell do low to middle income families complain about tax and vote for lower taxes for other people? The median household in my state earned just $44,000, they're not even taxed, and we're assuming no children.

frugalnacho

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So before we even count EITC we're looking at a tax free income of $20,300 per person in a childless household as long as they contributed at least $2,000 to a retirement plan ($6,300 at 0%, $4,000 at 0%, $10,000 at 10%, 50% match non refundable tax credit on up to $2,000), right?

So if you earn $22,300 then you can tIRA $2,000, live on $20,300 and not pay a cent in tax, before we even count EITC paying you back some.
If you can live on $18,300 then you can earn $20,300, ROTH $2000 and still not pay a cent in tax.

Why the hell do low to middle income families complain about tax and vote for lower taxes for other people? The median household in my state earned just $44,000, they're not even taxed, and we're assuming no children.

The tax savers credit gets phased out at higher incomes. If you and your wife earned $20,300 each ($40,600 total), and you each contribute $2,000 to a tIRA, then your AGI is going to be $36,600.  $36,600 will only qualify you for a savers credit of $800 total, not $2000.  The cut off point for that calculation is $36,500, so if you contributed $100 more to a tIRA you would lower your AGI to $36,500 and qualify for the full $2000 credit.

This has the credit rates and income limits for the savers credit:
http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-Retirement-Savings-Contributions-Credit-%28Saver%E2%80%99s-Credit%29

I am not sure which order the credits are applied, so hopefully someone else can help.  If they apply your EIC first and reduce you to $0 liability (or even pay you) then you won't be able to use the savers credit at all.

EDIT: I'm not sure you would qualify for the EIC at that income anyway.  I contributed enough to my 401k and me and my wife's IRA to get my AGI down to exactly $36,000 for 2014, which qualified me for the full $2,000 savers credit which wiped out my tax bill.  I was not eligible for EIC, but i'm still happy paying $0 tax.
« Last Edit: April 16, 2015, 01:17:29 PM by frugalnacho »

dsmexpat

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Questions such as "which order are the credits applied in?" seem to plague the system. And you're right about dropping out of the 50% match bracket but I'm pretty sure that we can manage on $36,500 if we have to. Well done on the 0 tax, I'm scheming to do the same.

Gin1984

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Questions such as "which order are the credits applied in?" seem to plague the system. And you're right about dropping out of the 50% match bracket but I'm pretty sure that we can manage on $36,500 if we have to. Well done on the 0 tax, I'm scheming to do the same.
Actually they don't because it is quite simple to determine.  Check out a 1040 form and you will have the answer easily enough.  And for the record, non-refundable credits get applied first.

dsmexpat

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I meant that in the sense that I have been entirely unable to find a list of "The Rules". I've extrapolated many of them from the forms because I can work out what they're trying to do but the way in which it's written, step by painstaking step, makes it difficult to see the forest for the trees. It's as if I read "bend forwards, open hand, reach down, grasp, straighten up, outstretch arm, release grip" and only when taken all together with context do I suddenly go "ooooh, you want me to pick up that pen off the floor and put it on the desk, makes sense". I get that it has to be that way because they want it to be a path that you can follow without knowing where it leads or why they're following it but it does cause problems like "what exactly is the EITC formula?" when the forms just give you a list of every possible income and combination of filing status and child number.

MDM

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I am not sure which order the credits are applied, so hopefully someone else can help.  If they apply your EIC first and reduce you to $0 liability (or even pay you) then you won't be able to use the savers credit at all.

I meant that in the sense that I have been entirely unable to find a list of "The Rules". I've extrapolated many of them from the forms because I can work out what they're trying to do but the way in which it's written, step by painstaking step, makes it difficult to see the forest for the trees. It's as if I read "bend forwards, open hand, reach down, grasp, straighten up, outstretch arm, release grip" and only when taken all together with context do I suddenly go "ooooh, you want me to pick up that pen off the floor and put it on the desk, makes sense". I get that it has to be that way because they want it to be a path that you can follow without knowing where it leads or why they're following it but it does cause problems like "what exactly is the EITC formula?" when the forms just give you a list of every possible income and combination of filing status and child number.

Have you looked at the case study spreadsheet mentioned a few times above and found it incorrect?  Granted, it doesn't draw a roadmap, but it seems to answer all the questions being posed here.  If, however, it is incorrect please advise and it can be corrected.

frugalnacho

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I am not sure which order the credits are applied, so hopefully someone else can help.  If they apply your EIC first and reduce you to $0 liability (or even pay you) then you won't be able to use the savers credit at all.

I meant that in the sense that I have been entirely unable to find a list of "The Rules". I've extrapolated many of them from the forms because I can work out what they're trying to do but the way in which it's written, step by painstaking step, makes it difficult to see the forest for the trees. It's as if I read "bend forwards, open hand, reach down, grasp, straighten up, outstretch arm, release grip" and only when taken all together with context do I suddenly go "ooooh, you want me to pick up that pen off the floor and put it on the desk, makes sense". I get that it has to be that way because they want it to be a path that you can follow without knowing where it leads or why they're following it but it does cause problems like "what exactly is the EITC formula?" when the forms just give you a list of every possible income and combination of filing status and child number.

Have you looked at the case study spreadsheet mentioned a few times above and found it incorrect?  Granted, it doesn't draw a roadmap, but it seems to answer all the questions being posed here.  If, however, it is incorrect please advise and it can be corrected.

Me? No I haven't checked it out.  Well, I am right now.  Is there a way to add unreported income?  Like say you had a side hustle selling tomatoes from your garden that brought in $1,000/mo and you never intend to let the IRS know.  Or should you just use that money to displace some spending, and leave an equivalent amount out of your spending categories?

seattlecyclone

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I meant that in the sense that I have been entirely unable to find a list of "The Rules". I've extrapolated many of them from the forms because I can work out what they're trying to do but the way in which it's written, step by painstaking step, makes it difficult to see the forest for the trees. It's as if I read "bend forwards, open hand, reach down, grasp, straighten up, outstretch arm, release grip" and only when taken all together with context do I suddenly go "ooooh, you want me to pick up that pen off the floor and put it on the desk, makes sense". I get that it has to be that way because they want it to be a path that you can follow without knowing where it leads or why they're following it but it does cause problems like "what exactly is the EITC formula?" when the forms just give you a list of every possible income and combination of filing status and child number.

"The Rules" are written in the Internal Revenue Code. Don't read it all at once.

Tax credit ordering can generally be seen by looking at the back of Form 1040. The credits are generally applied in the order they're listed. The non-refundable credits come first. In the instructions for each, as part of the calculation they'll generally tell you to put down your tax, subtract all the credits listed above the one you're calculating right now, and that will be the limit for this particular credit.

Then the refundable credits come in the "payments" section and are all applied after the non-refundable credits.

MDM

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Is there a way to add unreported income?  Like say you had a side hustle selling tomatoes from your garden that brought in $1,000/mo and you never intend to let the IRS know.  Or should you just use that money to displace some spending, and leave an equivalent amount out of your spending categories?
It's Excel, so whatever you can do in Excel.... :)

Picking an expense category that doesn't apply to you and entering a negative number would be one way.

The "you" was generic, not aimed at any one individual.

frugalnacho

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Is there a way to add unreported income?  Like say you had a side hustle selling tomatoes from your garden that brought in $1,000/mo and you never intend to let the IRS know.  Or should you just use that money to displace some spending, and leave an equivalent amount out of your spending categories?
It's Excel, so whatever you can do in Excel.... :)

Picking an expense category that doesn't apply to you and entering a negative number would be one way.

The "you" was generic, not aimed at any one individual.

I've thought about this a bit more, but that would give erroneous calculations regarding FIRE dates and draw downs.  My expenses would be artificially low.  I need to keep my expenses real, as well as my income real, even if a portion is not reported.  I'm sure i'm not the only one here that has earned money under the table, and will probably earn more money under the table on my path to FIRE.

teen persuasion

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So before we even count EITC we're looking at a tax free income of $20,300 per person in a childless household as long as they contributed at least $2,000 to a retirement plan ($6,300 at 0%, $4,000 at 0%, $10,000 at 10%, 50% match non refundable tax credit on up to $2,000), right?

So if you earn $22,300 then you can tIRA $2,000, live on $20,300 and not pay a cent in tax, before we even count EITC paying you back some.
If you can live on $18,300 then you can earn $20,300, ROTH $2000 and still not pay a cent in tax.

Why the hell do low to middle income families complain about tax and vote for lower taxes for other people? The median household in my state earned just $44,000, they're not even taxed, and we're assuming no children.

It is not $20,300 per person, that is for the couple MFJ.  But you have the general idea.  The EITC for zero kids is relatively low, and phases out early, compared to with kids.

There is largely a trade-off between the EITC and retirement savers credit.  If you have 0 kids, and relatively low income (possibly thru retirement contributions), the retirement credit may eliminate your taxes if your AGI is in a sweet spot, but any EITC is negligible.  If you have kids on a similar income, you probably owe 0 in taxes (due to the children's added exemptions), so the retirement savers credit is pointless, but you can get a larger refund from the EITC.

Cathy

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I'm sure i'm not the only one here that has earned money under the table, and will probably earn more money under the table on my path to FIRE.

Heh. I'm way too much of a sucker to commit tax fraud. I faithfully report all my income and pay my tax owing in full, even when the government or governments would be hard-pressed to find all my income if I weren't so honest.

People who commit tax fraud effectively raise the rates for the rest of us, and ironically, these are often the same people who vote to raise rates on people other than themselves (all while claiming the current rates are low and yet declining to pay them), basically adding insult to injury.

dsmexpat

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So before we even count EITC we're looking at a tax free income of $20,300 per person in a childless household as long as they contributed at least $2,000 to a retirement plan ($6,300 at 0%, $4,000 at 0%, $10,000 at 10%, 50% match non refundable tax credit on up to $2,000), right?

So if you earn $22,300 then you can tIRA $2,000, live on $20,300 and not pay a cent in tax, before we even count EITC paying you back some.
If you can live on $18,300 then you can earn $20,300, ROTH $2000 and still not pay a cent in tax.

Why the hell do low to middle income families complain about tax and vote for lower taxes for other people? The median household in my state earned just $44,000, they're not even taxed, and we're assuming no children.

It is not $20,300 per person, that is for the couple MFJ.  But you have the general idea.  The EITC for zero kids is relatively low, and phases out early, compared to with kids.

There is largely a trade-off between the EITC and retirement savers credit.  If you have 0 kids, and relatively low income (possibly thru retirement contributions), the retirement credit may eliminate your taxes if your AGI is in a sweet spot, but any EITC is negligible.  If you have kids on a similar income, you probably owe 0 in taxes (due to the children's added exemptions), so the retirement savers credit is pointless, but you can get a larger refund from the EITC.
I don't think you read what I did. $4000 exemption, $6300 deduction, $10000 taxed at 10% to result in $1000 tax which is offset by the Saver's credit. It's per person.

MDM

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Probably not a large demographic, but a couple both over 50, both working, both having access to a 457 and 403b, having 3 children eligible for the Child Tax Credit, and taking the standard deduction could earn $169,000 and pay zero federal tax - actually, they would get ~$200 payment from the IRS.  Unless the AMT would kick in - I didn't check that.

CategoryMonthlyCommentsAnnual
Salary/Wages$14,083$169,000
Traditional IRA$1,083At maximum$13,000
401(k) / 403(b) / TSP / etc.$4,000At maximum$48,000
457 plans   $4,000At maximum$48,000
Federal Adj. Gross Inc.$5,000$60,000
Federal tax-$182015 rates, MFJ, stand. ded., 5 exempt.-$212


Filing Status21=S, 2=MFJ
# of earners2
AGI$60,000
Std. Deduct.$12,600
Act. Deduct.$12,600
# Exempt.5
Exemption$20,000
Taxable$27,400
Tax$3,188
Savers' credit$400
Tax after n-r credit$2,788
# Children <173
Child Tax Cred.$3,000
EIC$0
Net Tax-$212

MDM

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I've thought about this a bit more, but that would give erroneous calculations regarding FIRE dates and draw downs.  My expenses would be artificially low.  I need to keep my expenses real, as well as my income real, even if a portion is not reported.  I'm sure i'm not the only one here that has earned money under the table, and will probably earn more money under the table on my path to FIRE.
That looks correct.  If there are enough (some number >0, depending on the phase of the moon, etc.) people who have good examples it wouldn't be hard to add a row, e.g. between the current row 42 & 43, for non-taxable income in the template.  Of course one can make such a change in one's own copy....

frugalnacho

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I've thought about this a bit more, but that would give erroneous calculations regarding FIRE dates and draw downs.  My expenses would be artificially low.  I need to keep my expenses real, as well as my income real, even if a portion is not reported.  I'm sure i'm not the only one here that has earned money under the table, and will probably earn more money under the table on my path to FIRE.
That looks correct.  If there are enough (some number >0, depending on the phase of the moon, etc.) people who have good examples it wouldn't be hard to add a row, e.g. between the current row 42 & 43, for non-taxable income in the template.  Of course one can make such a change in one's own copy....

Or perhaps just a gift input?  A gift would essentially count as money earned under the table, or found in the street, etc as far as calculating taxes, correct? It would count as income, but be excluded from tax calculations. Good ol' Unky Randy might be gifting me some presents.  Or maybe my meth RV will be fully operational.  Or maybe my wife will just do a few baby sitting jobs.

MDM

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I've thought about this a bit more, but that would give erroneous calculations regarding FIRE dates and draw downs.  My expenses would be artificially low.  I need to keep my expenses real, as well as my income real, even if a portion is not reported.  I'm sure i'm not the only one here that has earned money under the table, and will probably earn more money under the table on my path to FIRE.
That looks correct.  If there are enough (some number >0, depending on the phase of the moon, etc.) people who have good examples it wouldn't be hard to add a row, e.g. between the current row 42 & 43, for non-taxable income in the template.  Of course one can make such a change in one's own copy....

Done.  You should be able to download the new template from the case study sticky.