Author Topic: Optimize Your Taxable Income  (Read 39379 times)

Mississippi Mudstache

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Optimize Your Taxable Income
« on: October 22, 2013, 07:42:19 AM »
2014 will be my first full year of Mustachianism, so I am currently planning next year's finances and stumbled upon an interesting concept: optimizing my taxable income. I found an income tax calculator and plugged in some numbers based on maxing out my 401(k), my HSA, and t.IRAs for myself and my wife. The assumptions I used were:

$69,000  income
$1,000    health/dental insurance premiums
$17,500  401(k)
$6,150    HSA (my employer puts in the other $400, so I don't get to claim that)
$11,000  t.IRAs
Standard deduction ($12,200) - next year we won't have enough deductions to itemize
2 personal exemptions ($7,800)
2 dependent children ($2,000 tax credit)

What I found was surprising - my tax liability after all deductions came out to $1335, which meant that after the $2000 child tax credit, our federal income tax would be zero. HOWEVER, since the child tax credit doesn't pay more than your tax liability, that also meant that we would be leaving money on the table by filling all possible tax-deferred accounts.

I did a little more work and found that my optimal tax-deferred contribution for 2014, based on the above assumptions, would be $28,700. This would reduce my tax liability to $2002, which would then be almost completely wiped out by the child tax credit. In other words, the optimal scenario is for me to put almost $6,000 less into my tax-deferred retirement accounts than the law allows! No federal income tax, and no state tax as well (I ran the number on another website for my state income taxes). How's that for tax optimization?

So, tentatively (since I still don't know exactly what my 2014 income will be), my retirement account funding for 2014 will look like:

401(k):   $17,500
HSA:        $6,150
t.IRA:       $5,050
Roth IRA: $5,950 (which should go into the account TAX-FREE!)

Anyway, I just found the idea of optimizing your taxable income to be interesting and thought that others my benefit from it. Obviously, your results will vary widely, depending upon whether you file singly or jointly, which tax credits and deductions you qualify for, how much you earn, and how much you can save. Your state income tax laws will factor in as well. I found it fun to play around with the calculator to find my ideal solution.

Also, now that I've laid out my plan, feel free to shoot holes in it if I've missed something :)

Sebastian

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Re: Optimize Your Taxable Income
« Reply #1 on: October 22, 2013, 08:18:25 AM »
Not sure if I did it completely right, but I calculated what my taxes will be with my 401K and IRA deductions and one without as if I invested nothing.

I save a little over $700 bucks in taxes from making those investments. Not to mention the company match with my 401K will be a nice bonus.

In the words of Michael Scott "this is a win win win situation!"

Thanks for sharing this nifty tool :)

simonsez

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Re: Optimize Your Taxable Income
« Reply #2 on: October 22, 2013, 10:55:40 AM »
Nice tax hedge.  Why risk paying a non-zero tax rate in the future when you can get a guaranteed 0% right now!

Good work!

KatieSSS

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Re: Optimize Your Taxable Income
« Reply #3 on: October 22, 2013, 11:15:47 AM »
Hmmmm...when I do this it tells me my tax liability is around $3,300, but I know more is being taken out of my paycheck than that for the year. If I look at what is currently being withheld in taxes, it is around $9,700 for the current year. I used the standard deduction and filing status as single. Does this mean I'll get a huge tax refund for 2013 or am I missing something? The $6,000 difference seems crazy. I'm not good with taxes, so I'm starting from a pretty low point, education-wise, on this.

seattlecyclone

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Re: Optimize Your Taxable Income
« Reply #4 on: October 22, 2013, 06:03:01 PM »
HOWEVER, since the child tax credit doesn't pay more than your tax liability, that also meant that we would be leaving money on the table by filling all possible tax-deferred accounts.

Have you verified that you're not eligible for the "additional child tax credit"? This is a refundable credit designed to give many parents the full child tax credit even if it brings their net tax liability below zero. There are some additional restrictions on who is eligible and how much it's worth, beyond the requirements for the non-refundable child tax credit, but if you have earned income from a job you can probably claim it.

Even if you are eligible for the additional child tax credit, you may still find it advantageous to put more of your retirement savings in a Roth IRA instead of a traditional one since your tax bracket is so low. That will depend on your long-term income plans and whether you expect tax rates to stay as low as they are now indefinitely.

seattlecyclone

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Re: Optimize Your Taxable Income
« Reply #5 on: October 22, 2013, 07:12:47 PM »
A couple more things:
* You get to claim exemptions for your kids as well as yourself and your wife, for a total of four exemptions.
* People who make retirement account contributions and have a relatively low income are eligible for a "saver's credit" that is applied to your return before the child tax credit.
* Your W-2 income is just low enough that you would probably qualify for a small earned income tax credit as long as the HSA contributions are made in the form of pre-tax payroll deductions.

My math for your minimum taxable income scenario:
Gross W-2 income$44,350(after health insurance, 401(k) contributions, and HSA contributions that are all excluded from income pre-tax)
TIRA deduction$11,000
Adjusted gross income$33,350
Standard deduction$12,200
Exemptions$15,600
Taxable income$5,550
Tax (before credits)$558
Retirement savings contribution credit$558(Could have been as high as $2,000 if your tax liability had been higher)
Regular child tax credit$0(No more tax left to credit!)
Tax after non-refundable credits$0
Earned income credit$854
Additional child tax credit$2,000
Total tax liabilityNegative $2,854

The earned income credit and additional child tax credit both use earned income figures calculated before applying the TIRA deduction, so doing some Roth contributions instead of TIRA contributions won't change your tax refund. The saver's credit is calculated using adjusted gross income and has a cliff at $35,500 AGI.

Let's do a couple of alternative scenarios:
Scenario 1 - Switch $2,149 of TIRA contributions to Roth contributions. AGI is $35,499.
Gross W-2 income$44,350(after health insurance, 401(k) contributions, and HSA contributions that are all excluded from income pre-tax)
TIRA deduction$8,851
Adjusted gross income$35,499
Standard deduction$12,200
Exemptions$15,600
Taxable income$7,699
Tax (before credits)$768
Retirement savings contribution credit$768(Could have been as high as $2,000 if your tax liability had been higher)
Regular child tax credit$0(No more tax left to credit!)
Tax after non-refundable credits$0
Earned income credit$854
Additional child tax credit$2,000
Total tax liabilityNegative $2,854

Scenario 2 - Switch $2,151 of TIRA contributions to Roth contributions. AGI is $35,501.
Gross W-2 income$44,350(after health insurance, 401(k) contributions, and HSA contributions that are all excluded from income pre-tax)
TIRA deduction$8,849
Adjusted gross income$35,501
Standard deduction$12,200
Exemptions$15,600
Taxable income$7,701
Tax (before credits)$773
Retirement savings contribution credit$773(Could have been as high as $800 if your tax liability had been higher. Note that the excess credit is much less here.)
Regular child tax credit$0(No more tax left to credit!)
Tax after non-refundable credits$0
Earned income credit$854
Additional child tax credit$2,000
Total tax liabilityNegative $2,854

Scenario 3 - Switch $2,500 of TIRA contributions to Roth contributions. AGI is $35,850.
Gross W-2 income$44,350(after health insurance, 401(k) contributions, and HSA contributions that are all excluded from income pre-tax)
TIRA deduction$8,500
Adjusted gross income$35,850
Standard deduction$12,200
Exemptions$15,600
Taxable income$8,050
Tax (before credits)$808
Retirement savings contribution credit$800(No credit is "wasted" this time.)
Regular child tax credit$8
Tax after non-refundable credits$0
Earned income credit$854
Additional child tax credit$1,992
Total tax liabilityNegative $2,846

After this, additional contributions to the Roth IRA will further increase your AGI and increase your pre-credit tax burden (which increases your regular child tax credit and decreases the additional child tax credit). Once the AGI passes $38,500, your maximum retirement savings credit steps down to $400. The earned income credit should be yours regardless of your Roth/TIRA choices.

Also, all these calculations are made with 2013's tax rates. Annual inflation adjustments will change many of the numbers used in calculating taxes (standard deduction, exemption amounts, retirement contribution limits, and more) for 2014.
« Last Edit: October 22, 2013, 07:17:00 PM by seattlecyclone »

i_am_the_slime

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Re: Optimize Your Taxable Income
« Reply #6 on: October 22, 2013, 07:19:05 PM »
2 personal exemptions ($7,800)
2 dependent children ($2,000 tax credit)

If you are married filing jointly and have 2 children, that is 4 exemptions not 2.

Mississippi Mudstache

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Re: Optimize Your Taxable Income
« Reply #7 on: October 23, 2013, 07:53:17 AM »
seattlecyclone:

Many thanks for the additional information! You can surely tell that I am a complete newbie - things were so much simpler when I was single, but the deductions are obviously better as a married father :)

I did some research, and it does appear that I will probably be eligible for both the additional child tax credit and the retirement savings credit (which I didn't even know existed!) The last couple of years, I have outsourced my tax return, but lately I've become very interested in tax laws so I can file my own returns and optimize my finances. Are you an accountant/tax professional? Are there any books or other sources you could recommend for a beginner like myself who is interested in learning about personal income tax law? Thanks again!

seattlecyclone

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Re: Optimize Your Taxable Income
« Reply #8 on: October 23, 2013, 09:31:54 AM »
I'm not a tax professional, just a software developer who has done my own taxes since I was in college. If you want to really start to understand this stuff, I might suggest skimming through the entire instruction manual for form 1040, line by line. It's really dry, but it basically explains everything that might affect your tax liability and how to report it to the IRS. You don't have to read everything in detail (the sections on farm income don't apply to most people anymore, for example), but it's good to be very familiar with everything you're eligible for right now, and at least aware of things that might apply to you in the future (such as college education credits or rental income reporting) so that you know to look into them more when they become relevant.

For things that are relevant to you right now, the instructions may refer you to other IRS numbered publications or form instructions that explain about the topic in more detail. Read those too.

KatieSSS

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Re: Optimize Your Taxable Income
« Reply #9 on: October 23, 2013, 11:58:33 AM »
Thanks, seattlecyclone. That is really helpful!

simonsez

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Re: Optimize Your Taxable Income
« Reply #10 on: October 23, 2013, 12:09:19 PM »
For things that are relevant to you right now, the instructions may refer you to other IRS numbered publications or form instructions that explain about the topic in more detail. Read those too.

Like Pub 970!  Reading the updated table once a year about the student loan interest phaseout (pg 25-29 last year) is a good reminder to me each year to keep going strong with the 401k.

http://www.irs.gov/pub/irs-pdf/p970.pdf

KatieSSS

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Re: Optimize Your Taxable Income
« Reply #11 on: October 23, 2013, 12:24:20 PM »
For things that are relevant to you right now, the instructions may refer you to other IRS numbered publications or form instructions that explain about the topic in more detail. Read those too.

Like Pub 970!  Reading the updated table once a year about the student loan interest phaseout (pg 25-29 last year) is a good reminder to me each year to keep going strong with the 401k.

http://www.irs.gov/pub/irs-pdf/p970.pdf

Wow - that is really good to know! I didn't realized the student loan deduction was being phased out. No matter for me, though, as my adjusted gross income won't be high enough for me not to qualify for that credit. Plus, this should be the last year I pay interest on student loans ever. YAY.

Mazzinator

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Re: Optimize Your Taxable Income
« Reply #12 on: October 23, 2013, 12:59:07 PM »
Seattlecyclone- you are awesome!!! I'm still confused about the child tax credit (i'm easily confused) Can you double check mine??? (Sorry if this is a highjack? Should i start my own thread? I never know)




Gross W-2 income   $58,500   (after health insurance, 401(k) contributions, and HSA contributions that are all excluded from income pre-tax)
TIRA deduction   $10,600 (it's complicated)
Student loan interest $2,500
Adjusted gross income   $45,400
Standard deduction   $12,200
Exemptions   $15,600
Taxable income   $17,600
Tax (before credits)   $1,760
Retirement savings contribution credit   $400*
Regular child tax credit   $1,360
Tax after non-refundable credits   $0
Earned income credit   $0
Additional child tax credit   $640**
Total tax liability   Negative $640

*Is this the "savers credit?" Is it calculated at 10% of $2000 x2 (for AGI between 38,501-59,000)
**Is this correct?

Thank you again! And thanks for all your help in my other post!

ETA: i used this
http://www.bankrate.com/calculators/tax-planning/1040-form-tax-calculator.aspx
And
http://www.irs.gov/pub/irs-pdf/f8880.pdf
« Last Edit: October 23, 2013, 01:06:59 PM by Mazzinator »

seattlecyclone

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Re: Optimize Your Taxable Income
« Reply #13 on: October 23, 2013, 02:54:14 PM »
Your calculations look like they're probably in the right ballpark (assuming you have two dependent children), though it's always possible you'll report some additional income, deductions, or credits based on your work, family, and investment situation.

Yes, the retirement savings contribution credit is commonly called the "saver's credit" since it's easier to say. :-)

The way the child tax credit works, in a nutshell, is that it starts at $1000 per kid, and gradually phases out for married couples with AGI above $110k (in 2012, might be indexed for inflation, I'm not sure). The "regular" child tax credit can never be more than the amount of tax you otherwise owe. That's why it's called a "nonrefundable" tax credit, because it can't cause your total tax to be negative. If your "regular" child tax credit is capped for this reason, you might still be able to claim the rest of it as a refundable "additional child tax credit" if you meet some certain additional requirements. The main requirement is that you can't claim an "additional child tax credit" that's more than 15% of (your earned income - $3,000). But your work income seems plenty high for this to not be a concern for you.

teen persuasion

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Re: Optimize Your Taxable Income
« Reply #14 on: October 25, 2013, 08:45:48 AM »
+1

I've been doing this for years.  Unfortunately, I can't take advantage of the Saver's credit, since our taxable income  = 0.  It will probably become more important for us as the kids continue to head off to college.

I wanted to mention that you should also check your state income taxes.  In NY, the EITC is matched at 30%, and CTC is matched at 33% for kids over 4.

ichangedmyname

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Re: Optimize Your Taxable Income
« Reply #15 on: October 25, 2013, 09:18:57 AM »
I am going to read this later. Been thinking about this too. So thanks for sharing!

aj_yooper

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Re: Optimize Your Taxable Income
« Reply #16 on: October 25, 2013, 09:54:07 AM »
seattlecyclone, you are amazing!

aj_yooper

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Re: Optimize Your Taxable Income
« Reply #17 on: October 25, 2013, 08:59:15 PM »
I like your idea of optimizing taxes, but I now have a different thought.  Reducing taxes now probably increases your cash flow, but I don't think it helps your retirement income, if you stay within your current 15% marginal tax rate bracket.

You are in the 15% marginal taxable rate so your current long term capital gains rate is 0%.  Any money in a taxable account will receive that 0% rate for long term capital gains and this continues up to $72,500 of income, when it shifts to 15%; qualified dividends are also taxed at the same rate as long term capital gains.  So a Roth IRA or a traditional IRA at your marginal tax rate/income level will not have a significant improvement over a taxable account on your net money at retirement, if you manage your portfolio turnover wisely, i.e., harvest only long term capital gains and avoid frequent portfolio changes.  The taxable account has the advantage of allowing tax loss harvesting which can reduce your taxable income (with little effect on your asset allocation goals)  and provides extra liquidity financially-you can cash in taxable account equities sans tax advantaged rules.  A Roth IRA account adds a further firewall to your retirement funding, but it may not be necessary but probably doesn't hurt. 

By using a taxable account instead of a tax deferred vehicle, you pay your taxes now at the 15% marginal tax rate.  When you retire, you probably will be taxed on at least the 15% marginal tax rate on all tax deferred distributions (401k or traditional IRA), so the net money is the same.  You could be at a higher rate then which would mean you will pay a higher marginal tax rate on tax deferred retirement distributions than you will on a taxable account.  A Roth or two probably will not hurt you then, except Roth rules limit liquidity somewhat.

Further, when you retire, you will be at a given marginal tax rate.  If the marginal tax rate is 33% or lower, the current long term capital gains rate is 15% or 0%.  If you expect your retirement income to be above the 33% marginal tax rate, then a tax deferred account is not as helpful as a taxable account where you will pay a long term capital gain rate of 15% when your are at the 33% marginal tax rate.  Usually, retirement incomes are less than working income.  Tax rates can change though.

Funding your 401k to capture any employer match is very beneficial, but it could be done in a 401k or a Roth 401k when you are at your current marginal tax rate.  Funding a health savings account (which would be utilized as a retirement account strategy), especially if it is subsidized by your employer, is very beneficial, irregardless of marginal tax rate.  The key is to use tax deferral strategies to stay below the 25% marginal tax rate ($72,500).

I would use tax deferral strategies to keep your income in the 15% marginal tax rate, but then consider shifting to taxable accounts for the rest of your money.  A Roth IRA or two would be fine, but may not be necessary, if you feel you will be retiring in a bracket under 33%.  Of course, take any tax credits that are available.

I am not a tax professional, but these are my thoughts for general discussion.  They could be wrong, but this is what I think.  YMMV

fiveoh

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Re: Optimize Your Taxable Income
« Reply #18 on: October 25, 2013, 09:36:22 PM »
I like your idea of optimizing taxes, but I now have a different thought.  Reducing taxes now probably increases your cash flow, but I don't think it helps your retirement income, if you stay within your current 15% marginal tax rate bracket.

You are in the 15% marginal taxable rate so your current long term capital gains rate is 0%.  Any money in a taxable account will receive that 0% rate for long term capital gains and this continues up to $72,500 of income, when it shifts to 15%; qualified dividends are also taxed at the same rate as long term capital gains.  So a Roth IRA or a traditional IRA at your marginal tax rate/income level will not have a significant improvement over a taxable account on your net money at retirement, if you manage your portfolio turnover wisely, i.e., harvest only long term capital gains and avoid frequent portfolio changes.  The taxable account has the advantage of allowing tax loss harvesting which can reduce your taxable income (with little effect on your asset allocation goals)  and provides extra liquidity financially-you can cash in taxable account equities sans tax advantaged rules.  A Roth IRA account adds a further firewall to your retirement funding, but it may not be necessary but probably doesn't hurt. 

By using a taxable account instead of a tax deferred vehicle, you pay your taxes now at the 15% marginal tax rate.  When you retire, you probably will be taxed on at least the 15% marginal tax rate on all tax deferred distributions (401k or traditional IRA), so the net money is the same.  You could be at a higher rate then which would mean you will pay a higher marginal tax rate on tax deferred retirement distributions than you will on a taxable account.  A Roth or two probably will not hurt you then, except Roth rules limit liquidity somewhat.

Further, when you retire, you will be at a given marginal tax rate.  If the marginal tax rate is 33% or lower, the current long term capital gains rate is 15% or 0%.  If you expect your retirement income to be above the 33% marginal tax rate, then a tax deferred account is not as helpful as a taxable account where you will pay a long term capital gain rate of 15% when your are at the 33% marginal tax rate.  Usually, retirement incomes are less than working income.  Tax rates can change though.

Funding your 401k to capture any employer match is very beneficial, but it could be done in a 401k or a Roth 401k when you are at your current marginal tax rate.  Funding a health savings account (which would be utilized as a retirement account strategy), especially if it is subsidized by your employer, is very beneficial, irregardless of marginal tax rate.  The key is to use tax deferral strategies to stay below the 25% marginal tax rate ($72,500).

I would use tax deferral strategies to keep your income in the 15% marginal tax rate, but then consider shifting to taxable accounts for the rest of your money.  A Roth IRA or two would be fine, but may not be necessary, if you feel you will be retiring in a bracket under 33%.  Of course, take any tax credits that are available.

I am not a tax professional, but these are my thoughts for general discussion.  They could be wrong, but this is what I think.  YMMV

Correct me if i'm wrong, but doesn't capital gains/div in a taxable account still count towards income even though it's taxed at 0%, but Roth IRA distributions do not count as income?

TheDude

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Re: Optimize Your Taxable Income
« Reply #19 on: October 25, 2013, 10:10:26 PM »
Great thread, I though I was going to get to zero tax this year but then I earned an extra 3600 at part time job that bumped our tax up to about a 1K still only about 1% but damn I thought I was going to get there. I created a spreadsheet where I track my tax. Last year was my first and I was within about 100 bucks at the time I filed. Once I update the number to be the exact same my spreadsheet was with up about $5. The one thing I keep thinking about is should I be contributing more to a Roth? The think I am worried about is mandatory withdraw rates when I become 70. Oh taxes how I love/hate you. Its a game and I enjoy it.

Insanity

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Re: Optimize Your Taxable Income
« Reply #20 on: October 25, 2013, 10:21:05 PM »
Wow, I feel dumb reading this thread.   

I'll definitely have to look at that 1040 documentation. 




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Re: Optimize Your Taxable Income
« Reply #21 on: October 26, 2013, 11:23:24 AM »
Thanks to everyone on this thread. This info will help me come tax time. Also my taxable income is much lower than I thought so that's awesome!

Also I hadn't ever heard of the saver's credit, so I'm excited to learn more about that.

Question to those who do their own taxes: Do you use tax software or just do the IRS paperwork to file? In the past I have always used turbotax.

Thanks again

aj_yooper

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Re: Optimize Your Taxable Income
« Reply #22 on: October 26, 2013, 11:43:10 AM »
Correct me if i'm wrong, but doesn't capital gains/div in a taxable account still count towards income even though it's taxed at 0%, but Roth IRA distributions do not count as income?

Capital gains and qualified dividends are taxed at the given long term capital gains rate for that marginal tax bracket.  So, it is treated as income by the capital gains tax only.  The Roth distributions are all tax free so the Roth does protect the short term capital gains and interest earned, which is an advantage.  In the strategy I suggested, putting REITs, bonds, CDs, small cap indexes in a Roth is a good plan.

*Edit:   I think you are right; the capital gain, although taxed as a capital gain, also shows as income, which might affect your marginal rate bracket.
« Last Edit: October 28, 2013, 02:18:24 PM by aj_yooper »

simonsez

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Re: Optimize Your Taxable Income
« Reply #23 on: October 28, 2013, 08:38:54 AM »
Question to those who do their own taxes: Do you use tax software or just do the IRS paperwork to file? In the past I have always used turbotax.

I did use Turbotax when my income was low enough to be free.  I still use the Turbotax estimator throughout the year for a quick reference.

Now, I do my federal on paper and my state on the computer since e-filing is free (VA).  I like having it all laid out and slowly going line by line (even when most lines are 0 or I just drop the previous value down).  However, if my taxes were more complicated I'd pay someone else.  1040 with a 1099-MISC and 1098-E (SL interest), no kids, no credits, and we don't itemize.

aj_yooper

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Re: Optimize Your Taxable Income
« Reply #24 on: October 28, 2013, 08:56:29 AM »
I've used TaxActOnline (http://www.taxact.com/taxes-online/bundle-and-save.asp); it is about $18 with free federal and state e-filing.  Not bad, and it does more complicated returns too.

teen persuasion

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Re: Optimize Your Taxable Income
« Reply #25 on: October 29, 2013, 08:36:07 AM »
I prefer to do my taxes on paper first, and then run it thru TurboTax so I can e-file for free (another advantage of being eligible for EITC).  I've learned the hard way that I have to access TT thru my state's tax website for e-filing to be free for my state return, too.

I really prefer to do the calculations myself; I dislike the Q & A method of TT.  It is too easy to miss something obscure.  Of course, I'd also prefer if the IRS offered a simplified version (formulas) for those of us that are fluent in math, rather than the COBOLesque version for the math-illiterate (like my DH).

rocketman48097

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Re: Optimize Your Taxable Income
« Reply #26 on: November 01, 2013, 01:40:32 PM »
I think there are some holes missing.  I think you might want to check on the earned income tax credit, which is refundable.  It is possible with your income that you could max out your IRA's and instead of owing zero, they government could end up PAYING you more than you put in.  This happens all the time in America and is why 49% of Americans pay no income tax. 

The best way to check this scenario is to put your numbers in tax software.  Of course, you can wait until April 15th to contribute to a tax deductible IRA, so you can even do this in February.  Plug in different scenarios before you file.  I use taxact.com, and it's not quite as good as turbo tax but is still excellent for only $10 per year.  In fact, the first year is free I think.  $8 for state returns but since I live in TN, I don't file a state return because TN has NO STATE INCOME TAX.  A huge benefit. 

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Re: Optimize Your Taxable Income
« Reply #27 on: November 03, 2013, 02:03:57 PM »
Mississippi Mustache, congratulations on achieving 3rd Level Jedi Tax Master status.

This is what the masters do, they dial in just the right amounts of everything to minimize taxes.  People will often do that at the margins of different tax brackets, to edge just under one bracket.

What's cool about your scenario is how if you never even dug into it, you would have never even known any better and you would have been all happy just to pay no taxes. But now you realized that you can fill more Roth space without even any tax hit, and STILL pay no taxes! Nice!

Granted, if you retire early, you probably could convert these Traditional IRA funds year by year anyway at 0%, but maybe you wouldn't have that chance, so at least you have it in Roth space and don't need to worry further.

As you've found, doing your own taxes and what you learn from doing your taxes and researching the tax code more can really help. For me, what helped in doing my own taxes was the self-delivered slap in the face when I saw just how much of an impact lowering your taxable income is, and just how high your marginal tax rate can be when you add it all up. Doing my own taxes helped convince me that I need to max my 401(k) -- which I wasn't << SLAP !! >> and I also learned that my wife could do a Traditional IRA instead of Roth IRA, which lowered our income further.  The result was that we lost much less of a valuable tax credit (child tax credit) with the higher 401(k) contributions, and the lower taxable income pushed us into the top of the 15% tax bracket. And I've now got more in my 401(k).

Oh, and it also showed me how important it is to lower your "above the line" adjusted gross income, and not just your "below the line" taxable income. For many tax credits, you qualify based on your AGI and not your taxable income. So, after years of not signing up for my company's flexible spending account (FSA), this year I did sign up. It lowers my AGI and not only do I pay less taxes but by lowering my AGI, I qualify for more of the child tax credit.

Another trick you can do is time certain taxable events by the tax year, to your advantage. For example, this year I'll be in the 25% tax bracket due to some extra one-time income, but I highly expect that next year I'll drop back to the 15% tax bracket. So, this year I'll be advancing some extra charitable donations that I would ordinarily have given next year, into this calendar year, in order to save 10% on those donations. It will be around $3,000. By making those donations this year intend of next year, I'll have $300 more in my pocket.

Last point: a lot of people do various what-if scenarios in tax software. I actually coded up my own 1040 spreadsheet that does all this. I found that by creating this spreadsheet, line by line, and working out the various formulas (none of which are complicated) really showed me how it works in a way that filling it out in a software program doesn't make as clear to you. For example, I have a "tab" in the sheet where I do the brackets (10%, 15%, 25%) where I see how much I have in each bracket, and how much "head room" I have until I bump up into the next higher bracket. Seeing that amount spotlighted it what made me say, "Hmm, I'm $3,000 into the 25% tax bracket...what would happen if I front-loaded my 2014 donations into 2013, cool, that will drop me into the 15% tax bracket..."

teen persuasion

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Re: Optimize Your Taxable Income
« Reply #28 on: November 04, 2013, 07:43:21 AM »
I think there are some holes missing. I think you might want to check on the earned income tax credit, which is refundable.  It is possible with your income that you could max out your IRA's and instead of owing zero, they government could end up PAYING you more than you put in.  This happens all the time in America and is why 49% of Americans pay no income tax. 

The best way to check this scenario is to put your numbers in tax software.  Of course, you can wait until April 15th to contribute to a tax deductible IRA, so you can even do this in February.  Plug in different scenarios before you file.  I use taxact.com, and it's not quite as good as turbo tax but is still excellent for only $10 per year.  In fact, the first year is free I think.  $8 for state returns but since I live in TN, I don't file a state return because TN has NO STATE INCOME TAX.  A huge benefit.

The OP could be eligible for some EITC, but putting money in a Roth IRA will have no effect on that credit (doesn't alter AGI), and putting money in a tIRA usually doesn't increase EITC since that credit is figured 2 ways (based on your wages on line 7, and again based on your AGI) and then you get the lower amount.  So using a tIRA would lower your AGI (higher EITC), but it doesn't touch your line 7 wages.  This assumes that most/all of your income is wages; if you have other income that raises your AGI, contributing to a tIRA would help get AGI closer to line 7 wages.

There is another gotcha with the EITC and saving in taxable accounts: investment income of more than $3200 disqualifies you from receiving EITC.  In light of that, saving in retirement accounts is better if you are income eligible for EITC.

Iron Mike Sharpe

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Re: Optimize Your Taxable Income
« Reply #29 on: November 04, 2013, 08:58:08 AM »
Props on this thread getting me started thinking about optimizing my own taxes.  I am in the 25% federal tax bracket.

My current situation is I get 26 paychecks a year + a bonus check of up to 10% of my salary.  I am currently sending 22% of my income to my 401K (we can do a max of 25%, I do not hit the $17,500 limit).  So, after the 22% to my 401K, I use two paychecks each month to make my monthly budget.  This leaves an extra two paychecks a year + my bonus check and I just send these three to the Roth IRA.

Anyway, I was looking over my benefits at work and realized I don't need the Silver health insurance package and I can go to Bronze.  Last week I ran my numbers of my monthly budget and I saw I could send $600 of my own money plus the $300 from the company for the health survey to an HSA account.  I thought, "cool, I was only saving $420 a year for future health care costs, now I'm at $900 a year."  I thought I was doing great.

Anyway, I had bad insomnia last night.  As I laid in bed, I wondered why do I need to budget X amount of money each month to say home repairs and car replacement funds?  I don't need to spend that money each month.  As long as I fully fund my year targets at some point during the year, I should be good.

So, I ran the numbers.  If I increased my 401K contribution rate to the max 25% and then increased my HSA contribution to $3000 from $600, I will be sending a little over $4000 combined to those two accounts.  The taxes I would have paid on that would have been a little over $1400.  So, my take home pay each year will be $2600 less.  I will take that amount out of those extra two checks and my bonus check to fund things like home reapirs and car replacement.  So, I do have $2600 less to fund my Roth IRA. However, I am anticipating on being in the 15% bracket when I retire, so getting the tax savings now is more important for me.  And I do have a hobby that produces income each year.  I can just take the first $2600 of that hobby income and send it to the Roth IRA.

Essentially, I just figured out a way to give myself a $1400/year or so raise last night, just by having insomnia.

Mississippi Mudstache

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Re: Optimize Your Taxable Income
« Reply #30 on: November 04, 2013, 12:06:42 PM »
I'm happy to hear that others have been inspired to dig a little deeper into their taxes - our tax laws may be incredibly complicated, but it seems that those complications create opportunities for those who are willing to study them a bit. Also, my thanks go out to the long-time tax jedis who have contributed and pointed out that my tax picture is even rosier than I originally thought. I would have never thought it was possible to get $2000-$3000 back from Uncle Sam with a near-$70,000 salary!

Granted, if you retire early, you probably could convert these Traditional IRA funds year by year anyway at 0%, but maybe you wouldn't have that chance, so at least you have it in Roth space and don't need to worry further.

I do indeed intend to retire early, and I expect that I will be able to convert all of my tax-deferred savings into Roths without paying a dime in taxes, but (as I'm sure you're well aware), the benefit of putting the money into Roths now is that I will avoid the 5-year waiting period before the contributions can be withdrawn, so I will be building up some capital that I can spend early on in my retirement, before the Roth conversion ladder kicks in. And, if my income in retirement is high enough that I do end up paying taxes on the conversion, then I'll have nothing to complain about, because my income will be higher than I anticipate :)

hlca

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Re: Optimize Your Taxable Income
« Reply #31 on: November 05, 2013, 02:03:47 PM »

t.IRA:       $5,050
Roth IRA: $5,950 (which should go into the account TAX-FREE!)

Are the IRA contributions both for you?  If so, that might be over the limit.  I think the contributions for both (combined) are capped at $5500.  http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-IRA-Contribution-Limits

Mississippi Mudstache

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Re: Optimize Your Taxable Income
« Reply #32 on: November 05, 2013, 07:31:35 PM »
The IRS allows married couples to each contribute to an IRA, regardless of whether or not both spouses work.

Iron Mike Sharpe

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Re: Optimize Your Taxable Income
« Reply #33 on: November 06, 2013, 07:48:36 AM »
Ooooh, I played around with that calculator above.  It looks like by sending less to my Roth IRA and upping my 401K from 22% to 25% and then maxing out my HSA, I should be in the 15% tax bracket now.

Mazzinator

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Re: Optimize Your Taxable Income
« Reply #34 on: January 22, 2014, 01:06:33 PM »
Just wanted to say thank you to all of you!! This post helped me sooo much. Also i wanted to give this a 'bump' because it's getting close to tax time and i want to reference this to others.

eyePod

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Re: Optimize Your Taxable Income
« Reply #35 on: January 23, 2014, 11:55:33 AM »
I like your idea of optimizing taxes, but I now have a different thought.  Reducing taxes now probably increases your cash flow, but I don't think it helps your retirement income, if you stay within your current 15% marginal tax rate bracket.

You are in the 15% marginal taxable rate so your current long term capital gains rate is 0%.  Any money in a taxable account will receive that 0% rate for long term capital gains and this continues up to $72,500 of income, when it shifts to 15%; qualified dividends are also taxed at the same rate as long term capital gains.  So a Roth IRA or a traditional IRA at your marginal tax rate/income level will not have a significant improvement over a taxable account on your net money at retirement, if you manage your portfolio turnover wisely, i.e., harvest only long term capital gains and avoid frequent portfolio changes.  The taxable account has the advantage of allowing tax loss harvesting which can reduce your taxable income (with little effect on your asset allocation goals)  and provides extra liquidity financially-you can cash in taxable account equities sans tax advantaged rules.  A Roth IRA account adds a further firewall to your retirement funding, but it may not be necessary but probably doesn't hurt. 

By using a taxable account instead of a tax deferred vehicle, you pay your taxes now at the 15% marginal tax rate.  When you retire, you probably will be taxed on at least the 15% marginal tax rate on all tax deferred distributions (401k or traditional IRA), so the net money is the same.  You could be at a higher rate then which would mean you will pay a higher marginal tax rate on tax deferred retirement distributions than you will on a taxable account.  A Roth or two probably will not hurt you then, except Roth rules limit liquidity somewhat.

Further, when you retire, you will be at a given marginal tax rate.  If the marginal tax rate is 33% or lower, the current long term capital gains rate is 15% or 0%.  If you expect your retirement income to be above the 33% marginal tax rate, then a tax deferred account is not as helpful as a taxable account where you will pay a long term capital gain rate of 15% when your are at the 33% marginal tax rate.  Usually, retirement incomes are less than working income.  Tax rates can change though.

Funding your 401k to capture any employer match is very beneficial, but it could be done in a 401k or a Roth 401k when you are at your current marginal tax rate.  Funding a health savings account (which would be utilized as a retirement account strategy), especially if it is subsidized by your employer, is very beneficial, irregardless of marginal tax rate.  The key is to use tax deferral strategies to stay below the 25% marginal tax rate ($72,500).

I would use tax deferral strategies to keep your income in the 15% marginal tax rate, but then consider shifting to taxable accounts for the rest of your money.  A Roth IRA or two would be fine, but may not be necessary, if you feel you will be retiring in a bracket under 33%.  Of course, take any tax credits that are available.

I am not a tax professional, but these are my thoughts for general discussion.  They could be wrong, but this is what I think.  YMMV

This is why I like to have a nice split with my 401k and Roth IRA. It lets me keep money in a tax advantaged and a non-tax advantaged account, hedging my bets on whether or not I'm in a lower tax bracket in the future.

ChiStache

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Re: Optimize Your Taxable Income
« Reply #36 on: January 29, 2014, 03:51:55 PM »
Thank you to everyone who contributed to this thread. It is helping me think really productively about my #1 expense - taxes!

the fixer

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Re: Optimize Your Taxable Income
« Reply #37 on: January 29, 2014, 04:10:01 PM »
One tiny tip to share that I learned a couple years ago:

Your total tax is not an exact mathematical formula based on your income. To simplify things, the IRS has you look up your tax on the tax table in the instructions. This is a table that presents the total tax as a fixed number for a given $50 range of income.

Let's suppose you made $48,999 in taxable income, and the IRS says your total tax is $6,000 (made up, the actual number isn't important and I don't want to look it up!) and you're in the 25% bracket. If you had made an extra two dollars in taxable income, it would bump you up to the next $50 range with a tax of $6012, costing you $12 in taxes! So you ended up losing more to taxes than the marginal gain in income.

It's a small effect, but checking and adjusting where on the table you fall can save you a bit of money each year. I've also found that in practice it's really hard to get right because a little bit of extra interest income or something can screw it all up. So far I just hope that it all averages out over the years, but someone more enterprising than I might find good ways to game this.

rubybeth

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Re: Optimize Your Taxable Income
« Reply #38 on: January 29, 2014, 05:54:49 PM »
For things that are relevant to you right now, the instructions may refer you to other IRS numbered publications or form instructions that explain about the topic in more detail. Read those too.

Like Pub 970!  Reading the updated table once a year about the student loan interest phaseout (pg 25-29 last year) is a good reminder to me each year to keep going strong with the 401k.

http://www.irs.gov/pub/irs-pdf/p970.pdf

Wow - that is really good to know! I didn't realized the student loan deduction was being phased out. No matter for me, though, as my adjusted gross income won't be high enough for me not to qualify for that credit. Plus, this should be the last year I pay interest on student loans ever. YAY.

I feel the need to clarify this point. I don't believe the deduction "is being phased out" meaning that it's going away, I believe "phase out" in this case means that if you make over a certain amount of income, your ability to take the deduction goes away. Feel free to correct me if I'm wrong! :)

Jack

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Re: Optimize Your Taxable Income
« Reply #39 on: January 29, 2014, 07:29:39 PM »
I feel the need to clarify this point. I don't believe the deduction "is being phased out" meaning that it's going away, I believe "phase out" in this case means that if you make over a certain amount of income, your ability to take the deduction goes away. Feel free to correct me if I'm wrong! :)

It's good that you clarified that; I almost panicked when I read it above!

One thing that I noticed when I was working on my spreadsheet a few days ago is that the Saver's Credit has a huge discontinuity in it: if your AGI is <= $35500 you get 50% of your contribution, but if it's over that you only get 20%. For me, that has two implications: contributing enough to my traditional IRA to have an AGI of $35499 instead of ending up at $35501 saves me over $900 in taxes, and anything beyond that -- which isn't even halfway to maxing the IRA contribution -- can be contributed as Roth and not get taxed later or now!

Alas, if only these credits applied to the self-employment tax...

beltim

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Re: Optimize Your Taxable Income
« Reply #40 on: January 29, 2014, 07:34:15 PM »
I feel the need to clarify this point. I don't believe the deduction "is being phased out" meaning that it's going away, I believe "phase out" in this case means that if you make over a certain amount of income, your ability to take the deduction goes away. Feel free to correct me if I'm wrong! :)

It's good that you clarified that; I almost panicked when I read it above!

One thing that I noticed when I was working on my spreadsheet a few days ago is that the Saver's Credit has a huge discontinuity in it: if your AGI is <= $35500 you get 50% of your contribution, but if it's over that you only get 20%. For me, that has two implications: contributing enough to my traditional IRA to have an AGI of $35499 instead of ending up at $35501 saves me over $900 in taxes, and anything beyond that -- which isn't even halfway to maxing the IRA contribution -- can be contributed as Roth and not get taxed later or now!

Alas, if only these credits applied to the self-employment tax...

There are two other discontinuities as well: at 38,500 the credit goes from 20% to 10%, and at 59,000 the credit goes from 10% to 0%.

Although I usually prefer Roth IRAs at these income levels, contributing to a traditional IRA in order to get a higher credit is well worth it.

TomTX

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Re: Optimize Your Taxable Income
« Reply #41 on: January 29, 2014, 08:04:29 PM »
One tiny tip to share that I learned a couple years ago:

Your total tax is not an exact mathematical formula based on your income. To simplify things, the IRS has you look up your tax on the tax table in the instructions. This is a table that presents the total tax as a fixed number for a given $50 range of income.

Let's suppose you made $48,999 in taxable income, and the IRS says your total tax is $6,000 (made up, the actual number isn't important and I don't want to look it up!) and you're in the 25% bracket. If you had made an extra two dollars in taxable income, it would bump you up to the next $50 range with a tax of $6012, costing you $12 in taxes! So you ended up losing more to taxes than the marginal gain in income.

It's a small effect, but checking and adjusting where on the table you fall can save you a bit of money each year. I've also found that in practice it's really hard to get right because a little bit of extra interest income or something can screw it all up. So far I just hope that it all averages out over the years, but someone more enterprising than I might find good ways to game this.

So, don't max out your Traditional IRA. When you run your taxes (before April 15) and you find yourself $2 over the breakpoint - contribute $2 to your IRA for the prior year.

nottoolatetostart

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Re: Optimize Your Taxable Income
« Reply #42 on: January 30, 2014, 07:30:02 AM »
Got referred here from another thread....just wanted to say that you all are awesome.

Two action items that I am going to do after reading this: I'm going to take seattlecyclone's idea of reading the IRS publication and then take hoppy's advice of coding my own spreadsheets to put it all into action.

I have to say the best thing we ever did was get away from using our CPA....nothing against CPA's as I know some awesome ones. But the one my DH's family used (and we just used for the first 2 years of marriage) was a "punch in the numbers" kind of guy and it probably cost us more since I was too ignorant to understand all of this. I shudder to think how much extra we paid in taxes.

Also going to consider moving to Taxact instead of TT this year.

Thank you....you all rock!

MustachianAccountant

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Re: Optimize Your Taxable Income
« Reply #43 on: January 30, 2014, 09:00:46 AM »
seattlecyclone:

Are there any books or other sources you could recommend for a beginner like myself who is interested in learning about personal income tax law? Thanks again!

If you're a "hands on" type learner, I'd suggest getting involved with the IRS' VITA program. You would volunteer at a VITA site to do low-income people's tax returns. The VITA program provides all the training you need, as well as site coordinators who answer questions, and in return you get experience in tax return preparation. You'll see a lot of tax situations beyond your own, and begin to think outside the lines of your own tax situation. Where I live, there's a VITA program administered by the United Way, so that might be a good place to start.

Cheddar Stacker

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Re: Optimize Your Taxable Income
« Reply #44 on: January 30, 2014, 10:47:19 AM »

I feel the need to clarify this point. I don't believe the deduction "is being phased out" meaning that it's going away, I believe "phase out" in this case means that if you make over a certain amount of income, your ability to take the deduction goes away. Feel free to correct me if I'm wrong! :)

You are correct. Here's the excel formula I use within my tax spreadsheet for those who might be interested. This formula will only work if you reach the minimum phaseout level, otherwise just use 100% of SL interest. If you're an excel nut and want to "fix it" to also include AGI < the limits go for it.

=IF(C27>155000,0,(1-(C27-125000)/30000)*B30)

So C27 is effectively AGI (slightly modified) and B30 is total student loan interest paid. The phase-out begins at $125K and ends at $155K, married filing joint. There's no cliff really, it's just a percentage of how far you go in that range. $140K AGI would get you a 50% deduction for SL interest.

rubybeth

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Re: Optimize Your Taxable Income
« Reply #45 on: January 30, 2014, 11:15:52 AM »

I feel the need to clarify this point. I don't believe the deduction "is being phased out" meaning that it's going away, I believe "phase out" in this case means that if you make over a certain amount of income, your ability to take the deduction goes away. Feel free to correct me if I'm wrong! :)

You are correct. Here's the excel formula I use within my tax spreadsheet for those who might be interested. This formula will only work if you reach the minimum phaseout level, otherwise just use 100% of SL interest. If you're an excel nut and want to "fix it" to also include AGI < the limits go for it.

=IF(C27>155000,0,(1-(C27-125000)/30000)*B30)

So C27 is effectively AGI (slightly modified) and B30 is total student loan interest paid. The phase-out begins at $125K and ends at $155K, married filing joint. There's no cliff really, it's just a percentage of how far you go in that range. $140K AGI would get you a 50% deduction for SL interest.

Thanks, that's very helpful. I just didn't want anyone to freak out if they read "phased out" and misinterpreted it. :)

MooseOutFront

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Re: Optimize Your Taxable Income
« Reply #46 on: January 30, 2014, 11:20:07 AM »
Question.

For 2014 I'm looking at this scenario:
AGI: $89,266
From AGI: $(29,617)
Taxable: $59,649

So this puts me inside the 15% bracket by $72,500-$59,649 = $12,851

I currently max all possible tax advantaged space.

Should I be considering backing off the 401k contributions and investing in taxable instead to get my taxable income up to $72,500?  I generally see 15% as an acceptable tax and it'ss the rate I plan to pay in retirement, but otoh I also like the idea of delaying any taxes possible and just trying my luck with structuring future income to avoid high taxes, possibly even paying 0% in the future. 

On a related note, I have no taxable currently, but will have $110M in Roth principal to live off of in ER while I wait for roth conversions to ripen.

simonsez

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Re: Optimize Your Taxable Income
« Reply #47 on: January 30, 2014, 11:32:54 AM »
On a related note, I have no taxable currently, but will have $110M in Roth principal to live off of in ER while I wait for roth conversions to ripen.
Jesus titty-fucking Christ!  $110,000,000?

Cheddar Stacker

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Re: Optimize Your Taxable Income
« Reply #48 on: January 30, 2014, 11:34:15 AM »
Question.

For 2014 I'm looking at this scenario:
AGI: $89,266
From AGI: $(29,617)
Taxable: $59,649

So this puts me inside the 15% bracket by $72,500-$59,649 = $12,851

I currently max all possible tax advantaged space.

Should I be considering backing off the 401k contributions and investing in taxable instead to get my taxable income up to $72,500?  I generally see 15% as an acceptable tax and it'ss the rate I plan to pay in retirement, but otoh I also like the idea of delaying any taxes possible and just trying my luck with structuring future income to avoid high taxes, possibly even paying 0% in the future. 

On a related note, I have no taxable currently, but will have $110M in Roth principal to live off of in ER while I wait for roth conversions to ripen.

I don't think you should back off the tax deferrals unless you have a short-term need for the cash. You are already paying 15% tax on every taxable dollar you earn over the $17,850 at 10%. Why pay more now? Note: Tax tables have increased slightly for 2014, the numbers quoted here are 2013 brackets MFJ.

BTW, do you mean $110K Roth, because if you have $110 Million in a Roth you must be a magician and I think you're in the wrong forum. ; ) 

MooseOutFront

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Re: Optimize Your Taxable Income
« Reply #49 on: January 30, 2014, 11:40:00 AM »
Jesus titty-fucking Christ!  $110,000,000?
Ha! Yeah sorry.  I'm a banker and we use M for k and MM for million.  M is the roman numeral for 1000. Gets me every time on message boards though.
« Last Edit: January 30, 2014, 11:42:41 AM by MooseOutFront »