Author Topic: Optimizing taxes - maximizing benefits for parttime working  (Read 13178 times)

ender

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Optimizing taxes - maximizing benefits for parttime working
« on: January 26, 2016, 01:25:44 PM »
I often ponder partial retirement.  Something where I work 2-3 days a week on average for a year.

Several reasons drive this:
  • If/when we have kids, that's a part of their life I want to be vitally involved in (whether we're FI or not)
  • Life flexibility from working 3 days a week would be significant
  • Taxes greatly, greatly, GREATLY favor someone doing this
The last reason is pretty significant. Imagining a family of 5, I want to investigate an "optimal" income strategy based on current tax code.

There are a few current tax incentives I am aware of which can amplify income. Namely, how the EITC, savers credit, and child tax credit interact with 401(k) contributions.

Child Tax Credit

This is pretty simple. Unless your household income is more than $110k, you get $1k in refundable credits per qualifying child.

A note, each child also reduces your federal taxable income by $4050.

EITC

According to this calculator you receive the following for a family of 3 based on a few amounts of earned income (assuming AGI is not higher due to Roth conversions, etc):
  • $20k --> $6,241
  • $24k --> $6,153
  • $25k --> $5,942
  • $26k --> $5,732
  • $30k --> $4,890
  • $35k --> $3,838
  • $40k --> $2,786
  • $45k --> $1,734
  • $50k --> $682

A few interesting observations. First, for someone with an earned income/AGI of only $20k you get a huge EITC. Second, your benefit isn't really reduced much going to $25k income but after that the tax benefit starts dropping about $200 for every $1000 in additional income.

The "sweet" spot is $24k or so earned income. This gets complicated and I'm hoping to get clarity. My understanding is that on a normal W-2 the amount of "earned income" is Box1. This is post 401k/HSA withdrawals. So payroll deductions like 401k/HSA do reduce your earned income (as well as AGI). The language on Box1 is identical to the what is earned income? page from the IRS.

However, deductible IRAs only reduce AGI and not earned income. Since EITC is the lower amount of either your AGI/earned income, assuming both are under these amounts, your earned income would stay the same.

The benefit here is that you can consequentially add a full HSA/401k contribution to the $24k sweet spot, giving your "real" income to be $24k+$18k+$6.75k = $48,750 salary. Additional income will still give you more net money, however your marginal tax rate will be about 30% (between FICA and loss of EITC).

Savers Credit

This isn't that useful for any of the above situations, because it's a nonrefundable credit. However, if you don't have children this can be worth $4,000 in federal tax refund if your AGI is within certain thresholds. Note that 401k/traditional IRAs both reduce this and so can "double" count as the percentage of your contributions you get back increase significantly as you lower AGI.


Summary

For a family of 5 making $50k a year:
  • Contribute $18,000 to a 401k
  • Contribute $6,750 to a family HSA
  • Have $25,250 earned income remaining
  • Pay no federal income tax
  • Receive about $5,900 from EITC
  • Receive $3,000 in refundable child-credits

After FICA, they have $22k take-home pay plus $8900 in tax returns for a grand total of:
  • $30,900 after-tax income
  • $18,000 401k savings
  • $6,750 HSA savings

Or in total $55.7k net worth increase. Obviously if you want to/have to earn less you can adjust the $18,000 in 401(k) contributions as desired.

What other strategies or tax incentives am I unaware of that can be used to improve this approach?

Mississippi Mudstache

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #1 on: January 26, 2016, 01:55:27 PM »
You've got it. Just a few minor points I would address:

Quote
A note, each child also reduces your federal taxable income by $4050.

For anyone filing this year, note that this figure is for 2016. For 2015 taxes, the personal exemption is $4000.

Quote
Saver's Credit: This isn't that useful for any of the above situations, because it's a nonrefundable credit. However, if you don't have children this can be worth $4,000 in federal tax refund if your AGI is within certain thresholds.

If you work through From 8880, you'll notice that the maximum Saver's Credit possible is actually $2000, not $4000. In practice, it is nearly impossible to actually claim the full benefit. The Saver's Credit comes in handy when you're above the "optimal" threshold that you discuss here. We had reported earned income of ~$45,000 this year after deducting 401K, HSA, healthcare premiums, and FICA. I found that the optimal strategy was to dial in my AGI to $39,500 and not a dollar more, using the traditional IRA contributions, which reduced our federal tax to $0 using the Saver's Credit. That way, we got back 100% of our Additional Child Tax Credit ($3000, since we have 3 kids) and a small EITC to boot. As you note, there's nothing you can do with the IRA contributions to affect your earned income for EITC purposes. I was also disappointed to learn that rental losses don't reduce EITC income, either, since I had a $5000 loss this year.

Great thoughts, though. I've worked through exactly the same scenario myself with the same plan in mind.
« Last Edit: January 26, 2016, 02:56:13 PM by Mississippi Mudstache »

teen persuasion

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #2 on: January 26, 2016, 02:16:01 PM »
I see you've been looking over my shoulder.

Check your state tax return for credits.  NYS matches EITC at 30% and CTC at 33% ( for children over age 4, I believe).  My refundable credits are slowly shrinking as the kids age out, but I've had refunds large enough to fully fund 2 Roth IRAs.

The lower AGI is also useful to help qualify for the Simplified Needs Test on the FAFSA (AGI < $50k) so assets are ignored, or auto EFC = 0 (AGI < $24k).  It was much easier a few years ago when the auto EFC = 0 cutoff was $32k.  $24k is just a bit too tight to reach.

ender

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #3 on: January 26, 2016, 06:53:54 PM »

Great thoughts, though. I've worked through exactly the same scenario myself with the same plan in mind.

Yeah. Amazing how planning works for this sort of thing (definitely used 2016 figures).

Hard to say how realistic or feasible it'd be to do, but hey, planning is fun :-)

I see you've been looking over my shoulder.

Check your state tax return for credits.  NYS matches EITC at 30% and CTC at 33% ( for children over age 4, I believe).  My refundable credits are slowly shrinking as the kids age out, but I've had refunds large enough to fully fund 2 Roth IRAs.

The lower AGI is also useful to help qualify for the Simplified Needs Test on the FAFSA (AGI < $50k) so assets are ignored, or auto EFC = 0 (AGI < $24k).  It was much easier a few years ago when the auto EFC = 0 cutoff was $32k.  $24k is just a bit too tight to reach.

Oooh I didn't think about states matching EITC. Looks like we've got a 15% "match."

Nor did I think about FAFSA implications. Seems that could be really beneficial then during their college years. Though you'd lose the other credits.

MDM

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #4 on: January 26, 2016, 10:43:57 PM »
Yeah. Amazing how planning works for this sort of thing (definitely used 2016 figures).

Hard to say how realistic or feasible it'd be to do, but hey, planning is fun :-)

Chart below merely confirms what you have found (albeit with 2015 tax numbers) so the results appear realistic.  Feasibility lies in the food, clothing, and shelter expertise of the beholder. :)


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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #5 on: January 26, 2016, 10:58:49 PM »
It's interesting to look at the marginal tax rates created as a result of these tax credits.

Assumptions: family of five, married filing jointly, three kids under 17, each spouse contributes at least $2,000 to a 401(k), no income besides wages. 2015 tax brackets and EIC amounts used.

For your family of five, the first $3,000 of income has a -45% marginal tax rate, as there is no tax before credits and the earned income credit is phasing in at 45¢ per dollar of earned income.

At $3,000 of earned income, the Additional Child Tax Credit starts to phase in at 15¢ per dollar, giving a -60% marginal tax rate from there until you hit the maximum earned income credit at $13,850. This point is where we find the highest negative effective tax rate (-56.8% of AGI).

From there until $23,000, the Additional Child Tax Credit keeps phasing in while the Earned Income Credit is in a plateau. Marginal rate from $13,850 to $23,000: -15%.

At $23,000 of earned income, the Additional Child Tax Credit hits its maximum $3,000 value, and the EIC will still be at its maximum value of $6,242 until you hit $23,650 of earned income. Marginal rate from $23,000 to $23,650: 0%. If you're looking for the maximum possible tax credit, this is the range to aim for. Your effective tax rate will still be a very respectable -40% of AGI in this range.

Now we've hit the end of the negative marginal tax rates. From $23,650 of earned income the EIC starts phasing out at roughly 21¢ per dollar. The 10% tax bracket starts to kick in at $32,600, but the saver's credit completely counteracts that until its second cliff at $39,500. Marginal rate from $23,650-$39,500: 21%.

Starting at $39,500, your saver's credit is a flat $400, so the 10% tax bracket finally starts to matter. The EIC is still phasing out. Marginal rate from $39,500-$51,050: 31%.

The 15% tax bracket starts at $51,050. The EIC phaseout ends at $53,267. Marginal rate in this range: 36%.

From here on up, the marginal tax rate is the same as the tax bracket, save for a cliff at $61,000 where the saver's credit goes away.

I'd like to call special attention to this $39,500-$53,267 range. With a federal tax rate of 31-36%, plus payroll tax of 7.45% and any state/local taxes that may apply, you could easily be paying half of the marginal dollar on taxes. If you still have young children at this point you should consider whether your pocketbook and sanity might both be better off if you cut back on work time and daycare expense simultaneously.
« Last Edit: January 28, 2016, 11:46:56 AM by seattlecyclone »

ender

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #6 on: January 27, 2016, 05:45:57 AM »
It's interesting to look at the marginal tax rates created as a result of these tax credits.

I think that was the most depressing part of this whole exercise, realizing how much the EITC phaseout causes the equivalent of a high marginal tax rate.

It gets even worse if your state has significant eitc matching, too.
« Last Edit: January 27, 2016, 07:00:53 AM by ender »

teen persuasion

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #7 on: January 27, 2016, 06:45:58 AM »
One gotcha to watch out for: taxable investment income.  Once you have investment income >$3400 you are ineligible for the EITC.  So if living semi ER includes tapping your taxable account, or your taxable account grows large enough, you could suddenly find the EITC is gone.

Mississippi Mudstache

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #8 on: January 27, 2016, 07:36:00 AM »
One gotcha to watch out for: taxable investment income.  Once you have investment income >$3400 you are ineligible for the EITC.  So if living semi ER includes tapping your taxable account, or your taxable account grows large enough, you could suddenly find the EITC is gone.

Lucky (?) for me, my income is not/will never be high enough to contribute so much as a dime to a taxable account. By the time I fill up the 401k (18K + 6.5% match), HSA ($6500), and two IRAs ($11,000) that's half my gross income and all I can handle. My ER plan involves living on earned income, whatever tax credits we may be eligible for, and tapping into the Roth IRAs if need be, which won't count against the EITC.

SomedayStache

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #9 on: January 27, 2016, 07:52:39 AM »
Posting to follow.  This kind of hurts my brain and my soul.

Mississippi Mudstache

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #10 on: January 27, 2016, 07:53:41 AM »
Posting to follow.  This kind of hurts my brain and my soul.

So you're following because you're a masochist?

seattlecyclone

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #11 on: January 27, 2016, 08:02:28 AM »
One gotcha to watch out for: taxable investment income.  Once you have investment income >$3400 you are ineligible for the EITC.  So if living semi ER includes tapping your taxable account, or your taxable account grows large enough, you could suddenly find the EITC is gone.

Indeed. A fund like VTSAX with a 2% yield will hit that number on dividends alone with less than $200k invested.

SomedayStache

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #12 on: January 27, 2016, 08:29:28 AM »
Posting to follow.  This kind of hurts my brain and my soul.

So you're following because you're a masochist?
It hurts my brain which means I need to look at the numbers a few times so I understand.

It hurts my soul because this is stupidly complicated and the people who really could use this knowledge probably will never know any of the details to be able to tweak their situations.  But it is what it is.  Maybe someday I can benefit from these trigger points and thresholds.

ender

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #13 on: January 27, 2016, 09:59:43 AM »
One gotcha to watch out for: taxable investment income.  Once you have investment income >$3400 you are ineligible for the EITC.  So if living semi ER includes tapping your taxable account, or your taxable account grows large enough, you could suddenly find the EITC is gone.

Indeed. A fund like VTSAX with a 2% yield will hit that number on dividends alone with less than $200k invested.

One advantage to planning out something like this when you are younger is that you can ensure your taxable accounts (if any) facilitate better overall tax picture over the next decades of your life.

You might prefer taxable investments with minimal dividend yield as a result.

One gotcha to watch out for: taxable investment income.  Once you have investment income >$3400 you are ineligible for the EITC.  So if living semi ER includes tapping your taxable account, or your taxable account grows large enough, you could suddenly find the EITC is gone.

Lucky (?) for me, my income is not/will never be high enough to contribute so much as a dime to a taxable account. By the time I fill up the 401k (18K + 6.5% match), HSA ($6500), and two IRAs ($11,000) that's half my gross income and all I can handle. My ER plan involves living on earned income, whatever tax credits we may be eligible for, and tapping into the Roth IRAs if need be, which won't count against the EITC.

Yeah, this is an interesting factor to consider too - this all becomes even more of an important/interesting discussion if your actual income is in the $50k-60k range to begin with because now you can fully use EVERYTHING here during working years.


Another use of this information is recognizing that earning a nominal amount of earned income to supplement your Roth conversions could actually give you a significant marginal rate on that income. If you're in a position to make a high hourly rate you could really capitalize on this optimization - maybe earn $10k and convert $30k or something, etc. The main disadvantage is that the lessened EITC actually makes your Roth conversions are going to be "taxed" at a crappy rate, given how the EITC phases out.

teen persuasion

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #14 on: January 27, 2016, 05:47:16 PM »
One gotcha to watch out for: taxable investment income.  Once you have investment income >$3400 you are ineligible for the EITC.  So if living semi ER includes tapping your taxable account, or your taxable account grows large enough, you could suddenly find the EITC is gone.

Indeed. A fund like VTSAX with a 2% yield will hit that number on dividends alone with less than $200k invested.

One advantage to planning out something like this when you are younger is that you can ensure your taxable accounts (if any) facilitate better overall tax picture over the next decades of your life.

You might prefer taxable investments with minimal dividend yield as a result.

One gotcha to watch out for: taxable investment income.  Once you have investment income >$3400 you are ineligible for the EITC.  So if living semi ER includes tapping your taxable account, or your taxable account grows large enough, you could suddenly find the EITC is gone.

Lucky (?) for me, my income is not/will never be high enough to contribute so much as a dime to a taxable account. By the time I fill up the 401k (18K + 6.5% match), HSA ($6500), and two IRAs ($11,000) that's half my gross income and all I can handle. My ER plan involves living on earned income, whatever tax credits we may be eligible for, and tapping into the Roth IRAs if need be, which won't count against the EITC.

Yeah, this is an interesting factor to consider too - this all becomes even more of an important/interesting discussion if your actual income is in the $50k-60k range to begin with because now you can fully use EVERYTHING here during working years.


Another use of this information is recognizing that earning a nominal amount of earned income to supplement your Roth conversions could actually give you a significant marginal rate on that income. If you're in a position to make a high hourly rate you could really capitalize on this optimization - maybe earn $10k and convert $30k or something, etc. The main disadvantage is that the lessened EITC actually makes your Roth conversions are going to be "taxed" at a crappy rate, given how the EITC phases out.

You could optimize it by looking at the two test points (line 7 wages and AGI).  Since you get the lesser EITC amount of either, try to align them on either side of the plateau.  E.g., if wages are $10k, EITC for MFJ with 3 kids is $4511.  EITC on AGI of $31,849 is $4516.  So you could convert $21,849.

The drawback is that the spread is smaller at the edges of the plateau, essentially the width of the plateau plus 2*distance down the phaseout ramp the distance up the phasein ramp and down the phaseout ramp, so trying to capture the maximum EITC means you can convert less than $10k.

ETA:  I just realized that the phasein and phaseout ramps are not equal; I had assumed they were, but seattlecyclone's post stuck in my head.  It is 45% up and 21% down, for 3 kids.  I think it is 40% for 2, and even smaller for 1.
« Last Edit: January 27, 2016, 05:56:49 PM by teen persuasion »

ender

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #15 on: January 28, 2016, 05:11:08 AM »
You could optimize it by looking at the two test points (line 7 wages and AGI).  Since you get the lesser EITC amount of either, try to align them on either side of the plateau.  E.g., if wages are $10k, EITC for MFJ with 3 kids is $4511.  EITC on AGI of $31,849 is $4516.  So you could convert $21,849.

The drawback is that the spread is smaller at the edges of the plateau, essentially the width of the plateau plus 2*distance down the phaseout ramp the distance up the phasein ramp and down the phaseout ramp, so trying to capture the maximum EITC means you can convert less than $10k.

ETA:  I just realized that the phasein and phaseout ramps are not equal; I had assumed they were, but seattlecyclone's post stuck in my head.  It is 45% up and 21% down, for 3 kids.  I think it is 40% for 2, and even smaller for 1.

Oooh this is a good addition (plus it'd involve much less working wages required anyways).

Something like this still could be a good plan, especially since we're going to start with quite a bit of Roth savings anyways - it'd be pretty straightforward to use this approach for ~5 years to start an easy Roth pipeline for our traditional IRA money.

The $10k you work would result in about $7k in tax benefits then as my understanding is the refundable portion of the child tax credit just requires you to have $3k earned income.


teen persuasion

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #16 on: January 28, 2016, 06:24:34 AM »
You could optimize it by looking at the two test points (line 7 wages and AGI).  Since you get the lesser EITC amount of either, try to align them on either side of the plateau.  E.g., if wages are $10k, EITC for MFJ with 3 kids is $4511.  EITC on AGI of $31,849 is $4516.  So you could convert $21,849.

The drawback is that the spread is smaller at the edges of the plateau, essentially the width of the plateau plus 2*distance down the phaseout ramp the distance up the phasein ramp and down the phaseout ramp, so trying to capture the maximum EITC means you can convert less than $10k.

ETA:  I just realized that the phasein and phaseout ramps are not equal; I had assumed they were, but seattlecyclone's post stuck in my head.  It is 45% up and 21% down, for 3 kids.  I think it is 40% for 2, and even smaller for 1.

Oooh this is a good addition (plus it'd involve much less working wages required anyways).

Something like this still could be a good plan, especially since we're going to start with quite a bit of Roth savings anyways - it'd be pretty straightforward to use this approach for ~5 years to start an easy Roth pipeline for our traditional IRA money.

The $10k you work would result in about $7k in tax benefits then as my understanding is the refundable portion of the child tax credit just requires you to have $3k earned income.

It looks like the non-refundable portion only requires $3k earned income.  The refundable portion is 15% of your income over $3k, or some comparison to FICA paid IFF you have 3 or more kids.  So $10k would only be eligible for $1050 max.  You'd need $23k earned income to get $3k CTC refunded.

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #17 on: January 28, 2016, 10:11:52 AM »
Posting to follow....Critique my assumptions below. I see opportunities here in about 4-5 years when our middle child goes to college and we switch from a larger paid off house to a small paid off condo with <$2.5K of property taxes.  Cash from the home sale and the kids' college accounts would cover any college expenses.  Tapping into retirement accounts - even Roth ladders would affect financial aid.

If I read the above right, $23,000-$23,500 for a family of 5 is the sweet spot, with $39,500 net income the upper limit of the 21% effective rate bump.  Colleges offer financial aid to families under $100K (but they don't include 401(k)/other deductions).  (Stanford is a free ride under $100K, assuming you have the grades and test scores to get in - my kids so far are a "no" for this option.)

$96,000 earnings by 2 parents
-18,500 401(k)
-18,500 401(k)
-11,000 IRA
-6,500 HSA
-2,000 Saver credit
= $39,500

or

$80,000 earnings by 2 parents
-18,500 401(k)
-18,500 401(k)
-11,000 IRAs
-6,500 HSA
-2,000 saver credit
=$23,500

I don't think our family could live on $23,500, so I'd probably be looking at the $39,500 range. In 5 years we will be "FI" so technically we wouldn't need to work or save at all, but the idea of a negative tax rate after all the years of being forced to pay would be really fun.  DH and I could earn $96,000 working very PT, which was our overall goal - just to work enough to pay for the kids college.

teen persuasion

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #18 on: January 28, 2016, 11:14:22 AM »
Posting to follow....Critique my assumptions below. I see opportunities here in about 4-5 years when our middle child goes to college and we switch from a larger paid off house to a small paid off condo with <$2.5K of property taxes.  Cash from the home sale and the kids' college accounts would cover any college expenses.  Tapping into retirement accounts - even Roth ladders would affect financial aid.

If I read the above right, $23,000-$23,500 for a family of 5 is the sweet spot, with $39,500 net income the upper limit of the 21% effective rate bump.  Colleges offer financial aid to families under $100K (but they don't include 401(k)/other deductions).  (Stanford is a free ride under $100K, assuming you have the grades and test scores to get in - my kids so far are a "no" for this option.)

$96,000 earnings by 2 parents
-18,500 401(k)
-18,500 401(k)
-11,000 IRA
-6,500 HSA
-2,000 Saver credit
= $39,500

or

$80,000 earnings by 2 parents
-18,500 401(k)
-18,500 401(k)
-11,000 IRAs
-6,500 HSA
-2,000 saver credit
=$23,500

I don't think our family could live on $23,500, so I'd probably be looking at the $39,500 range. In 5 years we will be "FI" so technically we wouldn't need to work or save at all, but the idea of a negative tax rate after all the years of being forced to pay would be really fun.  DH and I could earn $96,000 working very PT, which was our overall goal - just to work enough to pay for the kids college.

HSA and 401k contributions are useful for getting into EITC range, but IRA contributions are not.  Traditional IRA contributions lower your AGI, but not your line 7 wages, and the EITC tests both.  The retirement savers credit is not useful at all for eligibility for EITC, only for lowering tax owed.  At the peak EITC, generally no tax is owed anyways, so the nonrefundable credit is worthless.  I am not at peak EITC, and this may be the first year the savers credit will be useful; we are dropping from 3 kids to 2 .

seattlecyclone

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #19 on: January 28, 2016, 11:39:09 AM »
Yes, the EIC is based on your "earned income," which for most W-2 employees would just be the amount reported as "wages" on your tax return. That means 401(k) contributions help bring this number down. Any other pre-tax payroll deductions (HSA, health insurance premiums, some other things) would also bring this number down. Traditional IRA contributions and non-payroll HSA contributions would not.

So to get to $23,500 "earned income" with two earning parents and an employer-based HSA, you could have total salary of $23,500 + $18,000 + $18,000 + $6,500 = $66,000. Remember you wouldn't be "living on" this $23,500 amount. Since your taxes would likely be negative, you would actually have more like $30k to spend. If you plan ahead you can put some extra money in a savings account during higher-earning years and withdraw that to supplement your earnings. Aside from the minuscule interest you earn on that account, that wouldn't really affect things tax-wise.

College financial aid uses a whole different set of formulas. The "automatic zero EFC" that was discussed earlier is available to those families with adjusted gross income under $24,000. Therefore IRA deductions would count for this purpose. However, one other big requirement for this treatment on your FAFSA is that you either need to be on one or more federal means-tested welfare benefits (food stamps, free/reduced school lunch, WIC, SSI, TANF) or you have to file your taxes on Form 1040-A or 1040-EZ. If anything in your income situation requires you to file the full Form 1040, you don't get the automatic zero treatment. Some examples of things that would disqualify you from filing Form 1040-A are HSA contributions or withdrawals, capital gains, and rental property income.

Of course, if you're applying for a school like Stanford that doesn't even use the FAFSA, this is all moot.

Mississippi Mudstache

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #20 on: January 28, 2016, 12:05:50 PM »
This continues to be a great thread, ender. Thanks for starting it. I've worked through the numbers on my own, but seattlecyclone's and teen persuasion's additions have given me even more to chew on.

ender

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #21 on: January 28, 2016, 12:26:20 PM »
Yes, the EIC is based on your "earned income," which for most W-2 employees would just be the amount reported as "wages" on your tax return. That means 401(k) contributions help bring this number down. Any other pre-tax payroll deductions (HSA, health insurance premiums, some other things) would also bring this number down. Traditional IRA contributions and non-payroll HSA contributions would not.

So to get to $23,500 "earned income" with two earning parents and an employer-based HSA, you could have total salary of $23,500 + $18,000 + $18,000 + $6,500 = $66,000. Remember you wouldn't be "living on" this $23,500 amount. Since your taxes would likely be negative, you would actually have more like $30k to spend. If you plan ahead you can put some extra money in a savings account during higher-earning years and withdraw that to supplement your earnings. Aside from the minuscule interest you earn on that account, that wouldn't really affect things tax-wise.

It also gives people who get both a 457b and 401k at their job fairly absurd options. The real hat-trick would be getting a job that gives you access to both of them as it'd let you bump your salary up to around $55k, and after maxing both them and an HSA, drop your earned income to drop to about $12.5k (the "sweet spot" for maxing EITC). Assuming you had an IRA with a significant pretax balance you could then immediately convert $20k to Roth, tax free, to also stay there.

Would be rather amusing to be doing a pretax 401k and then converting the same amount from your IRA. Ah the joys of earned income vs AGI (I think a Roth 401k would not reduce earned income but it's not clear, if so you could just contribute directly to that - for free!).

Interestingly, this is a situation where paying off your house early could matter (vs investing in post tax accounts). Your capital gains and/or investment income realized during your "gaming the EITC" years could prevent you from getting the EITC.

Considering how much this affects per year, you might actually benefit financially from either saving your extra money into a large supply of cash to supplement your expenses if needed or even paying off your entire mortgage early. Because in this situation, you care also about minimizing your investment income. While you might get a lot of capital gains/dividends in your taxable account, those  $4000 in "free" capital gains actually cost you more in the EITC loss.

Being able to operate on a smaller overall cashflow from would be beneficial as a result.

This continues to be a great thread, ender. Thanks for starting it. I've worked through the numbers on my own, but seattlecyclone's and teen persuasion's additions have given me even more to chew on.

Thanks. It's something I am far too interested in for my own good. :)

tct

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #22 on: January 28, 2016, 03:02:33 PM »
One gotcha to watch out for: taxable investment income.  Once you have investment income >$3400 you are ineligible for the EITC.  So if living semi ER includes tapping your taxable account, or your taxable account grows large enough, you could suddenly find the EITC is gone.

Would receiving business income through an S corporation (pass thru, not w2 income) be considered "investment income" that could put you over the $3400 limit making you ineligible for EITC?

MDM

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #23 on: January 28, 2016, 03:16:18 PM »
One gotcha to watch out for: taxable investment income.  Once you have investment income >$3400 you are ineligible for the EITC.  So if living semi ER includes tapping your taxable account, or your taxable account grows large enough, you could suddenly find the EITC is gone.

Would receiving business income through an S corporation (pass thru, not w2 income) be considered "investment income" that could put you over the $3400 limit making you ineligible for EITC?

See Worksheet 1 on page 6 of https://www.irs.gov/pub/irs-pdf/p596.pdf.  Does that answer the question?

teen persuasion

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #24 on: January 28, 2016, 08:44:37 PM »


College financial aid uses a whole different set of formulas. The "automatic zero EFC" that was discussed earlier is available to those families with adjusted gross income under $24,000. Therefore IRA deductions would count for this purpose. However, one other big requirement for this treatment on your FAFSA is that you either need to be on one or more federal means-tested welfare benefits (food stamps, free/reduced school lunch, WIC, SSI, TANF) or you have to file your taxes on Form 1040-A or 1040-EZ. If anything in your income situation requires you to file the full Form 1040, you don't get the automatic zero treatment. Some examples of things that would disqualify you from filing Form 1040-A are HSA contributions or withdrawals, capital gains, and rental property income.

Of course, if you're applying for a school like Stanford that doesn't even use the FAFSA, this is all moot.

Another option for the second big requirement is being a "dislocated worker".  I know there have been semi-tongue-in-cheek threads about engineering your layoff when ready to FIRE; this would be another perk to trying that.

The free/reduced lunch designation is what has made us eligible for at least the no asset test for quite a few years of FAFSA filing.  The interesting part is the dates of eligibility.  On the current 2016-2017 FAFSA it specifies any family member received benefits during 2014 or 2015.  So if we are eligible for reduced lunches this school year, we receive benefits in both 2015 and 2016.  Assuming they continue moving the dates forward as they have been, we would continue to meet this requirement for three college years (received 2014 or 2015 for 2016-17, received 2015 or 2016 for 2017-18, received 2016 or 2017 for 2018-19).  Of course, eligibility for free/reduced lunches is based on GROSS income, which cannot be gamed. 

It will be interesting to see how the shifting of the FAFSA timetable will change the rules and process in the future.  We already know that 2015 is going to count twice - as income for 2016-17, and again for 2017-18 when the shift to prior-prior year income goes into effect and the filing date moves to October.

Laura Ingalls

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #25 on: January 29, 2016, 08:43:48 AM »
We are currently early semi retirees with two minor children.  So far our real life experience has been that the EITC has not panned out.  I suspect it will not work in 2016 either despite having fewer investments in taxable (we bought a house in 2015. The three years before we had rented.  The house was a cash purchase. )

We are doing the free lunch for zero EFC for FASFA.  If that world does not change majorly it will be very helpful in a few years. 

AnEDO

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #26 on: February 01, 2016, 02:39:35 PM »
We have a similar strategy.  Both wife and I will switch to part time in 2020 to spend more time with kids while they are young and to take advantage of the favorable tax treatment of lower earned income.  We don't plan to ever go full time again after that.  We will be bare bones FI but will continue to generate some income as a cushion and to allow for travel and adding more to the kid's 529.  We will keep overall income low and will strategically convert amounts from our IRA to ROTH IRA. 

ender

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #27 on: April 12, 2016, 07:32:36 PM »
Musing on this, I wonder at what point taking advantage of things like this becomes unethical...

Things which might factor in that I have not thought about:

  • obamacare
  • other gov relief programs (food stamps?? etc)

I suspect there are a LOT more benefits for someone who can keep their AGI so low if they are strategic about it.

couponvan

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #28 on: April 12, 2016, 09:37:23 PM »
I was so tempted to post an awesome CA house deal for a single person at 41K or family of 4 at $58K. $160K 3 br condo - all because of affordable housing. My mom qualified for a 2 br - $160K for a 3 br 2ba in Marin county! Surrounded by $1 million dollar homes. A FIRE person could lock in housing where a regular person could not. $1 million assets = $30k income for the housing calcs.

ender

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #29 on: April 13, 2016, 06:04:49 AM »
I was so tempted to post an awesome CA house deal for a single person at 41K or family of 4 at $58K. $160K 3 br condo - all because of affordable housing. My mom qualified for a 2 br - $160K for a 3 br 2ba in Marin county! Surrounded by $1 million dollar homes. A FIRE person could lock in housing where a regular person could not. $1 million assets = $30k income for the housing calcs.

Right?

There are a lot of programs I suspect legally available for folks who work part-time with MMM levels of spending.

seattlecyclone

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #30 on: April 13, 2016, 08:30:55 AM »
My take on it: it's not my fault that many government programs decided to use income as the only deciding criterion without also having a wealth test. If you're eligible, go nuts.

ender

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #31 on: April 13, 2016, 06:57:25 PM »
My take on it: it's not my fault that many government programs decided to use income as the only deciding criterion without also having a wealth test. If you're eligible, go nuts.

Sometime when I have more ambition I will try to update this with more of them, but honestly the idea of researching how "easy" to game or take advantage of a lot of government relief programs are is rather depressing ;-)

NESailor

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #32 on: April 19, 2016, 02:06:49 PM »
My take on it: it's not my fault that many government programs decided to use income as the only deciding criterion without also having a wealth test. If you're eligible, go nuts.

Sometime when I have more ambition I will try to update this with more of them, but honestly the idea of researching how "easy" to game or take advantage of a lot of government relief programs are is rather depressing ;-)


I actually find it hilarious in a twisted sort of way.   Programs designed to help the "needy" leveraged by highly sophisticated financially savvy people who may or may not actually be quite wealthy - mostly due to the inherent assumption by our lawmakers that everyone spends everything they have.  Seems like any one of you could take this interest and knowledge to a CPA/Financial Advisory firm and sell your services for lucrative wages (that would make you NOT qualify).   

Now that I think about it...maybe there really isn't a market for this.  The people who actually qualify without doing all sorts of financial kung fu are too uninformed (and maybe uninterested) to seek the optimal solution and those who could qualify if they optimized their financial setup are also mostly financially illiterate.

I'll want to look into this once I'm closer to FI.  We're at a household gross of about 110K going to about 90K next year while my wife becomes SAHM with 2 kids.  I'm wondering if there's any way to remain on track to FI while working less by leveraging these strategies somehow...

raygor

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Re: Optimizing taxes - maximizing benefits for parttime working
« Reply #33 on: June 08, 2016, 05:41:43 PM »
I'm not sure about optimizing taxes, but I've been running numbers on how we might downsize our family of 5, from a HCOL area to a medium one, but with several acres. I'd like to work part time, and feel I could make 50k in the first year. If we sell the house, we could make somewhere between 300k-500k after paying off everything (depending on if the market keeps going up as fast), which combined with 50k would allow us to live off 4.5k a month for decades to come. I feel I could raise that yearly salary over time (as a consultant, I have 20 yrs exp in my field), but wanted to start conservatively. I also think we could reduce our monthly expenses with some initial outlay of both time and money as we build up our homestead. I'm still running numbers, and mostly trying to convince my wife that we could leave and never return to this area.