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Learning, Sharing, and Teaching => Taxes => Topic started by: Cheddar Stacker on July 01, 2015, 08:41:14 AM

Title: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on July 01, 2015, 08:41:14 AM
Introduction

Early Retirees, and aspiring ones, are …… different. We don’t quite fit the mold. This is true in many areas, and it’s particularly true in tax planning. Our tax code is overly complex; ridiculous really. If you play the game right, you can avoid many taxes when you are working (See Root of Good (http://rootofgood.com/make-six-figure-income-pay-no-tax/) and Mad Fientist (http://www.madfientist.com/retire-even-earlier/)) and when you aren’t working (See Go Curry Cracker! (http://www.gocurrycracker.com/never-pay-taxes-again/)).

This guide should help those looking for an edge, or those simply looking for an explanation. It will also be heavily focused toward the early retiree given that we are on an early retirement forum. Therefore, it will likely contradict many of the common recommendations you’ll find elsewhere like “Young people should put all their money in Roth accounts since they will have higher taxes later in life”. Strategies recommended here might not apply to your friend/dad/sister/boss if they don’t lean toward a FIRE lifestyle.

All of these items should be considered on a Macro level if you want the maximum benefit in your tax planning strategy. In other words, a larger contribution to your 401K/IRA may increase your student loan interest deduction, therefore it may lower your AGI in two ways, therefore it increases your chances to qualify for the child tax credit and the saver’s credit, etc. It’s a very iterative process, but the more of these deductions/credits you aim for, the more it all snowballs. In addition, this is not something you should be thinking about at/after year end, this is something to keep in mind throughout the year.


Form 1040 Savings Measures (The Working Years):

This list sequential, meaning it roughly follows the lines on a 1040.

Pre-Tax Deductions: As you’ll see in the links provided above and below, there are many deductions you can take before income is ever taxed. These deductions can include 401(k)/403(b)/457(b) (https://en.wikipedia.org/wiki/401(k)), Health/Dental Insurance (https://en.wikipedia.org/wiki/Health_insurance), Cafeteria Plan (https://en.wikipedia.org/wiki/Cafeteria_plan), and Health Savings Account (https://en.wikipedia.org/wiki/Health_savings_account), among others. Some of these items reduce the FICA wage base as well, and they are the only available deductions against Social Security and Medicare Tax. All of these deductions reduce the income you are required to input on your tax return. Therefore, they all reduce your AGI, MAGI, taxable income, and tax, and they should be maximized whenever possible in most cases.

Tax Loss Harvesting (http://www.madfientist.com/tax-loss-harvesting/) is a way to sell securities in a regular (taxable) brokerage account in order to reduce taxable income. Any losses will first offset any other Capital Gains in the current year, including capital gain distributions on your Schedule D. The result from Schedule D carries to your 1040 and you can use a $3,000 loss to offset other income reducing your AGI and taxable income accordingly.

Traditional and Roth IRAs (http://www.irs.gov/Retirement-Plans/Traditional-and-Roth-IRAs) are another great tool to consider utilizing, and they are both good. A Traditional IRA contribution reduces your AGI and taxable income, a Roth contribution does not. A lot is said about both of these accounts all over this forum and the interwebs including a great analysis from The Mad Fientist (http://www.madfientist.com/traditional-ira-vs-roth-ira/). What you need to know for tax planning purposes is this: If you believe you will pay a higher tax rate in the future, go with Roth, and if you believe you will pay a lower tax rate in the future, go with Traditional. When you clear out all the other noise, this is really the only thing that matters. Most early retirees will benefit more from Traditional if they qualify (see the links to the IRS or key facts and figures for qualification), but this must be a case by case analysis.

Student Loan Interest (http://www.irs.gov/taxtopics/tc456.html) is a Pre-AGI tax deduction unlike mortgage interest, but it has some limitations. The first is you can only deduct up to $2,500 of interest payments; hopefully most of us won’t exceed that anyway. The second is many high income earners have a chance of losing all/part of this deduction. It is gradually phased out as your AGI grows from $130K-$160K (MFJ for 2014). This means if you pay $3,000 in SL interest and your AGI is $145K, your deduction will first be limited to $2,500, then cut in half to $1,250 because you have reached 50% of the phase-out.

Deductions/Exemptions:
 The Standard Deduction  (http://www.irs.gov/Credits-&-Deductions/Individuals/Standard-Deduction) is available to everyone, and can be particularly beneficial to a frugal early retiree. It doesn’t matter how much you spend, what city/state you live in, or what you ate for breakfast, you get $12,600 (MFJ for 2015). Some forum members barely exceed that amount in expenses each year.

The Itemized Deduction  (http://www.irs.gov/uac/Schedule-A-(Form-1040),-Itemized-Deductions) is available for the spendypants members. If your deductible expenses from this form exceed the standard amount, use the itemized amount; you can’t use both. For many people this is very easy to reach. If you live in a state with an income tax, real estate tax, and personal property tax (see Cheddar Stacker – my deductible taxes in 2014 were $9,080) you will likely itemize. If you are close to the top of the standard deduction, consider intentionally lumping expenses into one year. In 2015 forego charitable contributions and paying your real estate tax bill. In January 2016, pay your 2015 RE tax bill and make your 2015 charitable contributions. Then in December 2016, pay your 2016 RE tax bill and make your 2016 charitable contributions. The result can be a nice way to squeeze out an extra $1,000-2,000 in deductions.

Personal Exemptions  (http://www.irs.gov/publications/p17/ch03.html) are available for each person claimed on your tax return. Multiply the number claimed in box 6d times the personal exemption rate for any given year ($4,000 for 2015) and reduce your taxable income accordingly.

If I could highlight one thing from this section, it would be for the reader to realize there is an automatic $20,600, tax-free space in 2015 for a married couple. These numbers are adjusted for inflation each year. Given proper tax planning efforts, you should do everything in your power to create enough income each year to fill this space. The Roth Pipeline (conversion ladder), or simply withdrawing funds from a Traditional IRA will help with this.

Credits:
The Credit for Child and Dependent Care (http://www.irs.gov/Credits-&-Deductions/Individuals/Child-and-Dependent-Care-Credit) is a nice benefit for working parents with kids in daycare. If you have a cafeteria plan you should use that instead of this (don’t double dip), but this is a nice option for those who don’t have one. In summary, the IRS will pay for 20-35% of the cost of someone watching your kids, up to $3,000 in expenses for one kid, or $6,000 in expenses for two or more kids. This can result in a credit of up to $2,100 if all the cards fall into place for you. The qualifying expenses are limited to the lesser of the two parents’ taxable income, so pre-tax deductions can actually work against you here. Plan accordingly. One side note on this credit – the instructions are very clear that if you have two kids, but only one of them is in daycare, you can claim both of the kids on this form opening up the full 6,000 in expenses and potentially doubling the credit.

The Saver’s Credit (http://www.irs.gov/Credits-&-Deductions/Individuals/Retirement-Savings-Contributions-Credit-Savers-Credit) is something to shoot for if you earn a low income, or you are able to reduce your AGI to an extremely low level via Pre-Tax Deductions. The maximum credit is $1,000/person, so $2,000 for married couples. However, it can be very difficult to reach the maximum level of this credit as described here (http://forum.mrmoneymustache.com/taxes/do-i-qualify-for-the-savers-credit/msg396037/#msg396037) by teen persuasion. It’s a paradox. This is also one of the few legitimate "tax cliffs" out there where it's not a phase-out. You don't want to go $1 over the limits or you will not like the result.

The Child Tax Credit (http://www.irs.gov/pub/irs-pdf/p972.pdf) is awesome. Step 1, have a kid or 7. Step 2, pay less tax. Unfortunately it’s not quite that simple. The credit is up to $1,000 per child under age 17 at the end of the tax year, and it’s refundable through the additional child tax credit. Much like the student loan interest deduction, it has a phase out range. This credit is gradually phased out as your AGI grows from $110K-$150K (MFJ for 2014). So if you have 2 qualifying kids and a potential child tax credit of $2,000, but your AGI is $130K, you will receive a child tax credit of $1,000.

The Earned Income Credit (http://www.irs.gov/Credits-&-Deductions/Individuals/Earned-Income-Tax-Credit) or EIC is also something to shoot for if you earn a low income, or you are able to reduce your AGI to an extremely low level via Pre-Tax Deductions. This credit becomes much easier to qualify for when you have a few children. Investment income must be no more than $3,350 for the year.


Resources:
Key Facts and Figures (http://www.paychex.com/a/d/accounting/CCH_Fed_Facts_and_Figures_2015.pdf) is one of the best resources I’ve found online that summarizes a lot of data into just 2 pages. I keep a printed copy in my top desk drawer and refer to it often. You can get an updated version of this each year with this search: 2016 key facts and figures.

Annual Limits (http://www.cffpinfo.com/download/annual_limits/2015_Annual_Limits.pdf) is another fine resource listing much of the same information, but different enough that both should be reviewed.

MDM’s Case Study Spreadsheet (http://forum.mrmoneymustache.com/ask-a-mustachian/how-to-write-a-%27case-study%27-topic/msg274228/#msg274228) began as something to help organize case study posts.  That ability remains, and it has evolved to deal with common Mustachian tax issues, calculating most of the credits and deductions mentioned above.  It also includes a simple "time to FI" section.  One might consider it a gateway drug to more advanced tax and FI calculation tools.

The 1040 Instructions (http://www.irs.gov/pub/irs-pdf/i1040gi.pdf) are great if you want to dig into an specific line item on the tax return.

IRS.GOV (http://www.irs.gov) is great when all else fails, or if you just prefer going straight to one of the best online detailed sources of tax code, forms, instructions, bulletins, and revenue rulings.

FAQ:
How can I estimate the impact of particular tax planning events in my life?
The Taxcaster (https://turbotax.intuit.com/tax-tools/calculators/taxcaster/)

Can I (should I) prepare my own taxes?
You certainly can. Whether you should or not will vary a lot based on your specific tax situation, and your technical ability for DIY. There are many people around here who do their own complex returns as well as any CPA could. There are also many extremely brilliant people around here with complex tax situations who hire the experts. There's no shame in paying someone else to do it for you, but always remember you are your best advocate. Your tax preparer can't advise you properly without your help, so you need to know the basics as well.

What should I use to prepare my tax return?
Pencil and Paper is a strategy recommended by some around here. I’ve never done that myself, but I can understand how it can be of great benefit to do this. You must learn the nuances of each line on the 1040 in order to do it properly, so it will certainly give you an edge.

Creating a spreadsheet to reproduce your own tax return is also a good way to learn how the tax code works.  It can also predict tax consequences for the coming year (e.g., add a column for the new year and start by copying the previous year).

Tax software: Turbotax, TaxAct, Taxslayer

Free tax filing methods:
https://www.freefilefillableforms.com/#/fd
http://www.irs.gov/uac/Free-File:-Do-Your-Federal-Taxes-for-Free
http://www.mymoneyblog.com/free-online-tax-e-filing-options-for-all-50-states.html

Acknowledgements:
I obviously leaned heavily on many FI bloggers for links. Why re-create the wheel? But honestly I couldn’t really expand much on what they’ve already said. This is just a nice way to bring all these ideas into one place.

Special thanks to MDM for assisting with the creation and editing of this post.

Special thanks to everyone else on the forum who discusses these tax strategies regularly – you know who you are. I’ve learned a lot from all of you, and I hope you can say the same about me.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on July 01, 2015, 08:41:29 AM
Form 1040 Savings Measures (The Retirement Years):

Congrats, you’re done trading your time for more money! Hopefully you have plenty of time left, and hopefully this guide will help you preserve your portfolio to fund your remaining time.

This list sequential, meaning it roughly follows the lines on a 1040.

Wages should be $0, so let’s skip that line. No more of that FICA guy. However, there are some serious benefits to earning a little bit of income, including the earned income credit. It's worth considering the idea of earning a little bit of income if there's something you really want to do.

Taxable interest will come from checking/savings accounts, CD’s, corporate bonds, and some other sources. It’s important to keep some of your wealth in stable places, but there are also solid reasons to avoid this type of income. Aside from the fact it’s harder for your portfolio to keep pace with inflation, interest is taxed at ordinary rates.

Tax-exempt interest will come from municipal/government bonds. As of the writing of this guide it would be hard to receive a great return on these, but when interest rates return to normal levels this can be a solid place to park your stable funds to avoid taxes. Purchasing bonds issued within your own state can also help you avoid paying state income taxes, as these are not necessarily exempt from state taxes.

Ordinary Dividends will come from dividend paying stocks/mutual funds held in a taxable brokerage account. These are also taxed at ordinary tax rates, so you should attempt to keep them to a minimum. You can do this by either purchasing securities that pay less (or no) dividends, or by purchasing stocks/mutual funds that pay Qualified dividends.

Note: REITs pay heavy dividends, are generally a good investment, and can be a great way to diversify your portfolio. However, their dividends are Ordinary (never qualified) so keep that in mind during tax planning.

Qualified Dividends (https://en.wikipedia.org/wiki/Qualified_dividend) are ordinary dividends that are paid by a U.S. corporation, or a corporation traded on an established U.S. stock market, and meet the holding requirements (basically 60 days). These are taxed at Qualified tax rates which is a very, very good thing. With proper planning you can pay $0 tax on these, and they should be considered a good option for any early retiree.

When you purchase individual stocks and hold them long-term, you will receive Qualified dividends. When you purchase mutual funds, a high turnover of stocks held by the fund will produce Ordinary dividends, so you have less control over the Ordinary vs. Qualified. Pay attention to the type of dividends typically paid by a mutual fund when selecting them for purchase, because they can vary widely. Consider whether the fund itself has a buy and hold strategy, because high turnover creates higher taxes for you. *

Capital Gains (Losses) are reported when you sell securities. If you hold them for less than 365 days you will pay ordinary tax rates, and if you hold them for more than 365 days you will pay Qualified tax rates. So…..hold them for at least 1 year whenever possible. This is the area of your return where the Tax Loss Harvesting (http://www.madfientist.com/tax-loss-harvesting/) and Tax Gain Harvesting (http://www.madfientist.com/tax-gain-harvesting/) will be reported. Depending on your circumstances, you can create a lot of tax free income in this area while staying within the 15% tax bracket.

IRA Distributions are currently reported on line 15a. If they are distributions from a Roth IRA they will NOT be reported on line 15b. This means they will not become income so they don’t increase your AGI. If they are distributions from a Traditional IRA they will carry over to line 15b and become income which increases AGI. Anything reported on this line will be subject to Ordinary tax rates. This is where the Roth IRA Pipeline conversions will appear each year when you move them out of Traditional into Roth, and when you then withdraw them from the Roth later on.

401k Distributions, Pensions and annuities are currently reported on line 16a. If they are distributions from a Roth 401k (or tax free transfers out of a 401k into another tax deferred account) they will NOT be reported on line 16b. This means they will not become income so they don’t increase your AGI. If they are distributions from a Traditional 401k, a Pension, or an annuity they will carry over to line 16b and become income which increases AGI. Anything reported on this line will be subject to Ordinary tax rates.

Social Security Benefits are currently reported on line 20a but they are not necessarily taxable so not all of them carry over to line 20b. Up to 85% of your SS benefits may be taxable. In order to find out exactly what to put on line 20b you need to complete This Worksheet (http://fhttp://apps.irs.gov/app/vita/content/globalmedia/social_security_benefits_worksheet_1040i.pdf) but if you are MFJ you have to reach about $44K of income (including 50% of SS benefits) before anything related to SS benefits will become taxable. If you have time, it’s in your best interest to convert all possible Traditional funds into Roth funds before you begin drawing SS benefits, and before RMD’s begin.

Deductions/Exemptions: See the original post. Almost everything up there still applies, and there isn’t a lot to add. Unfortunately most of the credits mentioned up there are no longer applicable since you need earned income to qualify, with the child tax credit being the only exception.


Other notes/strategies/highlights:

-Utilize tax exempt or qualified rates whenever possible.

-Deductions/Exemptions will reduce Ordinary income first. If you have $40K Ordinary income, $60K Qualified income, and $35K deductions exemptions, you only have $5K in Ordinary taxable income and will only pay $500 in tax (10% bracket). You should create enough income to offset your Deductions/Exemptions. If you have any credits (Child tax credit, tuition credits, etc.) you should create enough income to offset those as well. I plan to create at least $40K income each year post FIRE while I still have 2 kids at home.

-Deplete Traditional accounts as fast as possible with the lowest possible effective tax rate. You might be able to pay 0% tax on your Traditional accounts, but if not project out the next 20 years and determine a reasonable amount to convert. Maybe a 5% effective rate averaged over 20 years is your best bet.

-Consider eligibility for ACA subsidies, and FAFSA in any strategy you utilize. There are entire threads devoted to this topic on the forum like this one (http://forum.mrmoneymustache.com/ask-a-mustachian/information-on-the-affordable-care-act-with-a-focus-on-early-retirees/) and not enough room here to discuss them.

-While Qualified tax rates are wonderful, not all states follow suit. Check local listings, and if you don’t like the rules in your state plan accordingly or move to a more favorable locale.

-Once you have a plan in place and understand the basics, you only need 7 minutes per year (http://www.gocurrycracker.com/7-minute-taxes/) to maximize your tax free space. Your hourly pay rate will be substantial, so take the time to learn this stuff.

-Consider a HELOC as a tax free source of cash during the first 5 years of the Roth Pipeline if there is ever a shortfall. It's a temporary fix, but could be better than another alternative.

What to avoid (from a tax-optimization standpoint):

-Annuities. Some people love these. Some very well respected, long-time early retirees even suggest these as a way to reduce the risk of portfolio failure. While they are one method for accomplishing reduced risk (although in my opinion a sub-optimal one), they are horrible in terms of tax strategy. You are essentially trading your potential Qualified taxable income for Ordinary taxable income.

Good luck, and let me know if I missed anything.

* Taxes should not be the only consideration when investing, but they shouldn't be ignored either. If a fund with a high turnover consistently beats the fund with a low turnover by 3%, but produces additional taxes, the net return of each option should be considered. Weigh the opportunity cost, and don't ignore the potential for a 12% return because you might have to pay a little more tax.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: tweezers on July 01, 2015, 08:51:30 AM
This is EXACTLY what I was hoping to see in a sticky when this new sub-forum was started.  THANK YOU!!!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Kris on July 01, 2015, 08:56:20 AM
Following the hell out of this.  Hope it gets stickied.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Axecleaver on July 01, 2015, 09:57:08 AM
Great post, Cheddar.

For future posts, I'd love to see targeted tax advice for people in high-income accumulation years, and/or small business owners (S corp/C corp/LLC decision tree, for example).
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on July 01, 2015, 10:26:32 AM
Thanks Axe, Tweezers, and Kris for the comments.

Great post, Cheddar.

For future posts, I'd love to see targeted tax advice for people in high-income accumulation years, and/or small business owners (S corp/C corp/LLC decision tree, for example).

My intent with this post was:
-Consolidate many ideas from around the web and forum geared toward early retirees.
-Make it as easy to understand as possible, particularly for any new members or tax novices.
-Aim to give ideas to both low earners and high earners, but not necessarily specific to ultra-high earners.
-Stick to personal taxes only.

I appreciate the feedback for future posts. I'll entertain any suggestions and time/knowledge permitting may devote future posts in this thread.

Also, there are many other CPA's on the forum, and many non-CPA's with immense tax knowledge. I hope this can be a place for anyone to share ideas and create more guides to follow. Hopefully this is just the start.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: johnny847 on July 02, 2015, 06:17:37 AM
The tax loss harvesting link doesn't discuss an important aspect about the wash sale rule:
With respect to TLH you get the worst of both worlds in retirement accounts. You cannot TLH in a retirement account but you can cause wash sales in a taxable account.
So for example say I want to TLH VTSAX in my taxable account. I sell some shares at a loss. If I buy some shares of VTSAX in my IRA within 30 days then I incur a wash sale, reducing the losses that I claim.
Furthermore, that loss is now forever disallowed. What a wash sale really does is it changes the cost basis of the shares I just bought. But the cost basis is irrelevant in an IRA!

This is why I don't have auto reinvestment for any of my dividends - it can cause a wash sale. Just make sure if you do this in Vanguard you are aware of  this quirk  (http://forum.mrmoneymustache.com/investor-alley/quirk-about-vanguard-that-you-may-want-to-be-aware-of/)
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Penny Lane on July 03, 2015, 08:52:52 AM
Such an excellent tool you have created, CS!  Since retiring, we no longer pay the Alt min; seems like a dream.  Although accountant points out that's because we are making LESS $! 

Maybe somewhere you can expound on being self-employed.  I do some consulting now for  fun and $, on my own time, when I want to, so I still consider myself retired.  I've always done that so i knew about FICA on dollar ONE, but our poor daughter, who earns very little and all self-employed, learned about that the hard way. 
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: TomTX on July 03, 2015, 07:39:53 PM
Excellent post. Thanks.

On the Saver's Credit: Your AGI doesn't have to be that low to get some benefit - for MFJ, the AGI is $60,000. A couple can get a $400 credit at this AGI. If your income is near one of the "cliffs" - you can leave some headroom in your IRA contributions until you do a first run-through on your taxes. If you need to get your AGI down a bit, put that much more in a Traditional IRA for the (prior) tax year up until tax day.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: electriceagle on July 07, 2015, 06:31:17 AM
The tax loss harvesting link doesn't discuss an important aspect about the wash sale rule:
With respect to TLH you get the worst of both worlds in retirement accounts. You cannot TLH in a retirement account but you can cause wash sales in a taxable account.
So for example say I want to TLH VTSAX in my taxable account. I sell some shares at a loss. If I buy some shares of VTSAX in my IRA within 30 days then I incur a wash sale, reducing the losses that I claim.
Furthermore, that loss is now forever disallowed. What a wash sale really does is it changes the cost basis of the shares I just bought. But the cost basis is irrelevant in an IRA!

This is why I don't have auto reinvestment for any of my dividends - it can cause a wash sale. Just make sure if you do this in Vanguard you are aware of  this quirk  (http://forum.mrmoneymustache.com/investor-alley/quirk-about-vanguard-that-you-may-want-to-be-aware-of/)

Many people put foreign mutual funds/ETFs in taxable because the taxes that they pay to foreign governments produce a credit. Bond funds can go into retirement accounts because the returns that they pay would otherwise be taxed as ordinary income.

If you plan your AA across accounts, you won't run into TLH problems nearly as much.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: johnny847 on July 07, 2015, 08:11:13 AM
The tax loss harvesting link doesn't discuss an important aspect about the wash sale rule:
With respect to TLH you get the worst of both worlds in retirement accounts. You cannot TLH in a retirement account but you can cause wash sales in a taxable account.
So for example say I want to TLH VTSAX in my taxable account. I sell some shares at a loss. If I buy some shares of VTSAX in my IRA within 30 days then I incur a wash sale, reducing the losses that I claim.
Furthermore, that loss is now forever disallowed. What a wash sale really does is it changes the cost basis of the shares I just bought. But the cost basis is irrelevant in an IRA!

This is why I don't have auto reinvestment for any of my dividends - it can cause a wash sale. Just make sure if you do this in Vanguard you are aware of  this quirk  (http://forum.mrmoneymustache.com/investor-alley/quirk-about-vanguard-that-you-may-want-to-be-aware-of/)

Many people put foreign mutual funds/ETFs in taxable because the taxes that they pay to foreign governments produce a credit. Bond funds can go into retirement accounts because the returns that they pay would otherwise be taxed as ordinary income.

If you plan your AA across accounts, you won't run into TLH problems nearly as much.

Okay, but not everyone can do that. I'm 100/0  stocks and bonds and 50/50 (really, I'm pegged to market weight) US/Intl. My taxable account is ~$57k and my IRAs are ~$17k. I do not have a workplace retirement account. It's not possible for me to avoid TLH issues.

Furthermore, while what you said about the foreign tax credit is true, you neglect the fact that for most foreign funds, the dividend yield is higher than a typical US stock fund, and the rate of qualified dividends is not 100% (whereas a tax efficient US stocks index fund such as VTSAX is). On the Bogleheads wiki page for VTIAX - Vanguard Total International Stock Index (http://www.bogleheads.org/wiki/Vanguard_Total_International_Stock_Index_Fund_tax_distributions) you can find the rate of qualified dividends in past years. It's usually around 70%. They also tell you the foreign tax credit amount.
Why is this important? I'll illustrate with examples - in some cases you should hold international funds in a retirement account, not a taxable account. In each case we assume that if you want to hold VTIAX in one account, you are displacing an equal amount of VTSAX which must be held in the other account.

But first let me explain how the FTC (foreign tax credit) and foreign tax withholding actually works:
Suppose you earn $1000 in dividends from VTIAX. Foreign countries will withhold some of that in taxes. Suppose it's $70.
Vanguard only pays you $930, not $1000. BUT, the US taxes you on $1000 in dividends, NOT $930. Then, if you held VTIAX in a taxable account, you qualify for the FTC (which if you d not have any other foreign income, is exactly equal to foreign tax withheld - otherwise this may not be true). This means you get the $70 back on your tax returns.

Somebody with a 0% tax rate:
The decision is clear: No matter which fund is held in the taxable account, no taxes are paid on dividends. But holding VTIAX in the taxable allows you to claim the FTC (foreign tax credit). So hold VTIAX in the taxable.

Somebody in the 39.6% marginal tax rate (and hence 23.8% LTCG/QDI tax rate - extra 3.8% for ACA tax):
Without loss of generality, look at a $10k holding
Let's take 2014 data (there isn't too much variation year to year).

VTIAX VTSAX
Dividend yield3.24%1.89%
Dividends$324$189
Foreign tax withholding$38$0
Qualified dividends$226.80$189
Unqualified dividends$97.20$0

Relevant equation:
FTC yield on VTIAX in 2014 was 0.38%. $10000*0.0038 = $38.

VTIAX in taxableVTIAX in retirement
VTSAX dividend$189$189
VTIAX dividend$324$324
FTC received$38$0
Foreign tax withheld$38$38
Taxes on dividends$92.47$44.98
Net Dividends$420.53$430.02
Relevant equations:
0.396*97.2 + .238*226.80 = $92.47.
0.238*189 = $44.98

So holding VTIAX in the retirement account is the winner.


Okay okay, that was just for illustrative purposes. Almost nobody on this forum is in the 39.6% bracket. What about the 25% bracket?

VTIAX in taxableVTIAX in retirement
VTSAX dividend$189$189
VTIAX dividend$324$324
FTC received$38$0
Foreign tax withheld$38$38
Taxes on dividends$58.32$28.35
Net Dividends$454.68$446.65
Relevant equations:
0.25*97.2+.15*226.80 = $58.32
0.15*189 = $28.35

So here, the taxable account is the winner.

But wait, there's more! I didn't add in the effect of state taxes. Of the states that have an income tax, most if not all of them start with your federal AGI and do not tax investment income at a favorable rate. Here, VTIAX's higher dividend yield hurts you if held in a taxable.

So what if you have a 6% marginal state tax rate?

VTIAX in taxableVTIAX in retirement
VTSAX dividend$189$189
VTIAX dividend$324$324
FTC received$38$0
Foreign tax withheld$38$38
Federal Taxes on dividends$58.32$28.35
State taxes on dividends19.4411.34
Net Dividends$435.24$435.31
Relevant equations:
.06*324 = $19.44
.06*189 = 11.34

Here there is no clear winner - fluctuations in the dividend yield for VTIAX and VTSAX in any given year is going to rule this one.

So as you can see, it's not as simple as saying international funds give you a FTC if held in a taxable so it should always be held in a taxable. You have to consider dividend yield and qualified dividend rate of your international fund and the displaced fund, and state and federal tax rates (both marginal and LTCG/QDI).

Now one could argue that $1 in a taxable account is not worth the same as $1 in a retirement account. But that is all solved with tax adjusted asset allocation.  (http://www.bogleheads.org/wiki/Tax-adjusted_asset_allocation)

BUT keep in mind that all of this analysis assumes you make enough to save in both a taxable account and a retirement account. If you only have enough to save in a retirement account, don't avoid VTIAX just because of the tax issue - don't let the tax tail wag the dog.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: hobbes1 on July 07, 2015, 09:01:16 AM
looking forward to perusing this thread! Thanks!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cathy on July 07, 2015, 04:40:14 PM
...But first let me explain how the FTC (foreign tax credit) and foreign tax withholding actually works:
Suppose you earn $1000 in dividends from VTIAX. Foreign countries will withhold some of that in taxes. Suppose it's $70.
Vanguard only pays you $930, not $1000. BUT, the US taxes you on $1000 in dividends, NOT $930. Then, if you held VTIAX in a taxable account, you qualify for the FTC (which if you d not have any other foreign income, is exactly equal to foreign tax withheld - otherwise this may not be true). This means you get the $70 back on your tax returns. ...

This is generally true, but it does raise the question of "why?", which I will answer.

In the US, mutual funds are often "regulated investment companies" within the meaning of 26 USC § 851. A regulated investment company is not a disregarded entity under the Internal Revenue Code. It is in fact its own legal personality, subject to income tax generally as a corporation, or, if certain requirements are met, under the alternative taxation regime of 26 USC § 852. Furthermore, as we learned in my previous post (http://forum.mrmoneymustache.com/investor-alley/dividend-yield-of-vun-vs-vti/msg719583/#msg719583) (from a Canadian perspective), when a regulated investment company purchases and holds foreign securities, it may have to pay foreign taxes. These taxes are paid by the regulated investment company (i.e. the mutual fund) and not by the person who owns shares in the fund.

Given that it is the fund (and not its shareholders) that pays the foreign taxes, the default rule is that the shareholder will not need to include the foreign tax amount in her income, and also will not be able to claim a foreign tax credit, because she did not pay any foreign tax. In other words, the default rule is that the shareholder will only report on her US tax return the amount of dividend actually received (i.e. not including the foreign tax, which was paid by the fund and never received by the shareholder).

The default rule described above is subject to an exception found in 26 USC § 853. This latter statute provides that if a regulated investment company satisfies certain technical conditions and has more than 50% of its assets in stock and securities of foreign corporations (as of the close of the taxable year), then it may make an election to change the foreign tax credit rule. If the regulated investment company makes this election, then for the purpose of the tax laws, the foreign tax paid by the fund is deemed to have been received by the shareholders and then paid by them as foreign taxes. The foreign tax credit statute, 26 USC § 901(k)(2), confirms that these amounts are eligible for the foreign tax credit if the usual technical requirements are met, including the minimum holding period.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Uncle Scrooge on July 15, 2015, 07:33:28 AM
"If I could highlight one thing from this section, it would be for the reader to realize there is an automatic $20,600, tax-free space in 2015 for a married couple. These numbers are adjusted for inflation each year. Given proper tax planning efforts, you should do everything in your power to create enough income each year to fill this space. The Roth Pipeline (conversion ladder), or simply withdrawing funds from a Traditional IRA will help with this."



Can someone explain this a little further for me please? Does this mean you can transfer $20,600 each year from a 401k over to a Roth IRA and avoid taxes?
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: dandarc on July 15, 2015, 07:42:07 AM
"If I could highlight one thing from this section, it would be for the reader to realize there is an automatic $20,600, tax-free space in 2015 for a married couple. These numbers are adjusted for inflation each year. Given proper tax planning efforts, you should do everything in your power to create enough income each year to fill this space. The Roth Pipeline (conversion ladder), or simply withdrawing funds from a Traditional IRA will help with this."



Can someone explain this a little further for me please? Does this mean you can transfer $20,600 each year from a 401k over to a Roth IRA and avoid taxes?
If you had no other income, yes that's exactly what it means.  Very important part of your withdrawal strategy - minimizing taxes really helps extend the life of your portfolio.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on July 15, 2015, 07:47:42 AM
"If I could highlight one thing from this section, it would be for the reader to realize there is an automatic $20,600, tax-free space in 2015 for a married couple. These numbers are adjusted for inflation each year. Given proper tax planning efforts, you should do everything in your power to create enough income each year to fill this space. The Roth Pipeline (conversion ladder), or simply withdrawing funds from a Traditional IRA will help with this."



Can someone explain this a little further for me please? Does this mean you can transfer $20,600 each year from a 401k over to a Roth IRA and avoid taxes?
If you had no other income, yes that's exactly what it means.  Very important part of your withdrawal strategy - minimizing taxes really helps extend the life of your portfolio.

Yes, and it really belongs in the second post of this thread. I'm still working on that post but I'll be sure to expand on this point when I get to it.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Reynold on July 16, 2015, 08:03:05 AM

What should I use to prepare my tax return?
Pencil and Paper is a strategy recommended by some around here. I’ve never done that myself, but I can understand how it can be of great benefit to do this. You must learn the nuances of each line on the 1040 in order to do it properly, so it will certainly give you an edge.


I'd like to chime in to recommend this, if you haven't done your taxes before and want to start.  When I started doing my own taxes, I didn't have a computer at home (which gives you an idea how long ago that was), so pencil and paper was the only option.  When I got a computer and tax software for it, having worked through the forms on my own and read the instructions to do so I was able to do a much better job of using the software.  The big companies do their best to explain things in the software as you go along, but there are a lot of items which would be completely baffling if you don't know what they mean.  If you do know what they mean, you know which 90% you can skip right over and which 10% are actually relevant and you need to dig into. 

Also, if like a lot of people here, you have a business + wage income, depending on the business structure taxes can get a lot more complex, and the business software does a lot less hand holding than the personal.  I found it best to use an accountant for a year or two, then I could use what they did as a guideline for doing my own with the software.  Ditto the year I lived in 2 states and had income from 3, I didn't want to put the time into figuring out three sets of state tax returns on a one-time basis. 
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: doubled85 on July 24, 2015, 02:12:18 PM
So much fantastic information in here. A few points in no particular order:


/rant
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: themagicman on July 24, 2015, 02:45:42 PM
Following! Thank you for putting this together!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: ender on July 24, 2015, 07:15:37 PM
I hope someday to take complete advantage of the credit section by working part-time and basically maxing out all available tax credits.

This is a great resource!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Ellsie Equanimity on July 26, 2015, 01:21:17 PM
Alright, so I'm frugal and somewhat interested in finances, but I'm a newbie when it comes to the language and really understanding the details. Interested in learning more, but always feel a bit overwhelmed. And I’ve never done my own taxes - my dad took care of it (I’m in grad school, too, so haven’t yet had a “real job” with much income for it to matter. I got married this year and my husband and I will be filing jointly next year. He loves this stuff and I want to understand it better. I will be discussing this with him as well, but thought I’d post, too, for additional perspective as well as some 'this is what a total newbie has questions on' perspective for you.

I apologize if the questions are too basic or not formatted well (some stuff like the AGI I realized I had more questions as I went). I just went through what you said piece by piece and I tried to look up what seemed most basic so it wasn't all like 'google could have answered that for you...'

Tax Loss Harvesting (http://www.madfientist.com/tax-loss-harvesting/) is a way to sell securities in a regular (taxable) brokerage account in order to reduce taxable income. Any losses will first offset any other Capital Gains in the current year, including capital gain distributions on your Schedule D. The result from Schedule D carries to your 1040 and you can use a $3,000 loss to offset other income reducing your AGI and taxable income accordingly.

Is this legal? “Tax Loss Harvesting” sounds sketchy and the fact that it links to something that says “Tax Avoidance” seems concerning. I mean, I’m assuming you’re not suggesting anything illegal, but when does utilizing what’s there to your benefit become “tax evasion”? I’m ok with “playing their game” but I don’t want to do anything too sketchy.

What does “securities” mean exactly? What is a Schedule D? I don’t really follow what this is saying.

A Traditional IRA contribution reduces your AGI and taxable income, a Roth contribution does not.

My husband and I have talked a lot about this and he’s explained it to me many times and I get it….except that I have to think through it every time. Traditional is taxed now, and Roth later….so why does traditional reduce your taxable income and Roth not? If Roth doesn’t then aren’t you getting taxed twice on it?

Student Loan Interest (http://www.irs.gov/taxtopics/tc456.html) is a Pre-AGI tax deduction unlike mortgage interest

This part isn’t applicable to me but for the sake of learning: Pre-AGI tax deduction? What does that mean? I mean, I figured out the acronym, but what is the significance?

Deductions/Exemptions:
 The Standard Deduction  (http://www.irs.gov/Credits-&-Deductions/Individuals/Standard-Deduction) is available to everyone, and can be particularly beneficial to a frugal early retiree. It doesn’t matter how much you spend, what city/state you live in, or what you ate for breakfast, you get $12,600 (MFJ for 2015). Some forum members barely exceed that amount in expenses each year.

So…dumb question, but a deduction means you don’t pay taxes on that amount, right? Why do these exist anyway? (Not complaining, knowing why helps with remembering.)

The Itemized Deduction  (http://www.irs.gov/uac/Schedule-A-(Form-1040),-Itemized-Deductions) is available for the spendypants members. If your deductible expenses from this form exceed the standard amount, use the itemized amount; you can’t use both. For many people this is very easy to reach. If you live in a state with an income tax, real estate tax, and personal property tax (see Cheddar Stacker – my deductible taxes in 2014 were $9,080) you will likely itemize. If you are close to the top of the standard deduction, consider intentionally lumping expenses into one year. In 2015 forego charitable contributions and paying your real estate tax bill. In January 2016, pay your 2015 RE tax bill and make your 2015 charitable contributions. Then in December 2016, pay your 2016 RE tax bill and make your 2016 charitable contributions. The result can be a nice way to squeeze out an extra $1,000-2,000 in deductions.

What qualifies something as a deductible expense?

Personal Exemptions  (http://www.irs.gov/publications/p17/ch03.html) are available for each person claimed on your tax return. Multiply the number claimed in box 6d times the personal exemption rate for any given year ($4,000 for 2015) and reduce your taxable income accordingly.

Is this extra on top of the standard or itemized? Is it the same no matter how you file? Why might you file MFJ vs head of household?
And back everything up - I need some more explanation on pre/post-AGI. Are these deductions affecting your AGI? Is taxable income the same as AGI? What would it even mean for something to be a post-tax deduction?

If I could highlight one thing from this section, it would be for the reader to realize there is an automatic $20,600, tax-free space in 2015 for a married couple. These numbers are adjusted for inflation each year. Given proper tax planning efforts, you should do everything in your power to create enough income each year to fill this space. The Roth Pipeline (conversion ladder), or simply withdrawing funds from a Traditional IRA will help with this.

create enough income? Is this because as a retired person you may actually not have that much income? But if you somehow don’t and are living fine without it, why do you want to “create” that income?
Roth Pipeline must be converting roth to traditional?

The Child Tax Credit (http://www.irs.gov/pub/irs-pdf/p972.pdf) is awesome. Step 1, have a kid or 7. Step 2, pay less tax. Unfortunately it’s not quite that simple. The credit is up to $1,000 per child under age 17 at the end of the tax year, and it’s refundable through the additional child tax credit. Much like the student loan interest deduction, it has a phase out range. This credit is gradually phased out as your AGI grows from $110K-$150K (MFJ for 2014). So if you have 2 qualifying kids and a potential child tax credit of $2,000, but your AGI is $130K, you will receive a child tax credit of $1,000.

What is the difference between a deduction and a credit? What does it mean that the credit is refundable?

The Earned Income Credit (http://www.irs.gov/Credits-&-Deductions/Individuals/Earned-Income-Tax-Credit) or EIC is also something to shoot for if you earn a low income, or you are able to reduce your AGI to an extremely low level via Pre-Tax Deductions. This credit becomes much easier to qualify for when you have a few children. Investment income must be no more than $3,350 for the year.

Is investment income part of your AGI?

And a final global question - what happens if you mess up your taxes and file something wrong on accident?
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on July 26, 2015, 01:51:52 PM
Is this legal? “Tax Loss Harvesting” sounds sketchy and the fact that it links to something that says “Tax Avoidance” seems concerning. I mean, I’m assuming you’re not suggesting anything illegal, but when does utilizing what’s there to your benefit become “tax evasion”? I’m ok with “playing their game” but I don’t want to do anything too sketchy.
Yes, perfectly legal.  As long as you "utilize what's there" (aka follow the tax laws) then avoidance never becomes evasion.

Quote
What does “securities” mean exactly? What is a Schedule D? I don’t really follow what this is saying.
Think "stocks, mutual funds, etc." for securities.  Schedule D is used for capital gains (e.g., when you sell some securities that you previously bought).

Quote
My husband and I have talked a lot about this and he’s explained it to me many times and I get it….except that I have to think through it every time. Traditional is taxed now, and Roth later….so why does traditional reduce your taxable income and Roth not? If Roth doesn’t then aren’t you getting taxed twice on it?
Traditional is not taxed now, it is taxed later.  Roth is taxed now, not later.

Quote
This part isn’t applicable to me but for the sake of learning: Pre-AGI tax deduction? What does that mean? I mean, I figured out the acronym, but what is the significance?
It means that you can take this deduction in addition to the "standard deduction", vs. instead of the standard deduction if you itemized deductions.  For that matter, pre-AGI deductions can be taken in addition to your itemized deductions if you choose to itemize.

Quote
So…dumb question, but a deduction means you don’t pay taxes on that amount, right? Why do these exist anyway? (Not complaining, knowing why helps with remembering.)
The simple answer: because that is how the law is written.  To know for sure on "why" one would need to poll the law writers.  A reasonable guess here would be "to avoid taxing those with the lowest incomes."

Quote
What qualifies something as a deductible expense?
The tax law.  No two ways about it.  E.g., see http://www.irs.gov/taxtopics/tc500.html.

Quote
Is this extra on top of the standard or itemized?
Yes, either/both.
Quote
Is it the same no matter how you file?
No, it depends on how many people are covered by the return.

Quote
And back everything up - I need some more explanation on pre/post-AGI. Are these deductions affecting your AGI? Is taxable income the same as AGI? What would it even mean for something to be a post-tax deduction?
Without delving into details, you can think of pre-AGI deductions as those appearing on the front page of form 1040, while post-AGI deductions and exemptions appear on the back.  No, taxable income is not the same as AGI - see form 1040.

Quote
create enough income? Is this because as a retired person you may actually not have that much income? But if you somehow don’t and are living fine without it, why do you want to “create” that income?
"...not have that much taxable income."  You may not need it now, but you might need it later.

Quote
What is the difference between a deduction and a credit?
You subtract a deduction from your income on the way to calculating your taxable income.  The tax you pay is some fraction of your taxable income.  The deduction is "worth" (i.e., reduces your taxes by) your marginal rate times the deduction (e.g., 25% times the deduction).  A credit is subtracted directly from the tax you owe, thus is "worth" 100% of the credit amount.

Quote
What does it mean that the credit is refundable?
If your tax due is $100 and you have a $150 credit, with a "refundable " credit you get a $50 refund from the IRS.  With a "non-refundable" credit you simply pay $0 tax and "lose" the extra $50.

Quote
Is investment income part of your AGI?
Yes.

Quote
And a final global question - what happens if you mess up your taxes and file something wrong on accident?
You pay (or get a refund of) the difference between what you did pay and what you should have paid.  If you owe more, you also pay interest and possibly some flat fees in addition.  If you get a refund, the IRS pays you no interest.


Going line by line through Form 1040 would be a lot more efficient than random googling.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Lski'stash on July 26, 2015, 01:57:04 PM
Replying because I want to make sure I have this! Thanks!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Ellsie Equanimity on July 26, 2015, 02:48:10 PM
Thanks.

Going line by line through Form 1040 would be a lot more efficient than random googling.

Yeah, I think when my husband and I file taxes together for this year it will help a lot.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on July 26, 2015, 03:05:04 PM
Going line by line through Form 1040 would be a lot more efficient than random googling.
Yeah, I think when my husband and I file taxes together for this year it will help a lot.
You should do a dry run now - ok, in the next month or so - to ensure you aren't unpleasantly surprised next April.  My personal favorite would be for the two of you to put your Form 1040 (and any supporting forms/schedules needed) into your own spreadsheet form so you "learn by doing."  Doing it all by hand, or getting an old copy of 2014 TaxAct, TurboTax, etc., or any of the suggestions in the OP here are also reasonable approaches.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Ellsie Equanimity on July 26, 2015, 04:05:22 PM
You should do a dry run now - ok, in the next month or so - to ensure you aren't unpleasantly surprised next April.  My personal favorite would be for the two of you to put your Form 1040 (and any supporting forms/schedules needed) into your own spreadsheet form so you "learn by doing."  Doing it all by hand, or getting an old copy of 2014 TaxAct, TurboTax, etc., or any of the suggestions in the OP here are also reasonable approaches.

My husband did his taxes himself the past couple years (with Turbotax a few years and has done his own spreadsheets for them, too.) And we're doing a pretty exhaustive budget. So I don't think we'll have any surprises. Might be worth the dry-run though just for helping me learn sooner.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: johnny847 on July 26, 2015, 08:47:15 PM
You should do a dry run now - ok, in the next month or so - to ensure you aren't unpleasantly surprised next April.  My personal favorite would be for the two of you to put your Form 1040 (and any supporting forms/schedules needed) into your own spreadsheet form so you "learn by doing."  Doing it all by hand, or getting an old copy of 2014 TaxAct, TurboTax, etc., or any of the suggestions in the OP here are also reasonable approaches.

My husband did his taxes himself the past couple years (with Turbotax a few years and has done his own spreadsheets for them, too.) And we're doing a pretty exhaustive budget. So I don't think we'll have any surprises. Might be worth the dry-run though just for helping me learn sooner.

I'd do it by hand. There is no better way for you to learn about the portions of the tax code that affect you than filling out tax forms by hand.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: DrJohn on July 27, 2015, 08:38:25 AM
OK- this is great- but how does it play out for expatriates living in non-tax countries?  Maybe think of it as the next step of information provision?

Thanks.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on July 27, 2015, 10:54:38 AM
MDM, thanks for answering all those questions.

One additional note on the Pre-AGI deductions (The bottom of 1040 page 1):

They lower your AGI. This is a big deal in many ways. AGI is the focal point of many tax laws. 10% AGI floor for medical expenses, 2% AGI floor for miscellaneous expenses, threshold for determining traditional IRA deductibility (Modified AGI at least), etc.

Take advantage of any Pre-AGI deduction you can get, they're great.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Dan_Breakfree on July 29, 2015, 08:40:39 PM
Wow, really great information, thanks for compiling in one spot. We are fortunate to be in a very high income year and will eclipse the 33% bracket if we're not careful. I was already maxing out my 401k, but my wife wasn't on hers... we had been using her income to pile up cash savings, but this was before I knew about the Roth IRA conversion ladder.

To summarize, we just cranked her 401k contributions up to 50% and which will allow it to max out by the end of the year, effectively saving $4,950 in federal income tax!!! If we ever meet up, I owe many people on this forum a beer.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Workinghard on July 30, 2015, 06:39:15 AM
Thanks for compiling info and starting this thread!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on July 30, 2015, 03:38:04 PM
Finally posted the Retirement Years strategy in reply #1. Sorry for the delay, I tend to procrastinate (http://waitbutwhy.com/2015/07/why-im-always-late.html) quite a bit.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: brooklynguy on July 31, 2015, 08:21:24 AM
Finally posted the Retirement Years strategy in reply #1. Sorry for the delay, I tend to procrastinate (http://waitbutwhy.com/2015/07/why-im-always-late.html) quite a bit.

Excellent write-up, Chedds.  At the risk of looking a gift horse in the mouth, I have a couple of minor suggestions:

- the Ordinary Dividends and Qualified Dividends sections, when read in conjunction, make it sound like dividends received from a mutual fund (as opposed to directly held stock) can't be qualified -- perhaps tweak either or both of these sections to clarify that they can be?

- consider including a section on rental income, given that it is another common form of retirement income with its own 1040 line item
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on July 31, 2015, 08:36:23 AM
Finally posted the Retirement Years strategy in reply #1. Sorry for the delay, I tend to procrastinate (http://waitbutwhy.com/2015/07/why-im-always-late.html) quite a bit.

Excellent write-up, Chedds.  At the risk of looking a gift horse in the mouth, I have a couple of minor suggestions:

- the Ordinary Dividends and Qualified Dividends sections, when read in conjunction, make it sound like dividends received from a mutual fund (as opposed to directly held stock) can't be qualified -- perhaps tweak either or both of these sections to clarify that they can be?

- consider including a section on rental income, given that it is another common form of retirement income with its own 1040 line item

Thanks for the notes. I'll definitely tweak the dividends section, I don't want that to be misleading.

Rentals - I think that might deserve it's own reply sometime soon, and I'll link it up to reply #1 so it's easy to get to. As I mentioned before I tried to keep this personal vs. business, but it's a viable personal cash flow strategy for retirement so I understand the reason behind the suggestion.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on July 31, 2015, 08:56:35 AM
- the Ordinary Dividends and Qualified Dividends sections, when read in conjunction, make it sound like dividends received from a mutual fund (as opposed to directly held stock) can't be qualified -- perhaps tweak either or both of these sections to clarify that they can be?

Added the following 2 paragraphs, and tweaked a little bit more of the wording that was already there:

When you purchase individual stocks and hold them long-term, you will receive Qualified dividends. When you purchase mutual funds, a high turnover of stocks held by the fund will produce Ordinary dividends, so you have less control over the Ordinary vs. Qualified. Pay attention to the type of dividends typically paid by a mutual fund when selecting them for purchase, because they can vary widely. Consider whether the fund itself has a buy and hold strategy, because high turnover creates higher taxes for you. *

* Taxes should not be the only consideration when investing, but they shouldn't be ignored either. If a fund with a high turnover consistently beats the fund with a low turnover by 3%, but produces additional taxes, the net return of each option should be considered. Weigh the opportunity cost, and don't ignore the potential for a 12% return because you might have to pay a little more tax.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: ender on July 31, 2015, 03:57:41 PM
Quote
Wages should be $0, so let’s skip that line. No more of that FICA guy.


Not sure if this is the best place, but for many, a small amount of earned income in retirement can really pay off tax wise with refundable tax credits.

Quote
but if you are MFJ you have to reach about $44K of income (including 50% of SS benefits) before anything related to SS benefits will become taxable.

This isn't super clear to me, "including 50% of SS benefits" - do you mean if I have $50k SS income and $19k other income that means I have $19k+$25k = $44k? Or something else?

Honestly I'm not even sure reading the IRS page though what the implications are, so I can't really suggest alternate wordings - http://www.ssa.gov/planners/taxes.html - it looks like you only include 50% of your SS as "income" for tax purposes, until you hit $44k total taxable income?
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Tremeroy on July 31, 2015, 04:14:04 PM
Speaking specifically to learning the tax rules:
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on July 31, 2015, 09:41:11 PM
Quote
Wages should be $0, so let’s skip that line. No more of that FICA guy.


Not sure if this is the best place, but for many, a small amount of earned income in retirement can really pay off tax wise with refundable tax credits.

Very good point ender. A small amount of earned income can help in many ways. Not only does it supplement your SWR,  but all of the sudden the earned income credit is simple to reach (if you don't have a lot of investment income). I may circle back and add a note. Thanks.

Quote
but if you are MFJ you have to reach about $44K of income (including 50% of SS benefits) before anything related to SS benefits will become taxable.

This isn't super clear to me, "including 50% of SS benefits" - do you mean if I have $50k SS income and $19k other income that means I have $19k+$25k = $44k? Or something else?

Honestly I'm not even sure reading the IRS page though what the implications are, so I can't really suggest alternate wordings - http://www.ssa.gov/planners/taxes.html - it looks like you only include 50% of your SS as "income" for tax purposes, until you hit $44k total taxable income?

Yep, you got the idea. I've found in practice that around $20k income from non SS sources is safe. Beyond that the SS income starts to phase into the taxable range.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: N on August 01, 2015, 12:18:08 AM
thanks for assembling this!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on August 03, 2015, 08:34:53 AM
thanks for assembling this!

You're welcome.

@Ender, I added a note in the wages section based on your suggestion, thanks again.

I also added a note on REITs in the dividend section which I meant to include but forgot about until just now.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: anoneemus on August 07, 2015, 10:11:28 AM
Wow, very cool stuff! I am working my way through the initial post.

Having just checked out the Key Facts and Figures link, I want to flag an error on that sheet:

In the 2015 MFJ table, the calculation for taxes in the $151,200-$230,450 taxable income range is incorrect. It shows the calculation as: 26,387.50 + 28% 151,200 but the correct calculation is 29,387.50 + 28% 151,200. IOW it's $3000 off.

I built a spreadsheet to calculate our taxes given various assumptions about income and deductions, so some months ago I looked up the 2015 tax tables - that's why I honed in on that part of the worksheet and noticed the error.

Resources:
Key Facts and Figures (http://www.paychex.com/a/d/accounting/CCH_Fed_Facts_and_Figures_2015.pdf) is one of the best resources I’ve found online that summarizes a lot of data into just 2 pages. I keep a printed copy in my top desk drawer and refer to it often. You can get an updated version of this each year with this search: 2016 key facts and figures.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on August 07, 2015, 10:30:29 AM
Wow, very cool stuff! I am working my way through the initial post.

Having just checked out the Key Facts and Figures link, I want to flag an error on that sheet:

In the 2015 MFJ table, the calculation for taxes in the $151,200-$230,450 taxable income range is incorrect. It shows the calculation as: 26,387.50 + 28% 151,200 but the correct calculation is 29,387.50 + 28% 151,200. IOW it's $3000 off.

I built a spreadsheet to calculate our taxes given various assumptions about income and deductions, so some months ago I looked up the 2015 tax tables - that's why I honed in on that part of the worksheet and noticed the error.

Good catch! And congrats on reaching that level of income. I've never made it to the 28% tax bracket, but there are a few variables this year that could put us at the bottom of that bracket. Bittersweet.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on August 07, 2015, 10:56:23 AM
In the 2015 MFJ table, the calculation for taxes in the $151,200-$230,450 taxable income range is incorrect.

I built a spreadsheet to calculate our taxes given various assumptions about income and deductions

As CS said, good catch!  Given that, I suspect your own spreadsheet is pretty good.  If you see substantive ways to improve the MMM case study spreadsheet (http://forum.mrmoneymustache.com/ask-a-mustachian/how-to-write-a-%27case-study%27-topic/msg274228/#msg274228), let us know.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Paul der Krake on August 11, 2015, 08:42:02 PM
Does anyone have a good resource or general advice for small business owners, specifically married couples with one W-2 and one side business?

I have been reading "LLC for dummies"-type books for a little bit and tax efficiency is rarely discussed. Pointers would be appreciated.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: AllieVaulter on August 30, 2015, 07:00:49 PM
Following!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Malaysia41 on September 07, 2015, 02:43:04 AM
OK- this is great- but how does it play out for expatriates living in non-tax countries?  Maybe think of it as the next step of information provision?

Thanks.

Dr. John,

I've been doing (read obsessing) on the relative merits in living overseas in retirement, mainly because we're currently living overseas in retirement, and are ready to move to somewhere new.  How about I start a new thread?  I'll come back in here and post the link.  If it's a duplicate thread please let me know, but an initial search came up goose eggs.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: flagdude on September 14, 2015, 11:32:10 PM
Following
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: thrifted on October 05, 2015, 10:28:52 AM
this is amazing advice. so straight forward and succinct.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: JustGettingStarted1980 on November 11, 2015, 10:33:49 AM
Hi Cheddar (or anyone else who knows the answer),

Love the LC series, by the way :)

Question on Dependent Care FSA's.
-so I get a Tax deduction of $6000 from the IRS for my childcare expenses (well over 6K)
-i have a workplace Dependent Care FSA that does a pretax deduction of 5K, and then reimburses this money later. But it's a pain, have to fill out reimbursement paperwork, and can't get the money back until after I already paid the Nanny anyway.

-my question is, which is better?
-per my crappy math:

IRS Tax Deduction = $6000 x .28 = $1680
Pretax Dependent Care FAS = $5000 x .28 = $1400 and more money out of circulation as well as more paperwork

Is my math right?

Thanks,

JGS
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: johnny847 on November 11, 2015, 10:53:19 AM
Hi Cheddar (or anyone else who knows the answer),

Love the LC series, by the way :)

Question on Dependent Care FSA's.
-so I get a Tax deduction of $6000 from the IRS for my childcare expenses (well over 6K)
-i have a workplace Dependent Care FSA that does a pretax deduction of 5K, and then reimburses this money later. But it's a pain, have to fill out reimbursement paperwork, and can't get the money back until after I already paid the Nanny anyway.

-my question is, which is better?
-per my crappy math:

IRS Tax Deduction = $6000 x .28 = $1680
Pretax Dependent Care FAS = $5000 x .28 = $1400 and more money out of circulation as well as more paperwork

Is my math right?

Thanks,

JGS

Aren't dependent care FSA's pre FICA tax? If that's the case, add another .0765 to the .28 and you get a deduction of $1782.50.

Are you sure this is a deduction? I searched the internet for a dependent care deduction, and I could only find a mention of a credit, not a deduction. Can you link the appropriate IRS documents on this tax deduction?
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on November 11, 2015, 12:02:57 PM
Love the LC series, by the way :)

Thanks!

Johnny is correct on both fronts but I'll add a bit more info.

Your FSA is limited to $5K, and pre ALL tax. So you have to factor FICA into the mix. However, it might not be clear cut for you at 7.65%. You used 28% in your calculation, which indicates high income. If your wages exceed $118K/yr, you max out your Social Security at the top of that wage base. This means even if you get this deduction pre-tax, you might not benefit fully from the reduction in FICA tax. If your taxable wages > (118,000 + 5,000) or $123,000, you might only benefit as follows by using the FSA:

5,000
x 28% (Fed) x ?% (State/Local) x 1.45% (Medicare)

After that you should use the dependent care credit. As johnny mentioned, it's a credit not a deduction. You will receive 20% back below your income tax calculation (it's as if you paid in extra federal withholdings). Since you are already maxing out the FSA at $5,000, and the limit is $6,000, I would advise putting $1,000 on this form. You can claim expenses here that weren't reimbursed by an FSA.

It gets even more complex than that though, and this is the real reason why the FSA should be maxed: It lowers everything. FICA wages base, taxable wages on W-2, which in turn reduces your AGI, which in turn can increase other deductions/credits you aren't getting (like the child tax credit, although you may be phased out of that since you are in the 28% bracket, but with enough work you might be able to get this and other benefits). It also lowers any taxable income on a state or city tax return since your taxable wages (Box 1 on the W-2) will be lowered by the FSA withholding. The dependent care credit is a federal credit, and I know my state doesn't have a similar one.

Max out the FSA. It's worth it. If you are still unsure, send me a PM with the numbers and I'll let you know exactly how much it benefits you.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: smoghat on November 12, 2015, 11:44:42 AM
A really good CPA is worth his or her weight in gold. Now if you are retiring with an expected $38,000 a year of income, more power to you, but if you crack a million, a good CPA is an excellent resource. For my last three years of work, I paid about $1,000 a year to my CPA and about $3,000 a year to the IRS on $80,000 of traditional salaried income and $100k to $150k of earnings from my businesses.

Do YOU really know what are the red flags for an audit? If so, great, you are a superhero. Does a CPA with HR Block? Maybe not. But if you establish a relationship with someone who knows what he or she is doing and has been in the business for a long time, that info is invaluable and dirt cheap. The last time we saw our CPA he sat us down and talked to us about our financial plans (we just retired at 48, expected income between $160k and $250k for the first decade) for three hours. Charge? None. After 18 years we are valued customers. Oh, but since he works 120 miles away and it was our 30th high school reunion and we were hosting a party at a house we were renting for the weekend, we did get to deduct the hotel room as a tax plan on expense (IRS doesn't care how much we spent on the room, it makes sense to them and who cares where we went for dinner the next day). There's. 40% discount on the room.

Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: deeshen13 on November 23, 2015, 08:32:45 AM
"If I could highlight one thing from this section, it would be for the reader to realize there is an automatic $20,600, tax-free space in 2015 for a married couple. These numbers are adjusted for inflation each year. Given proper tax planning efforts, you should do everything in your power to create enough income each year to fill this space. The Roth Pipeline (conversion ladder), or simply withdrawing funds from a Traditional IRA will help with this."



Can someone explain this a little further for me please? Does this mean you can transfer $20,600 each year from a 401k over to a Roth IRA and avoid taxes?
If you had no other income, yes that's exactly what it means.  Very important part of your withdrawal strategy - minimizing taxes really helps extend the life of your portfolio.

Can someone elaborate on how we came up with $20,600 as the available amount for the backdoor Roth in 2015?  I assume its standard deduction + contribution limits of Roth + ??? = 12,600 + 5,500 = 18,100.  What am I missing?  Thanks!

Oh, and thanks so much for this thread.  Really appreciate the succinct advice in one place.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: johnny847 on November 23, 2015, 08:35:27 AM
"If I could highlight one thing from this section, it would be for the reader to realize there is an automatic $20,600, tax-free space in 2015 for a married couple. These numbers are adjusted for inflation each year. Given proper tax planning efforts, you should do everything in your power to create enough income each year to fill this space. The Roth Pipeline (conversion ladder), or simply withdrawing funds from a Traditional IRA will help with this."



Can someone explain this a little further for me please? Does this mean you can transfer $20,600 each year from a 401k over to a Roth IRA and avoid taxes?
If you had no other income, yes that's exactly what it means.  Very important part of your withdrawal strategy - minimizing taxes really helps extend the life of your portfolio.

Can someone elaborate on how we came up with $20,600 as the available amount for the backdoor Roth in 2015?  I assume its standard deduction + contribution limits of Roth + ??? = 12,600 + 5,500 = 18,100.  What am I missing?  Thanks!

Oh, and thanks so much for this thread.  Really appreciate the succinct advice in one place.

A married couple can claim the standard deduction of $12600 and two exemptions of $4000 each. The Roth contribution limit has nothing to do with it, and neither does the backdoor Roth. A backdoor Roth is used when your income is too high to contribute to a Roth directly.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on November 23, 2015, 08:39:14 AM
Johnny beat me to it but I'll post my reply anyway:

1) It's not a backdoor Roth (which is a contribution to a Roth when you are ineligible due to income), it's a conversion to a Roth as part of a Ladder or as part of proper tax planning during your drawdown.

2) It assumes a married couple, and uses 2015 tax rules which will be adjusted for inflation each year.

3) Standard deduction = 12,600

4) Personal exemption =   4,000 ( x 2 for a married couple)

If you have a big amount of itemized deductions you can increase that $12,600 accordingly. If you have 5 kids you can increase the exemptions accordingly.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: deeshen13 on November 23, 2015, 10:19:42 AM
Straightforward enough; thanks guys.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Penny Lane on December 02, 2015, 07:19:26 AM
This is such a good thread; thanks to Cheddar for doing all this work to help us!

I have a Roth ?-- I have always made too much to have one, but now that I am mostly retired and consult I will be eligible this year.  Do I have until 4.15.16 to fund one?  Do I have to set up the actual account before 12.31.15?  I am also considering doing some Roth conversion as I have massive tIRA's/401K's; can I do that early in 2016 when I have a better idea of my tax situation?  I will still be in 25%ile and perhaps I should fill that?  I am in my early 60's-- would I still have to wait 5 yrs before accessing the Roth $ ( although I would not plan to touch it for a long time)?  I figured out about how much my required draws will be at 70.5--whoa!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on December 02, 2015, 10:19:32 AM
This is such a good thread; thanks to Cheddar for doing all this work to help us!

; )  Just doing my part, so many great resources around this place.

If I'm you I'd put together a spreadsheet detailing annual anticipated growth of the Traditional accounts and annual anticipated conversations from T to R. You must do the RMD's when the time comes, and if they will bump you into the 25% bracket on their own you might as well start pulling them out now and filling up all of the 15% bracket and maybe even continue into the 25% bracket.

Try to get the lowest effective tax rate over the next 30 years, don't worry about 2016 or 2017 alone.

You can do the conversion in early 2016, the only reason to wait would be if you want to see how the rest of the year plays out. You can open the Roth account (if you don't already have one) anytime before 4/15 each year. I'm unsure the answer on the 5 year waiting period on a Roth after you turn 59.5, but it seems like you should have immediate access to everything. Google should be able to answer that if someone else here doesn't.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: johnny847 on December 02, 2015, 10:30:48 AM
You can do the conversion in early 2016, the only reason to wait would be if you want to see how the rest of the year plays out.

Penny Lane can certainly do a conversion in early 2016, however, that conversion will be counted towards the 2016 tax year, NOT 2015.

To do an "after the fact" conversion for the 2015 tax year, one must convert far more than one actually intends in 2015. Then in early 2016, before filing taxes, one can recharacterize a portion (or all if one desires) of the conversion amount. This would let one treat that portion of the conversion as if it never happened.
(Technically this can be done through 10/15 by amending one's taxes or filing for an extension, but it is much easier to just do it before one files one's tax return).
For more details, read here (https://www.bogleheads.org/wiki/IRA_recharacterization).
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on December 02, 2015, 10:40:58 AM
You can do the conversion in early 2016, the only reason to wait would be if you want to see how the rest of the year plays out.

Penny Lane can certainly do a conversion in early 2016, however, that conversion will be counted towards the 2016 tax year, NOT 2015.

To do an "after the fact" conversion for the 2015 tax year, one must convert far more than one actually intends in 2015. Then in early 2016, before filing taxes, one can recharacterize a portion (or all if one desires) of the conversion amount. This would let one treat that portion of the conversion as if it never happened.
(Technically this can be done through 10/15 by amending one's taxes or filing for an extension, but it is much easier to just do it before one files one's tax return).
For more details, read here (https://www.bogleheads.org/wiki/IRA_recharacterization).

Agree.

I was working under the mistaken assumption (shame on me) that Penny just retired after making a very high wage in 2015 . If that's the case, no reason to pile on more income in 2015, but after a re-read it's clear income is down in 2015. It's worth considering converting some in 2015 if the numbers work out in favor of that, and the conversion is included in income in the year it's initiated.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: grenzbegriff on December 02, 2015, 02:48:48 PM
Hi Cheddar Stacker, and others.  Very nice guide, it was simple enough for me to understand.

In the past I've always taken the standard deduction.  But as tax time approaches I'm investigating and I believe I will want to take itemized deduction this time.  I'd love for someone to check my logic:

Gross income: ~$200k
401k contribution: ~$18k  (employer matched +$9k)
Charitable giving: ~$12k
California state income tax: ~$14k  (on income of $170k due to above)

If I understand right, this means my adjusted gross income for federal income tax will be ~$156k if I take the itemized deduction.  Does that sound correct?  Would my adjusted gross income be ~$200k - $6300 if I were to take the standard deduction?  (I'm single with no dependents.)

That seems like a fairly huge benefit to taking itemized deduction, but I might be figuring wrong. 
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: johnny847 on December 02, 2015, 02:58:53 PM
Hi Cheddar Stacker, etc.

In the past I've always taken the standard deduction.  But as tax time approaches I'm investigating and I believe I will want to take itemized deduction this time.  But I'd love for someone to check my logic:

Gross income: ~$200k
401k contribution: ~$18k  (employer matched +$9k)
Charitable giving: ~$12k



If I understand right, this means my adjusted gross income for federal income tax will be ~$156k if I take the itemized deduction.  Does that sound correct? 
No. Because of a technicality. Your standard/itemized deduction does not affect your AGI.
Taxable income = AGI - std or itemized deduction - exemption(s).
This is an important distinction because your eligibility for other deductions and credits is dependent on your AGI, not your taxable income.

The exemption is $4k. So you will have $152k in federal taxable income.

Would my adjusted gross income be ~$200k - $6300 if I were to take the standard deduction?  (I'm single with no dependents.)
No, your AGI would be
$200k - 18k = $182k in either case (standard or itemized deduction).

You would have a taxable income of $171,700 if you took the standard deduction instead of itemizing (remember, $4000 for personal exemption).

You said:
California state income tax: ~$14k  (on income of $170k due to above)
Does CA give you a deduction for charitable giving? Because you've made the same mistake again. Your Federal AGI is $182k. Not $170k. I assume that CA like most states taxes you based on your federal AGI (and with their own deductions and exemptions).

Make sure you've got documentation for that $12k in charitable giving.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: seattlecyclone on December 02, 2015, 03:01:00 PM
Hi Cheddar Stacker, and others.  Very nice guide, it was simple enough for me to understand.

In the past I've always taken the standard deduction.  But as tax time approaches I'm investigating and I believe I will want to take itemized deduction this time.  I'd love for someone to check my logic:

Gross income: ~$200k
401k contribution: ~$18k  (employer matched +$9k)
Charitable giving: ~$12k
California state income tax: ~$14k  (on income of $170k due to above)

If I understand right, this means my adjusted gross income for federal income tax will be ~$156k if I take the itemized deduction.  Does that sound correct?  Would my adjusted gross income be ~$200k - $6300 if I were to take the standard deduction?  (I'm single with no dependents.)

That seems like a fairly huge benefit to taking itemized deduction, but I might be figuring wrong. 


Your adjusted gross income is the number on the bottom of the first page of your Form 1040. This includes the income reported on your W-2, other income from investments or other sources, and a select few deductions. It does not include the standard deduction, itemized deductions, or personal exemptions.

Your adjusted gross income would be $200k - $18k = $182k. The $156k number (actually $152k since you should also get a $4k personal exemption) is your taxable income if you choose to itemize deductions. Charitable giving and state tax are both itemized deductions. Your itemized deductions are much large than your standard deduction, so you're correct that you would probably benefit from itemizing. Given your high income and high state tax, you may be in AMT territory, so be aware of that possibility.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: grenzbegriff on December 02, 2015, 03:23:10 PM
Thanks!

So for deciding whether to itemize, if your AGI is high enough that your state income tax is more than $6300, you probably should itemize.

For recording charitable giving, it's all through paycheck deduction or credit card, so that should be straightforward according to this IRS page (https://www.irs.gov/Charities-&-Non-Profits/Substantiating-Charitable-Contributions).


One further question:  If I understand right, I can't get any tax deduction by contribution to a traditional IRA because my income is too high.  (Example calculation: http://i.imgur.com/J0KgcIn.png).  Since I'm expecting to have a much lower income by age 40 than I do now, I don't think using a Roth IRA makes sense.  So I'm not intending to contribute at all to an IRA.  Does that make sense?  (I often hear people talking about IRAs but every time I investigate I don't see a benefit for me.)

Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: johnny847 on December 02, 2015, 03:32:46 PM
One further question:  If I understand right, I can't get any tax deduction by contribution to a traditional IRA because my income is too high.  (Example calculation: http://i.imgur.com/J0KgcIn.png).  Since I'm expecting to have a much lower income by age 40 than I do now, I don't think using a Roth IRA makes sense.  So I'm not intending to contribute at all to an IRA.  Does that make sense?  (I often hear people talking about IRAs but every time I investigate I don't see a benefit for me.)

No. You can do a backdoor Roth IRA. I'm sure it's been mentioned at some point earlier in this thread, but you can read about it here (https://www.bogleheads.org/wiki/Backdoor_Roth_IRA).

If you currently have a Traditional, SEP, or SIMPLE IRA, it's not always clear if you should use the backdoor. If this pertains to you, we can guide you on that - just tell us the balance of the aforementioned IRAs.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on December 02, 2015, 03:42:25 PM
So for deciding whether to itemize, if your AGI is high enough that your state income tax is more than $6300, you probably should itemize.
There is a more direct way: "You should itemize deductions if your allowable itemized deductions are greater than your standard deduction" - see https://www.irs.gov/taxtopics/tc501.html.  See also https://turbotax.intuit.com/tax-tools/tax-tips/Tax-Deductions-and-Credits/Tax-Deduction-Wisdom---Should-You-Itemize-/INF12061.html for even more details.

Quote
For recording charitable giving, it's all through paycheck deduction or credit card
That may be true for you.  In general, gifts via check, cash, property donation, etc. are also legitimate ways to have charitable giving.

Quote
Since I'm expecting to have a much lower income by age 40 than I do now, I don't think using a Roth IRA makes sense.
Why not?
Have you compared your spendable income from a taxable account vs. a Roth account, starting with the same initial contribution?  Be sure to include any federal and state tax on the taxable account's annual earnings and the long term capital gains when sold.  Taxable could be "better" than Roth if you assume losses and Tax Loss Harvesting, but....
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Cheddar Stacker on December 02, 2015, 03:43:41 PM
Hi Cheddar Stacker, and others.  Very nice guide, it was simple enough for me to understand.

In the past I've always taken the standard deduction. 

Johnny and Seattle have all your questions covered, but I'd consider posting some details here from your 2014 tax return, and 2013, and 2012. And do it quickly because the statute of limitations for 2012 will likely be running out within 4 months.

If your potential itemized deductions from those years exceeds the standard deduction (your state tax alone would if you made that much income) you can amend those tax returns and get refunds. You'd have to amend the California returns as well. It's not a terribly hard thing to do, but you might want to find a friend or a tax expert to help if you haven't done it before.

It could be worth a few thousand dollars, so paying someone a few hundred to do it is better than doing nothing if you're unsure how to do it.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: seattlecyclone on December 02, 2015, 03:54:25 PM
One further question:  If I understand right, I can't get any tax deduction by contribution to a traditional IRA because my income is too high.  (Example calculation: http://i.imgur.com/J0KgcIn.png).  Since I'm expecting to have a much lower income by age 40 than I do now, I don't think using a Roth IRA makes sense.  So I'm not intending to contribute at all to an IRA.  Does that make sense?  (I often hear people talking about IRAs but every time I investigate I don't see a benefit for me.)

You have to consider where else you would put the money. A deductible IRA is great if you can get one, but if that's not an option you'll often be better off putting your money in a Roth IRA than a taxable account. If you invest outside of your IRA you'll be paying taxes on dividends and capital gains every year, at least until you retire and go down into the 15% or lower tax bracket. If that money is in a Roth IRA instead, you'll never pay tax on it again as long as you wait until age 60 to remove the gains. You'll have to weigh the pros and cons for your particular situation, but you may find that a Roth IRA is a great option for part of your money.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: grenzbegriff on December 02, 2015, 04:19:05 PM
Wow, thanks everyone!

Yes, Cheddar Stacker, in 2014 I paid $12k in california state income tax, so I might be able to get ~$2k back if I amend the tax return.  I think I'll try doing it myself, I may as well learn how this stuff works.

I only paid $3k state tax in 2013 and very little before that, so I don't think those years are worth investigating.  (No significant charitable giving or any sort of spending in those years either.)

seattlecyclone, thanks for the suggestion about the backdoor Roth IRA.  I don't have any IRAs right now.  The reason I brought this up now is so I have time to make changes before the year is up.  It looks like I can put $5500 into a traditional IRA and then move it to a Roth IRA.  I use vanguard, so I'll do it there. 

Edit: I'm reading this thread (http://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/) about withdrawing from the Roth IRA tax free.   Sorry for asking questions that are already answered.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on December 02, 2015, 04:53:32 PM
... in 2014 I paid $12k in california state income tax, so I might be able to get ~$2k back if I amend the tax return.  I think I'll try doing it myself, I may as well learn how this stuff works.
Just curious: how was the original 2014 return done - by a CPA, or by software (which?), or by yourself, or...?  And was there a conscious decision to take standard vs. itemized?
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: grenzbegriff on December 02, 2015, 05:08:32 PM
I used TurboTax.  I made the decision to take standard deduction, not realizing that state income tax was deductible.  (So I thought my total itemized deduction would have been close to $0.)

It could be surprising that TurboTax didn't make it completely obvious to me that this was the wrong choice.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on December 02, 2015, 05:18:15 PM
It could be surprising that TurboTax didn't make it completely obvious to me that this was the wrong choice.
Obviousness can be in the eye of the beholder.  If you go back through your 2014 TurboTax, do you get a screen similar to the one below?

(http://s16.postimg.cc/lugqlqlf9/screenshot_60.png)
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: grenzbegriff on December 03, 2015, 08:56:30 AM
Looking back at my tax return, it looks like I misremembered taking the standard deduction.  I did take the itemized deduction of $12k in 2014.  So there was no problem with turbotax -- just me remembering the wrong thing and not checking. 
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: TomTX on December 05, 2015, 05:30:28 AM
Looking back at my tax return, it looks like I misremembered taking the standard deduction.  I did take the itemized deduction of $12k in 2014.  So there was no problem with turbotax -- just me remembering the wrong thing and not checking.

Go back and check 2012 now - you are getting close to the deadline for filing an amended return if you did take the standard deduction for that one. 2013 and 2014 have plenty of time left.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: deeshen13 on December 09, 2015, 08:15:07 AM
I don't want to start a new thread for this simple question, but it seemed apropos to ask here (and I received help with a n00b question early here).

In early retirement, with regards to qualified dividends, there's a lot of emphasis on keeping income in the 10/15% income tax bracket, so the qualified dividends are taxed at 0%.  As a single individual, that means if you have no other income, you can earn $37,450+6300+4000=$47,750 in qualified dividends annually and pay no taxes on them.  Pretty sweet.

My question is if you earn say 50k in qualified dividends (and move into the 25% income tax bracket), does all 50k of qualified dividends now get taxed at 15% or just (50,000-47,750) the $2250 above the threshold.  I would have to presume it's the latter, correct?
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: johnny847 on December 09, 2015, 08:26:59 AM
I don't want to start a new thread for this simple question, but it seemed apropos to ask here (and I received help with a n00b question early here).

In early retirement, with regards to qualified dividends, there's a lot of emphasis on keeping income in the 10/15% income tax bracket, so the qualified dividends are taxed at 0%.  As a single individual, that means if you have no other income, you can earn $37,450+6300+4000=$47,750 in qualified dividends annually and pay no taxes on them.  Pretty sweet.

My question is if you earn say 50k in qualified dividends (and move into the 25% income tax bracket), does all 50k of qualified dividends now get taxed at 15% or just (50,000-47,750) the $2250 above the threshold.  I would have to presume it's the latter, correct?

The latter.

As a side note, to be even more efficient, if your only reported income is a tIRA conversion and ltcg /qdi you could convert $10300 from a traditional to a Roth and have $37450 in ltcg /qdi and pay nothing in tax.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: deeshen13 on December 09, 2015, 03:42:53 PM
Awesome, thanks johnny.  Your suggestion sounds like the golden goose, love it!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: johnny847 on December 09, 2015, 08:51:58 PM
Awesome, thanks johnny.  Your suggestion sounds like the golden goose, love it!

Haha I learned of the idea from Jeremy over at GoCurryCracker (http://www.gocurrycracker.com/the-go-curry-cracker-2013-taxes/).

I'd wager that this has been linked before in this thread, but I'm too lazy to go back and check
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: freedom8991 on January 23, 2016, 09:46:38 AM
Thank you for putting this together!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: NinetyFour on January 23, 2016, 10:02:48 AM
Following.  Thanks, CS and others.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: JustGettingStarted1980 on October 27, 2016, 10:35:13 AM
Ok Tax Maestros, I got another quick question.

My wife makes $20000/year, she contributes $18000 directly to a 401K she has access to.
We contribute to Roth IRA's, and since she has worked less this year due to our childcare needs,  she has made less income. Together our income is over 200K.

My question is, how much can she contribute to a Backdoor Roth IRA in 2016? Is it the $2000 difference between W2 income and 401K contribution? Or can we contribute the max of $5500 for her?

It makes sense that it would only be the $2000, but I've been wrong too many times before to trust "common sense".

Thanks,

JGS
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: seattlecyclone on October 27, 2016, 11:26:42 AM
Ok Tax Maestro's, I got another quick question.

My wife makes $20000/year, she contributes $18000 directly to a 401K she has access to.
We contribute to Roth IRA's, and since she has worked less this year due to our childcare needs,  she has made less income. Together our income is over 200K.

My question is, how much can she contribute to a Backdoor Roth IRA in 2016? Is it the $2000 difference between W2 income and 401K contribution? Or can we contribute the max of $5500 for her?

It makes sense that it would only be the $2000, but I've been wrong too many times before to trust "common sense".

Thanks,

JGS

Traditional 401(k) contributions are excluded from your income before the W-2 and therefore don't count toward your MAGI for IRA contribution purposes. Roth 401(k) contributions do count as compensation.

Do be aware that there's a "spousal IRA" rule that allows each spouse to make a full $5,500 IRA contribution if the sum of their countable compensation is at least $11,000. If you're still working and earned at least $9,000 that shows up on your W-2, you should both be able to make full IRA contributions.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: JustGettingStarted1980 on October 27, 2016, 02:24:30 PM
Thanks Seattle Cyclone, once again you've helped me out. Now I have to scrounge up the money to fund it!
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: brad0247 on February 04, 2017, 10:46:31 PM
In 2015 forego charitable contributions and paying your real estate tax bill. In January 2016, pay your 2015 RE tax bill and make your 2015 charitable contributions. Then in December 2016, pay your 2016 RE tax bill and make your 2016 charitable contributions. The result can be a nice way to squeeze out an extra $1,000-2,000 in deductions.

I thought you had to make your charitable contributions by end of year. For example, all contributions for 2016 need to have been made by December 31, 2016.

Source: https://www.irs.gov/charities-non-profits/charitable-organizations/charitable-contribution-deductions
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on February 04, 2017, 11:58:29 PM
I thought you had to make your charitable contributions by end of year. For example, all contributions for 2016 need to have been made by December 31, 2016.
That's correct, if you want to count them in that year.  But you need to put CS's suggestion in context:
Quote
If you are close to the top of the standard deduction, consider intentionally lumping expenses into one year. In 2015 forego charitable contributions and paying your real estate tax bill. In January 2016, pay your 2015 RE tax bill and make your 2015 charitable contributions. Then in December 2016, pay your 2016 RE tax bill and make your 2016 charitable contributions. The result can be a nice way to squeeze out an extra $1,000-2,000 in deductions.

E.g., take a single person paying $5150 in mortgage interest, with a summer property tax bill of $300 and a winter property tax bill (payable any time between Dec. and Feb.) of $500.  Charitable contributions are $250, usually made in a lump sum in December. 

If those are all done annually, the total of $6200 does not exceed the standard deduction (of $6300) so there is no point itemizing.

Instead, one could have a year in which the mortgage and summer tax bill ($5150 + $300) are the only payments.  The $6300 standard deduction is taken.  The next year, both winter tax bills are paid (e.g., one in Jan. and the other in Dec.), plus a "double" charitable contribution of $500 is made.  Now the itemized total is $5150 + $300 + 2*$500 + 2*$250 = $6950 and the itemized deduction is taken.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: TomTX on February 05, 2017, 05:48:51 AM
In 2015 forego charitable contributions and paying your real estate tax bill. In January 2016, pay your 2015 RE tax bill and make your 2015 charitable contributions. Then in December 2016, pay your 2016 RE tax bill and make your 2016 charitable contributions. The result can be a nice way to squeeze out an extra $1,000-2,000 in deductions.

I thought you had to make your charitable contributions by end of year. For example, all contributions for 2016 need to have been made by December 31, 2016.

Source: https://www.irs.gov/charities-non-profits/charitable-organizations/charitable-contribution-deductions

Go re-read what he wrote. Pretend the writer normally gives to charity just after Christmas. All the charitable contributions are in 2016.  What would normally be the "2015" charitable contributions were actually given in January 2016. The "2016" contributions were given in December 2016.

From the charity's point of view, it's a 1-week shift in timing. To the IRS, the deductions are all lumped into the 2016 tax year.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: simonsez on July 07, 2017, 03:36:35 PM
Pre-Tax Deductions: As you’ll see in the links provided above and below, there are many deductions you can take before income is ever taxed. These deductions can include 401(k)/403(b)/457(b) (https://en.wikipedia.org/wiki/401(k)), Health/Dental Insurance (https://en.wikipedia.org/wiki/Health_insurance), Cafeteria Plan (https://en.wikipedia.org/wiki/Cafeteria_plan), and Health Savings Account (https://en.wikipedia.org/wiki/Health_savings_account), among others. Some of these items reduce the FICA wage base as well, and they are the only available deductions against Social Security and Medicare Tax. All of these deductions reduce the income you are required to input on your tax return. Therefore, they all reduce your AGI, MAGI, taxable income, and tax, and they should be maximized whenever possible in most cases.

Can you expand on this at all as it pertains to FICA?  Specifically, how do you reduce the FICA wage base?  In looking at my W2 from last year, I see that my S.S. (Box 3, I did not make more than 127k or whatever the upper limit was) and Medicare wages (Box 5) were the amounts you would get if you added back my traditional 401k contributions.  That is to say, the SS Income/Medicare Income was higher than my wages reported in Box 1 and contributing to my 401k did not lower the FICA wage base. 

I don't have a Cafeteria Plan or access to an HSA so maybe it is unattainable for me to lower my FICA wage base.

Side note: if there are ways to avoid income being in the FICA wage base, it would help high earners* reduce the amount of Additional Medicare tax (extra 0.9% on all wages past 200k) that would be deducted.

*-provided the Cafeteria Plan, if used, is not overly favorable toward highly compensated employees as then the CP bennies would be treated as income, defeating the whole purpose.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on July 07, 2017, 04:16:59 PM
Pre-Tax Deductions: As you’ll see in the links provided above and below, there are many deductions you can take before income is ever taxed. These deductions can include 401(k)/403(b)/457(b) (https://en.wikipedia.org/wiki/401(k)), Health/Dental Insurance (https://en.wikipedia.org/wiki/Health_insurance), Cafeteria Plan (https://en.wikipedia.org/wiki/Cafeteria_plan), and Health Savings Account (https://en.wikipedia.org/wiki/Health_savings_account), among others. Some of these items reduce the FICA wage base as well, and they are the only available deductions against Social Security and Medicare Tax. All of these deductions reduce the income you are required to input on your tax return. Therefore, they all reduce your AGI, MAGI, taxable income, and tax, and they should be maximized whenever possible in most cases.

Can you expand on this at all as it pertains to FICA?  Specifically, how do you reduce the FICA wage base?  In looking at my W2 from last year, I see that my S.S. (Box 3, I did not make more than 127k or whatever the upper limit was) and Medicare wages (Box 5) were the amounts you would get if you added back my traditional 401k contributions.  That is to say, the SS Income/Medicare Income was higher than my wages reported in Box 1 and contributing to my 401k did not lower the FICA wage base. 

I don't have a Cafeteria Plan or access to an HSA so maybe it is unattainable for me to lower my FICA wage base.

Side note: if there are ways to avoid income being in the FICA wage base, it would help high earners* reduce the amount of Additional Medicare tax (extra 0.9% on all wages past 200k) that would be deducted.

*-provided the Cafeteria Plan, if used, is not overly favorable toward highly compensated employees as then the CP bennies would be treated as income, defeating the whole purpose.
See Box 1—Wages, tips, other compensation (https://www.irs.gov/instructions/iw2w3/ch01.html) and Box 3 and Box 5 as well.

Some common contributions not counted in the FICA wage base:
Pretax Health Ins.
Pretax Vision/Dental Ins.
Healthcare Flex Savings Acct. (FSA)
Daycare FSA
Employer-sponsored HSA
Pretax Commuter costs

Some common contributions that do count in the FICA wage base:
401(k) / 403(b) / TSP / etc.
457 plans   
Personal HSA
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Array on March 02, 2018, 10:40:11 AM
Quote
One side note on this credit – the instructions are very clear that if you have two kids, but only one of them is in daycare, you can claim both of the kids on this form opening up the full 6,000 in expenses and potentially doubling the credit.

Is this still valid? I could not find anything explicitly noting this from the IRS link.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: seattlecyclone on March 02, 2018, 10:46:04 AM
From the instructions (https://www.irs.gov/pub/irs-pdf/i2441.pdf):

Quote
To qualify for the credit, you must have one or more qualifying persons. You should show the expenses for each child in column (c) of line 2. However, it is possible a qualifying child could have no expenses and a second child could have expenses exceeding $3,000. You should list -0- for the one child and the actual amount for the second child. The $6,000 limit would still be used to compute your credit unless you have already excluded or deducted, in Part III, certain dependent care benefits paid to you (or on your behalf) by your employer.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: K-12FI on March 06, 2018, 08:24:20 AM
Was on reddit; wondering how some here thought on the following:

Quote
Consider the following:

You are married, making 50K a year, with spouse at home with child.

You would have a $24,000 standard deduction, bringing taxable income (before healthcare premiums) to $26,000. the first 19,050 is taxed at 10%, for a total of $1,905. The next $6,950 is taxed at 12%, for $834 of liability, making a total of $2,739 in tax liability if you use no traditional.

Now, let's take this further:

Remember that the Child Tax Credit is $2,000. So the entire $1,905 of tax liability is covered. In addition, $95 of tax liability at 12% comes out to an additional $791.

So, after all is said and done, you have the following tax free (federal) space:

$24,000+$19,050+$791= $43,841 of federal tax free space. So your goal should be to get your AGI DOWN to this number, then use the rest of your investing space for Roth.

Let's say your living expenses come out to $24,000. That means you can contribute up to $19841 to Roth with no federal tax implications today.

In this case, I could contribute $11,000 to a Roth IRA, and 8841 to a Roth 401K. Any additional income for investing ($50,000-$43841, or $6159) should be contributed to the Trad 401k, to bring your AGI down to the $43841.

Hope this makes sense!

I've always seen the Roth Sucks by GCC, and why Roth is better by Mad Fientist, but this viewpoint just really confused me: Am I missing something?
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: secondcor521 on March 06, 2018, 08:55:00 AM
Was on reddit; wondering how some here thought on the following:

Quote
Consider the following:

You are married, making 50K a year, with spouse at home with child.

You would have a $24,000 standard deduction, bringing taxable income (before healthcare premiums) to $26,000. the first 19,050 is taxed at 10%, for a total of $1,905. The next $6,950 is taxed at 12%, for $834 of liability, making a total of $2,739 in tax liability if you use no traditional.

Now, let's take this further:

Remember that the Child Tax Credit is $2,000. So the entire $1,905 of tax liability is covered. In addition, $95 of tax liability at 12% comes out to an additional $791.

So, after all is said and done, you have the following tax free (federal) space:

$24,000+$19,050+$791= $43,841 of federal tax free space. So your goal should be to get your AGI DOWN to this number, then use the rest of your investing space for Roth.

Let's say your living expenses come out to $24,000. That means you can contribute up to $19841 to Roth with no federal tax implications today.

In this case, I could contribute $11,000 to a Roth IRA, and 8841 to a Roth 401K. Any additional income for investing ($50,000-$43841, or $6159) should be contributed to the Trad 401k, to bring your AGI down to the $43841.

Hope this makes sense!

I've always seen the Roth Sucks by GCC, and why Roth is better by Mad Fientist, but this viewpoint just really confused me: Am I missing something?

Not sure what you're missing.  The example is a fairly simple scenario, so IRL your situation is probably a little bit more complicated, but the concept behind it is sound.

The child in this scenario would have to be under 17 at the end of the tax year.  That is an unstated assumption.  Also having a Roth 401k available is assumed.

Basically, the $24,000 standard deduction erases that much from income.  The $2,000 child tax credit erases the additional ~$20K of income because it's mostly taxed at about 10%:  $2,000/~10% = $20,000.

The next step that they didn't really explain is that if your marginal income tax rate is 0%, then you want to contribute to a Roth.  Earning income at a 0% rate then putting it in a Roth means completely tax free income.

The contributions to a traditional IRA are just to get the AGI down to where one is in a zero percent marginal bracket.

Actually, the hypothetical family would also probably qualify for the Retirement Savings Tax Credit, which would raise that ~$44K to about ~$46K because the RSTC is 10% of the first $2K at that income level IIRC.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: dandarc on March 06, 2018, 08:58:47 AM
Was on reddit; wondering how some here thought on the following:

. . . snip . . .

I've always seen the Roth Sucks by GCC, and why Roth is better by Mad Fientist, but this viewpoint just really confused me: Am I missing something?
Long story short - if your marginal tax rate is 0%, then Roth is the obvious choice.

Kind of a detailed scenario of just how high your "income" can be and still get a 0% marginal tax.

It ignore's the savers credit, although with the new things around the child tax credit and what is refundable and what isn't, I'm not as confident how that will intersect.  The other thing is - a portion of the child tax credit is refundable, so saying the $2,000 credit "covers" the tax on the 10% bracket + a little is not entirely true - your income tax can go negative, and likely would if you further reduced taxable income.  I'd think with numbers like this, you could potentially get your income down to the 50% saver's credit, which would 0 out your tax liability before refundable credits + get you the full refundable portion of the child tax credit.  Maybe the EITC factors in too.  Marginal rates at lower incomes can be shockingly high when you factor in everything. 

Basically, I'm not sure the analysis is complete and 100% correct, but the idea is definitely down the right track as to where Roth is clearly the way to go - once there is no tax savings to be had, Roth beats Traditional hands down.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: seattlecyclone on March 06, 2018, 09:03:54 AM
Was on reddit; wondering how some here thought on the following:

Quote
Consider the following:

You are married, making 50K a year, with spouse at home with child.

You would have a $24,000 standard deduction, bringing taxable income (before healthcare premiums) to $26,000. the first 19,050 is taxed at 10%, for a total of $1,905. The next $6,950 is taxed at 12%, for $834 of liability, making a total of $2,739 in tax liability if you use no traditional.

Now, let's take this further:

Remember that the Child Tax Credit is $2,000. So the entire $1,905 of tax liability is covered. In addition, $95 of tax liability at 12% comes out to an additional $791.

So, after all is said and done, you have the following tax free (federal) space:

$24,000+$19,050+$791= $43,841 of federal tax free space. So your goal should be to get your AGI DOWN to this number, then use the rest of your investing space for Roth.

Let's say your living expenses come out to $24,000. That means you can contribute up to $19841 to Roth with no federal tax implications today.

In this case, I could contribute $11,000 to a Roth IRA, and 8841 to a Roth 401K. Any additional income for investing ($50,000-$43841, or $6159) should be contributed to the Trad 401k, to bring your AGI down to the $43841.

Hope this makes sense!

I've always seen the Roth Sucks by GCC, and why Roth is better by Mad Fientist, but this viewpoint just really confused me: Am I missing something?

The reasoning behind the "Roth sucks" posts is pretty simple: when you have a choice, you should choose to pay tax when your marginal tax rate is lower rather than higher. Most Mustachian-type people with high savings rates will find that they spend less in retirement than they earn while working, often much less. Furthermore, any money that does come out of Roth or taxable accounts generally won't count as regular income, meaning that your tax bracket in retirement will be determined by some number less than your overall spending. These factors make it so that the default assumption should be for a lower marginal tax rate in retirement, making traditional the better default option unless you have crunched the numbers for your particular situation and know that you will have a taxable income high enough to push you into a higher bracket than currently.

One thing that the author may be missing here is that $1,400 of the child tax credit is refundable, meaning that it's possible to have a negative tax liability. Sure, you can get to zero exactly by bringing the AGI down to $43,841 (note: I haven't verified this number), but there's nothing magical about the zero point when it's possible to owe negative $1,400. In this case you still have a marginal tax rate of 10-12% even with an overall tax liability of zero.

That is a pretty low tax rate. Roth might be a better option for them here, but they would need to make that decision with some knowledge of what they predict their taxable income to be in retirement such that they might have a higher marginal rate. The fact that their tax liability is zero is not sufficient information to make that decision.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Radioherd88 on February 11, 2019, 04:40:48 PM


Traditional and Roth IRAs (http://www.irs.gov/Retirement-Plans/Traditional-and-Roth-IRAs) are another great tool to consider utilizing, and they are both good. A Traditional IRA contribution reduces your AGI and taxable income, a Roth contribution does not. A lot is said about both of these accounts all over this forum and the interwebs including a great analysis from The Mad Fientist (http://www.madfientist.com/traditional-ira-vs-roth-ira/). What you need to know for tax planning purposes is this: If you believe you will pay a higher tax rate in the future, go with Roth, and if you believe you will pay a lower tax rate in the future, go with Traditional. When you clear out all the other noise, this is really the only thing that matters. Most early retirees will benefit more from Traditional if they qualify (see the links to the IRS or key facts and figures for qualification), but this must be a case by case analysis.



Great post Cheddar - I’m stuck on whether contributing to a non deductible IRA or Roth is better than a straight Vanguard taxable fund? I'm not eligible for deductible IRA but it still has benefits.

I have my other tax advantaged accounts maxed but I need more of my funds to use before 59.5 so figure I can’t touch the IRA’s till then right? Or can I still access the “contributions” at any time from either IRA and just not the gains?
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on February 12, 2019, 11:50:37 AM
Great post Cheddar - I’m stuck on whether contributing to a non deductible IRA or Roth is better than a straight Vanguard taxable fund? I'm not eligible for deductible IRA but it still has benefits.
For all three:
a) non-deductible tIRA
b) Roth IRA
c) taxable account
the contribution is made with after-tax dollars.

Assuming the investment grows in value, Roth is the only one with no (under current law) possibility of tax on earnings.

Quote
I have my other tax advantaged accounts maxed but I need more of my funds to use before 59.5 so figure I can’t touch the IRA’s till then right? Or can I still access the “contributions” at any time from either IRA and just not the gains?
See How to withdraw funds from your IRA and 401k without penalty before age 59.5 (https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/).
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Radioherd88 on February 13, 2019, 10:43:25 AM
Great post Cheddar - I’m stuck on whether contributing to a non deductible IRA or Roth is better than a straight Vanguard taxable fund? I'm not eligible for deductible IRA but it still has benefits.
For all three:
a) non-deductible tIRA
b) Roth IRA
c) taxable account
the contribution is made with after-tax dollars.

Assuming the investment grows in value, Roth is the only one with no (under current law) possibility of tax on earnings.


That was my initial thinking too (hence my converting the non deductible tIRA) last year, but then i read somewhere else that the non deductible IRA still had some benefits to make it better than the taxable account (dividends not taxed or something)?

Anyways, regardless of non deductible IRA vs taxable account, Roth is still the clear winner, especially if doing a conversion ladder to use it before 59.5?

Thanks

Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on February 13, 2019, 11:03:53 AM
That was my initial thinking too (hence my converting the non deductible tIRA) last year, but then i read somewhere else that the non deductible IRA still had some benefits to make it better than the taxable account (dividends not taxed or something)?
While the money stays within the IRA, gains are not taxed.  But when gains are withdrawn, they are taxed at ordinary income rates.  Ordinary income rates are higher than the Long Term Capital Gain and Qualified Dividend (LTCG & QD) rates that can apply to a taxable account.

Quote
Anyways, regardless of non deductible IRA vs taxable account, Roth is still the clear winner,
Yes.

Quote
especially if doing a conversion ladder to use it before 59.5?
Don't understand this part of the question.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Radioherd88 on February 13, 2019, 02:50:49 PM

Quote
especially if doing a conversion ladder to use it before 59.5?
Don't understand this part of the question.
[/quote]

Basically my main reservation with the roth was that it would tie the money up until 59.5 so i was thinking normal taxable was better for this reason
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on February 13, 2019, 02:59:07 PM
Roth contributions are withdrawable at any time, for any reason, without tax or penalty.

Yes, Roth earnings withdrawn prior to age 59.5 may be liable for both tax and penalty.
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: Radioherd88 on February 14, 2019, 04:04:37 PM
Roth contributions are withdrawable at any time, for any reason, without tax or penalty.

Yes, Roth earnings withdrawn prior to age 59.5 may be liable for both tax and penalty.

Ok thanks yes that was my initial clarifying question -

How exactly do you report whats a contribution and what's earnings in 10 year's time then? Each year you report your IRA base and then as long as you don't withdraw more than that before 59.5 it's never taxed?

E.g - I contribute the max of $11, 000 a year (for both spouse and I) for 10 years = I can withdraw $110, 000 before 59.5 without penalty or tax attached?

To get me to 59.5 I can also do the conversion ladder with a 401k/403B, and I can also use my 457b if i leave my employer (as you can use this penalty free before 59.5?
Title: Re: The Mustache Tax Guide (U.S. Version)
Post by: MDM on February 14, 2019, 04:31:49 PM
How exactly do you report whats a contribution and what's earnings in 10 year's time then? Each year you report your IRA base and then as long as you don't withdraw more than that before 59.5 it's never taxed?
See part III of Form 8606 (https://www.irs.gov/forms-pubs/about-form-8606) and the instructions for it.

Quote
E.g - I contribute the max of $11, 000 a year (for both spouse and I) for 10 years = I can withdraw $110, 000 before 59.5 without penalty or tax attached?

To get me to 59.5 I can also do the conversion ladder with a 401k/403B, and I can also use my 457b if i leave my employer (as you can use this penalty free before 59.5?
Yes and yes.