The tax system in the United States might as well seem like a foreign language to most individuals.? Vague statues.? Obscure language.? When you examine the tax system carefully it heavily favors those with higher incomes and those who invest.? The investing part is not necessarily bad since Americans need to save more given the current state of the economy.? I always wonder how many people understand all the complexities of the tax system to take advantage of every option available.? The tax law and code is longer than the Bible.? It is also rare to take advantage of all the tax benefits since few families actually have high incomes to maximize the return.? If an individual makes more than $166,000 a year this will place them in the top 5 percent of income earners.? Let us examine a family that has a gross income of $150,000 from their own business and see if we can get their Federal Income tax liability down to zero dollars.
The feasibility of zero in Federal Income tax on a $150,000 income
I remember reading an article early in 2011 about modifying your income via write offs, deductions, and investment vehicles on a $150,000 gross income and getting the Federal Income tax liability down to zero.? I happened to find the printed paper with notes written all over the page.? The page was a mess but I decided to put all the data into an easily readable format below:
*Click to enlarge
Now let us breakdown a few of the items above:
-$43,100 from self-employed 401k plus 20% company match.? As a self-employed person you can contribute on both the employee and employer side of the equation at $16,500.? You can also contribute another 20% of net income as a company match bringing the total to $43,100 that can be stashed away in the self-employed 401k.? Keep in mind most individuals working for a company (which is the vast majority of Americans) will only be able to reduce their income by $16,500.
-$10,000 into Traditional IRAs.? Keep in mind the above scenario has both spouses putting in $5,000 each into IRAs.? Most investment books would recommend putting after tax income into a Roth IRA so it can grow at full potential and won?t be subject to taxes on withdrawals.? We are using the Traditional IRA above to maximize the deductions for lowering the tax basis.
-$10,000 on mortgage interest.? The home mortgage interest rate deduction is still a big line item for most households.? The housing crisis has definitely put this into perspective for most given that the typical family is only pulling in $50,000 and not $150,000.? So the maximum benefit is rarely realized in this case given the typically priced home of $150,000 but also a lower income base rarely utilizes all these other tax benefits to their full potential.
As you can see from the above data, it is possible to reduce the Federal Income tax liability to zero on a gross income of $150,000.? I remind readers that the typical US household makes $50,000 a year so realistically there is only so much they can take advantage of.? At this level, many families are spending a substantial portion of their net income on housing, fuel, food, college, and other daily cost expenses.
Yet as you can see above, the major deductions that drove income the lowest were favoring those that invest.? The self-employed 401k and IRAs alone reduced the tax liability by $53,100 (or more than the typical household makes).
I would be really curious to see the breakdown of how many families claim each deduction and at what income levels.? The above scenario on a $150,000 income demonstrates the ability for individuals to lower their tax basis via many write offs, deductions, and expenses. ?The complexity of the system and overall lower household incomes make scenarios like the above rare cases but possible nonetheless.
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