How Retirees Pay Zero Taxes

[kmt1972]

From Forbes

How Retirees Pay Zero Taxes - Forbes

"To illustrate, let’s invent a retired couple who live outside Boston. They own a $2 million home, have $7 million stashed away at their broker and haul in $200,000 a year in dividends, interest, Social Security and distributions from publicly traded partnerships. They have $30,000 in deductions, including $20,000 for property tax and $5,000 for a donation.

Type this example into Intuit’s TurboTax program and the federal income tax bill that comes out is $17."

Talks about using munis and low dividend tax rates to get to very low federal income tax. This is exactly how I will operate when I do ER.

 

[David1961]

Thanks for sharing. This is an area I want to learn more about.
For anybody who does not have Turbotax, I believe the "Schedule D Tax Worksheet" is where you calculate your taxes. It's available (I think) on the instruction booklet from the IRS and also on-line.
http://www.irs.gov/instructions/i1040sd/ch02.html

 

[Beryl]

"To illustrate, let’s invent a retired couple who live outside Boston. They own a $2 million home, have $7 million stashed away at their broker and haul in $200,000 a year in dividends, interest, Social Security and distributions from publicly traded partnerships. They have $30,000 in deductions, including $20,000 for property tax and $5,000 for a donation.

This scenario has a person hauling in $200,000 and only gives $5000 in donations? People I know who earn $50K donate at least that. This stingy person can learn from the likes of Buffet, Gates (who was rightfully criticized for being ungenerous years ago), and Winfrey, IMO.

(Shaking my head at selfishness.)

 

[audreyh1]

I wonder if they ran the AMT scenario on that couple. And wouldn't they be paying taxes on some of their Social Security?

 

[RunningBum]

I wonder if this really gives the best overall return? I don't mind paying some taxes if it means I'm getting a better return on my investment, meaning more than offsetting the taxes. And I wouldn't base my buy/sell stock decisions only on past gains and losses. Sometimes that results in selling off a stock that will bounce back, or holding a stock beyond its prime.

 

[haha]

Here's another one.

Case II is a widow with a $166,000 income from dividends, bond coupons, a private pension and Social Security. Her federal tax bill: $261.

I do not believe this. I am single like this widow, have no earned income, no pension, modest social security, and sub $10,000 RMDs. Yet this year I expect to pay about $5000 federal tax as per Turbo-Tax, having taken some considerable tax losses that I got from badly timed gold equity investments though my overall trading has been positive. I've filed single since 2007, and 2007 through 2012 my average annual FIT paid was $7168.

I think the only way this wealthy widow could pay this low tax is have huge NOLs, and likely also huge capital gain losses. I could pay very low taxes too if I just saw to it that I lost money all the time. The other possible explanation is pure fabrication.

If anyone has actually accomplished this, please tell me how.

Ha

 

[Tyro]

I notice a large part of the strategy in this article is via munis, yet one of the comments by Forbes' own staff cautions:

Janet Novack, Forbes Staff 7 hours ago
There’s an excellent article on the dangers lurking in munis in the new Forbes Investment Guide.

 

[target2019]

I know of people who are in similar positions. You can't necessarily compare two tax situations and expect same results. I also suspect that people who regularly avoid income taxes are paying for tax advice which specifically addresses these issues.

 

[kmt1972]

I wonder if they ran the AMT scenario on that couple. And wouldn't they be paying taxes on some of their Social Security?

For 401K/IRA/SS I agree that one cannot avoid taxes on those assuming they are over the deductions/exemptions threshold. As for AMT, the AMT code explictly seperates out Capital Gains and Qualified Dividends for the 15%/0% rate before then applying the AMT 26%/28% on the remaining income. So if a person has lots of Munis, Qualified Dividends and then some other income that are below various deductions the tax.

 

[kmt1972]

This scenario has a person hauling in $200,000 and only gives $5000 in donations? People I know who earn $50K donate at least that. This stingy person can learn from the likes of Buffet, Gates (who was rightfully criticized for being ungenerous years ago), and Winfrey, IMO.

(Shaking my head at selfishness.)

Well donations should be what one feels conformtable with and not some mandated amount or else what is the difference between that and a tax. Our income is around $1 million and our donations is around $9K so I guess we are far worse than this person using your standards.

 

[nun]

IMHO, the article is a good argument for dividends to be taxed just like earned income. YMMV.

 

[gerntz]

IMO, there's a good argument that dividends + the tax rate of the company they come from be taxed at a combined maximum rate. If the company's rate is already high, no reason the person receiving the post-tax dividends should be taxed at all unless you believe in confiscation.

 

[gerntz]

If you're getting income from muni bonds, you are paying a "tax" in the rate difference between those & taxable bonds. Say munis pay 2% & taxables pay 3%, you're effectively paying a 33% tax on the muni interest.

 

[Independent]

I wonder if this really gives the best overall return? I don't mind paying some taxes if it means I'm getting a better return on my investment, meaning more than offsetting the taxes. And I wouldn't base my buy/sell stock decisions only on past gains and losses. Sometimes that results in selling off a stock that will bounce back, or holding a stock beyond its prime.

Right. Someone paying $17 in taxes is in a 10% marginal FIT bracket. Traditionally, the interest gap between taxable bonds and munis has been more than 10% of the interest (e.g. taxable bonds pay 6.0%, munis pay 4.5%).

I'm sure that "avoiding all taxes" is fun, but I'd prefer a higher after-tax income.

 

[kaneohe]

Here's another one.

I do not believe this. I am single like this widow, have no earned income, no pension, modest social security, and sub $10,000 RMDs. Yet this year I expect to pay about $5000 federal tax as per Turbo-Tax, having taken some considerable tax losses that I got from badly timed gold equity investments though my overall trading has been positive. I've filed single since 2007, and 2007 through 2012 my average annual FIT paid was $7168.

I think the only way this wealthy widow could pay this low tax is have huge NOLs, and likely also huge capital gain losses. I could pay very low taxes too if I just saw to it that I lost money all the time. The other possible explanation is pure fabrication.

If anyone has actually accomplished this, please tell me how.

Ha

see kmt's response above (about AMT)..............the key would seem to be to have huge muni interest which doesn't appear in the AGI/taxable income. This would force 85% of SS to be in the AGI but if the sum of this, CG/QDIV, etc. were small enough you could have 0 or very small tax.

 

[eytonxav]

If these examples are really valid, its a good poster child for why the tax code needs an overhaul and elimination of all these various avoidance schemes.

 

[traineeinvestor]

IMO, there's a good argument that dividends + the tax rate of the company they come from be taxed at a combined maximum rate. If the company's rate is already high, no reason the person receiving the post-tax dividends should be taxed at all unless you believe in confiscation.

+1

Some countries already adopt this system of only taxing each stream of income once. Leaving aside questions of fairness, it also encourages companies to distribute surplus cash to shareholders instead of hoarding it to avoid double taxation.

 

[Hamlet]

I'm pretty sure there are an awful lot of people actually reducing their after-tax returns to avoid taxes.

There is nothing like taxes to fuel the irrational in people.

Right. Someone paying $17 in taxes is in a 10% marginal FIT bracket. Traditionally, the interest gap between taxable bonds and munis has been more than 10% of the interest (e.g. taxable bonds pay 6.0%, munis pay 4.5%).

I'm sure that "avoiding all taxes" is fun, but I'd prefer a higher after-tax income.

 

[scrabbler1]

I wonder if this really gives the best overall return? I don't mind paying some taxes if it means I'm getting a better return on my investment, meaning more than offsetting the taxes.

Good point. After I ERed in 2008, I began reducing my muni bond fund holdings because their edge over taxable bond funds went down when my income tax bracket dropped from 25% to 15%. The higher after-tax return from taxable bond funds overtook that from the muni bond funds.

A few years ago, I was looking at my dad's income tax returns and noticed that he was getting a refund which matched the amount being withheld from his IRA's RMD. His federal IT liability was zero, so there was no point in having taxes withheld. He liked getting his tax refund, so the first obstacle was explaining to him why this was "bad" and why we should fix this. He understood my explanation so we then called his FA at Ameripise and I told her to stop withholding taxes from his RMD which she has since done.

 

[sheehs1]

IMHO, the article is a good argument for dividends to be taxed just like earned income. YMMV.

People forget that in order to have that dividend income, the original "earned" income was " taxed at ordinary income rates the FIRST time.

They also forget the dividend rate whether by design or not, was a way to encourage further investment of this already once taxed money, so that the government continued to "share" in it. Granted to a lesser degree but they still get a piece of it.

I don't agree that dividend income should be taxed at ordinary income rates. It doesn't really matter what I think however, since the government will do what it wants to do. But just like with everything else, if they change it, there may be "unintended" consequences perhaps.

 

[Midpack]

It didn't seem like there was enough detail on the first theoretical case to agree/disagree. And while they may have avoided taxes in the theoretical year, they may only be delaying taxes on the non-muni portion of their portfolio (arguably at higher rates in the future), though again that's hard to know with so little detail.

The individual and corporate tax code in the US is far too complex, needs to be simplified considerably, though I am not holding my breath until when/if we ever have public campaign financing (not holding my breath on that either).

 

[sheehs1]

Here's another one.

I do not believe this. I am single like this widow, have no earned income, no pension, modest social security, and sub $10,000 RMDs. Yet this year I expect to pay about $5000 federal tax as per Turbo-Tax, having taken some considerable tax losses that I got from badly timed gold equity investments though my overall trading has been positive. I've filed single since 2007, and 2007 through 2012 my average annual FIT paid was $7168.

I think the only way this wealthy widow could pay this low tax is have huge NOLs, and likely also huge capital gain losses. I could pay very low taxes too if I just saw to it that I lost money all the time. The other possible explanation is pure fabrication.

If anyone has actually accomplished this, please tell me how.

Ha

I tend to agree with Ha. Would really like to see a "real" return to know how this is achieved, especially with the AMT side of things.

 

[ESRwannabe]

Hmm, I'm going to get hit with a big tax bill next year.

My speculation in HPQ made me $37k in short term capital gains this year. I'll also have about $8k in dividends by the end of the year. This is in my taxable brokerage account.

I don't have anything that I want to sell for a capital loss. So, it is what it is. It can be hard to pay low taxes when you are making a profit.

 

[kaneohe]

I tend to agree with Ha. Would really like to see a "real" return to know how this is achieved, especially with the AMT side of things.

How about 10K SS, 40K LTCG/QDIV, 120K muni interest?

 

[audreyh1]

For 401K/IRA/SS I agree that one cannot avoid taxes on those assuming they are over the deductions/exemptions threshold. As for AMT, the AMT code explictly seperates out Capital Gains and Qualified Dividends for the 15%/0% rate before then applying the AMT 26%/28% on the remaining income. So if a person has lots of Munis, Qualified Dividends and then some other income that are below various deductions the tax.

That's why the "pays zero tax" doesn't ring true. If you have social security income, you'll probably be paying the AMT rate on 85% of it from dollar zero even if the rest of your income is from qualified dividends. Even though you don't pay AMT rates on qualified dividends, the total income (excluding muni income) determines when you start paying AMT and most deductions like property taxes don't apply under the AMT rules. And you also have to be careful the type of muni income to avoid AMT taxes on muni income as well.

But, I agree it can be quite low.