Make $126k, pay no Federal Income Tax in 2020?

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mmmodem
Posts: 1845
Joined: Thu May 20, 2010 1:22 pm

Make $126k, pay no Federal Income Tax in 2020?

Post by mmmodem » Tue Jan 14, 2020 10:32 am

In the same vein as this post from a couple years ago that I shamelessly copied. I updated the tax bracket for 2020 and made it more relevant to our situation.
viewtopic.php?f=2&t=239899#p3751945

Married Filing Jointly
4 children under 17
Single Income Household
No State Income Tax
  • $126,362 Household Income
    $(24,800) Standard Deduction
    $(19,500) Traditional 401(k) contribution
    $(7,100) HSA contribution via cafeteria plan
    $(5,000) Health Insurance Premium
    -------------------------------
    $69,962 Taxable Income

    $(1,975) $19,750 in 10% bracket
    $(6,025) $50,212 in 12% bracket
    $(8,000) Total Federal Tax Liability
    $8,000 Child Tax Credit
    ----------------------------------
    $(0) Federal Income Tax Due

    $(8,741) FICA *7.65%
    $(12,000) Roth IRA contribution
    $74,021 Total Net Income
1. Did I do the math correctly? Payroll is questioning why my W4 results in very low federal tax withholding. I used the value in box 3 after going through the IRS tax withholding estimator. It indicated my tax obligation is zero for 2020.
https://www.irs.gov/individuals/tax-wit ... -estimator

2. Assuming salary is $125k a year, itemized deductions of $30k and $3k capitol loss, what would be the recommended strategy to roll over a previous employer's traditional 401k to Roth IRA to maximize the 12% tax bracket?
I estimate our tax situation to be more like this:
  • $125,000 Salary
    $6,000 Interest & Dividends
    $13,850 Roth IRA Rollover
    -------------------------------------------
    $144,850 Household Income

    $(30,000) Itemized Deduction
    $(19,500) Traditional 401(k) contribution
    $(7,100) HSA contribution via cafeteria plan
    $(3,000) Tax Loss Harvest
    $(5,000) Health Insurance Premium
    -----------------------------------------
    $80,250 Taxable Income

    $(1,975) $19,750 in 10% bracket
    $(7,260) $60,500 in 12% bracket

    $(9,235) Total Federal Tax Liability
    $8,000 Child Tax Credit
    ----------------------------------------------
    $(1,235) Federal Income Tax Due

    $(8,637) FICA *7.65%
    $(12,000) Roth IRA contribution
    $85,378 Total Net Income
3. We plan to move to California sometime in the near future. We have over $300k in a 401k and won't be able to roll over everything piece meal. Should we rollover to the top of 22% bracket to take advantage of no state income tax? Up to 24% bracket? We have the funds to pay the taxes either way.

4. Did I completely mess up. :oops: We are actually rich, need to pay taxes, and forget about rolling over the 401k? :confused

edit1: left out filing status
edit2: Incorrect 12% tax bracket calculation
Last edited by mmmodem on Tue Jan 14, 2020 1:48 pm, edited 2 times in total.

michaeljc70
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Re: Make $142k, pay no Federal Income Tax in 2020?

Post by michaeljc70 » Tue Jan 14, 2020 10:51 am

How are you deducting health insurance premiums? Those (and other medical expenses) need to exceed 10% of AGI to be deductible. Unless you are self employed which it seems you are not.

Silk McCue
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Re: Make $142k, pay no Federal Income Tax in 2020?

Post by Silk McCue » Tue Jan 14, 2020 10:52 am

This is wrong.

$(4,890) $60,500 in 12% bracket -> Should be $60,500 *.12 = $7260.

Cheers

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mhc
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Re: Make $142k, pay no Federal Income Tax in 2020?

Post by mhc » Tue Jan 14, 2020 11:12 am

michaeljc70 wrote:
Tue Jan 14, 2020 10:51 am
How are you deducting health insurance premiums? Those (and other medical expenses) need to exceed 10% of AGI to be deductible. Unless you are self employed which it seems you are not.
I think premiums through a cafeteria plan come out pre-tax

michaeljc70
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Re: Make $142k, pay no Federal Income Tax in 2020?

Post by michaeljc70 » Tue Jan 14, 2020 11:14 am

mhc wrote:
Tue Jan 14, 2020 11:12 am
michaeljc70 wrote:
Tue Jan 14, 2020 10:51 am
How are you deducting health insurance premiums? Those (and other medical expenses) need to exceed 10% of AGI to be deductible. Unless you are self employed which it seems you are not.
I think premiums through a cafeteria plan come out pre-tax
Yes, you are right.

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neurosphere
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Re: Make $142k, pay no Federal Income Tax in 2020?

Post by neurosphere » Tue Jan 14, 2020 11:22 am

mmmodem wrote:
Tue Jan 14, 2020 10:32 am
Payroll is questioning why my W4 results in very low federal tax withholding.
Interesting. Are they trying to be helpful, and point it out in case you filled out the form incorrectly, in order to prevent a tax surprise? Or are they asking for proof because they believe you are lying in order to avoid taxation. :shock:

I'm curious what the employer's responsibility is. In the old days, there used to be a requirement to report W4 forms based on the number of allowances claimed. Then, I think that went away. I wonder what obligations there are with the new form, if any? :?:
If you have to ask "Is a Target Date fund right for me?", the answer is "Yes".

michaeljc70
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Re: Make $142k, pay no Federal Income Tax in 2020?

Post by michaeljc70 » Tue Jan 14, 2020 11:44 am

neurosphere wrote:
Tue Jan 14, 2020 11:22 am
mmmodem wrote:
Tue Jan 14, 2020 10:32 am
Payroll is questioning why my W4 results in very low federal tax withholding.
Interesting. Are they trying to be helpful, and point it out in case you filled out the form incorrectly, in order to prevent a tax surprise? Or are they asking for proof because they believe you are lying in order to avoid taxation. :shock:

I'm curious what the employer's responsibility is. In the old days, there used to be a requirement to report W4 forms based on the number of allowances claimed. Then, I think that went away. I wonder what obligations there are with the new form, if any? :?:
There are legal methods to reduce withholding. Making up the number of exemptions is not a legal way. Of course, if you way under withhold there may be penalties.

I don't think the employer has any responsibility to verify the W4 for accuracy (like you have as many exemptions as you claim).

https://www.irs.gov/publications/p505#e ... 1000194389

Alternative method of figuring withholding allowances.
You don’t have to use the Form W-4 worksheets if you use a more accurate method of figuring the number of withholding allowances.

The method you use must be based on withholding schedules, the tax rate schedules, and the 2019 Estimated Tax Worksheet in chapter 2. It must take into account only the items of income, adjustments to income, deductions, and tax credits that are taken into account on Form W-4.

You can use the number of withholding allowances determined under an alternative method rather than the number determined using the Form W-4 worksheets. You still must give your employer a Form W-4 claiming your withholding allowances.

cas
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Joined: Wed Apr 26, 2017 8:41 am

Re: Make $142k, pay no Federal Income Tax in 2020?

Post by cas » Tue Jan 14, 2020 11:48 am

mmmodem wrote:
Tue Jan 14, 2020 10:32 am

  • $125,000 Salary
    $6,000 Interest & Dividends
    $13,850 Roth IRA Rollover
    -------------------------------------------
    $144,850 Household Income

    $(30,000) Itemized Deduction
    $(19,500) Traditional 401(k) contribution
    $(7,100) HSA contribution via cafeteria plan
    $(3,000) Tax Loss Harvest
    $(5,000) Health Insurance Premium
    -----------------------------------------
    $80,250 Taxable Income
It doesn't make a lot of dollar difference, but note that the top of the 0% bracket for qualified dividends no longer matches the top of the 12% bracket for ordinary income (as of the 2018 tax law).

Google is telling me that, for 2020 MFJ, the top of the 12% ordinary income bracket is $80,250.
The top of the 0% bracket for qualified dividends is $80,000.

So, assuming
  • some of the dividends are qualified dividends
  • you specifically calibrated the Roth conversion to just hit the top of the 12% bracket for ordinary income
... you have the side effect of going into the 15% QD/LTCG bracket by $250. This means that you would pay a 27% marginal rate*** on the last $250 of Roth conversion. (12% on the last $250 worth of Roth conversion dollars themselves + 15% on the $250 worth of qualified dividend dollars the Roth conversion dollars pushed from the 0% QD/LTCG bracket to the 15% QD/LTCG bracket.)

As I said, no big implications in real dollars, but...since you said the goal was to maximize the Roth conversion you could do within the 12% bracket...

Disclaimer: I have no experience with the effects kids can have on things phasing in and out in taxes, so I can't spot odd marginal tax rates that might result from that. If you haven't modeled the proposed Roth conversion with a tax program/calculator, I would highly recommend doing so, just to make sure that no other unanticipated phase-in/phase-out effects specific to your personal situation pop up.

***If you aren't familiar with the 27% "shadow tax bracket" created by the interaction of tax brackets for ordinary income and the special tax brackets for qualified dividends and capital gains, this article discusses the concept, with graphics:

Michael Kitces, Navigating The Capital Gains Bump Zone: When Ordinary Income Crowds Out Favorable Capital Gains Rates
, January 2019
Last edited by cas on Tue Jan 14, 2020 11:51 am, edited 1 time in total.

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neurosphere
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Re: Make $142k, pay no Federal Income Tax in 2020?

Post by neurosphere » Tue Jan 14, 2020 11:50 am

michaeljc70 wrote:
Tue Jan 14, 2020 11:44 am
You don’t have to use the Form W-4 worksheets if you use a more accurate method of figuring the number of withholding allowances.

The method you use must be based on withholding schedules, the tax rate schedules, and the 2019 Estimated Tax Worksheet in chapter 2. It must take into account only the items of income, adjustments to income, deductions, and tax credits that are taken into account on Form W-4.

You can use the number of withholding allowances determined under an alternative method rather than the number determined using the Form W-4 worksheets. You still must give your employer a Form W-4 claiming your withholding allowances.
[/i]
But there are no longer any allowances in 2020. :wink:

But I suspect the rules are similar, in that any "alternate" method to fill out the form is ok as long as it's accurate. Which is why I'm curious why payroll got involved.

I suspect that if the OP calculates his actual estimated tax liability for 2020, they can put whatever numbers on the 2020 W4 necessary to achieve the correct withholding.

Topic Author
mmmodem
Posts: 1845
Joined: Thu May 20, 2010 1:22 pm

Re: Make $142k, pay no Federal Income Tax in 2020?

Post by mmmodem » Tue Jan 14, 2020 1:45 pm

Silk McCue wrote:
Tue Jan 14, 2020 10:52 am
This is wrong.

$(4,890) $60,500 in 12% bracket -> Should be $60,500 *.12 = $7260.

Cheers
Thank you Silk McCue. Looks like my copy and paste error in Excel. Hopefully, I have the mistake corrected and this looks a little more believable.
neurosphere wrote:
Tue Jan 14, 2020 11:22 am
mmmodem wrote:
Tue Jan 14, 2020 10:32 am
Payroll is questioning why my W4 results in very low federal tax withholding.
Interesting. Are they trying to be helpful, and point it out in case you filled out the form incorrectly, in order to prevent a tax surprise? Or are they asking for proof because they believe you are lying in order to avoid taxation. :shock:

I'm curious what the employer's responsibility is. In the old days, there used to be a requirement to report W4 forms based on the number of allowances claimed. Then, I think that went away. I wonder what obligations there are with the new form, if any? :?:
I called payroll after my 1st paycheck of the year showed a $497 federal tax withholding. At first, I thought my W4 form was not received in time for the first paycheck. However, I weeded through IRS Pub 15-T and even using the worst circumstances of a W4 filing single, no kids, and 0 in box 3, I came up some $50 short of what was withheld. They took more money than they should have. Payroll didn't ask for proof, they just remarked that the W4 I was claiming was unusual because it indicated very little withholding. Which of course made no sense because I am seeing over withholding. I give them the benefit of the doubt that they wanted to help prevent a tax surprise for me.
cas wrote:
Tue Jan 14, 2020 11:48 am
It doesn't make a lot of dollar difference, but note that the top of the 0% bracket for qualified dividends no longer matches the top of the 12% bracket for ordinary income (as of the 2018 tax law).

Google is telling me that, for 2020 MFJ, the top of the 12% ordinary income bracket is $80,250.
The top of the 0% bracket for qualified dividends is $80,000.

So, assuming
  • some of the dividends are qualified dividends
  • you specifically calibrated the Roth conversion to just hit the top of the 12% bracket for ordinary income
... you have the side effect of going into the 15% QD/LTCG bracket by $250. This means that you would pay a 27% marginal rate*** on the last $250 of Roth conversion. (12% on the last $250 worth of Roth conversion dollars themselves + 15% on the $250 worth of qualified dividend dollars the Roth conversion dollars pushed from the 0% QD/LTCG bracket to the 15% QD/LTCG bracket.)

As I said, no big implications in real dollars, but...since you said the goal was to maximize the Roth conversion you could do within the 12% bracket...

Disclaimer: I have no experience with the effects kids can have on things phasing in and out in taxes, so I can't spot odd marginal tax rates that might result from that. If you haven't modeled the proposed Roth conversion with a tax program/calculator, I would highly recommend doing so, just to make sure that no other unanticipated phase-in/phase-out effects specific to your personal situation pop up.

***If you aren't familiar with the 27% "shadow tax bracket" created by the interaction of tax brackets for ordinary income and the special tax brackets for qualified dividends and capital gains, this article discusses the concept, with graphics:

Michael Kitces, Navigating The Capital Gains Bump Zone: When Ordinary Income Crowds Out Favorable Capital Gains Rates
, January 2019
Thank you, cas. I am not aware of this. I will have to investigate further. That is quite the fine detail.

cas
Posts: 824
Joined: Wed Apr 26, 2017 8:41 am

Re: Make $142k, pay no Federal Income Tax in 2020?

Post by cas » Tue Jan 14, 2020 2:26 pm

mmmodem wrote:
Tue Jan 14, 2020 1:45 pm
cas wrote:
Tue Jan 14, 2020 11:48 am

***If you aren't familiar with the 27% "shadow tax bracket" created by the interaction of tax brackets for ordinary income and the special tax brackets for qualified dividends and capital gains, this article discusses the concept, with graphics:

Michael Kitces, Navigating The Capital Gains Bump Zone: When Ordinary Income Crowds Out Favorable Capital Gains Rates
, January 2019
Thank you, cas. I am not aware of this. I will have to investigate further. That is quite the fine detail.
It would become more of an issue if you did decide to push your Roth conversion up towards the top of the 22% bracket. At that point, the 27% "shadow" bracket wouldn't be just $250. It would be as wide as the value of your qualified dividends (plus any long term capital gains.)

So ... if I recall correctly, you said you had $6000 in interest and dividends. If $5000 of that was qualified dividends, then you would have a 27% "shadow" bracket that was $5000 wide, sitting in between your 12% and 22% brackets (and consuming $5000 worth of your nominal 12% bracket).

Even so, you might decide to consider a $5000 wide 27% marginal bracket just a "speed bump" to get through to the more advantageous 22% rate on the other side. But it is worthwhile knowing that the speed bump is there.

The article mentioned above has an example involving Roth conversions. Sometimes Kitces isn't the easiest reading, but he's usually quite thorough.

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