How One Family Earns $100,000 But Pays just $11.25 in Taxes

The deadline for taxes in the United States is April 18^th this year. That’s coming up much more quickly than you think and if you haven’t done your taxes yet this year it’s nearly time. Before getting to collecting all of your tax forms and filing your paperwork, however, I’d like to introduce you to a family that’s about to do their taxes. We’ll call them the Savers: Mom Saver, Dad Saver, and Baby Saver.

Like many Americans the Savers don’t mind doing their share in paying the portion of taxes they owe. But they also know that good ole’ Uncle Sam offers them lots of incentives and programs with which they can save on their taxes. For 2015 the Savers decided they were going to make the most of these opportunities and see just how low they could get their taxable income and, thus, how little they could pay in federal taxes. Between the two of them Mom and Dad Saver earned a combined $100,000/year and they file jointly. Let’s dig in to see how they do on their savings.

The Standard Deduction

Itemizing their taxable income is too much work so the Savers opt to simply take the standard deduction. They don’t own a home yet, so they don’t have mortgage interest to deduct from their taxes (people who own property are much more likely to itemize their United States tax return because of the mortgage tax deduction). The standard deductions for Americans in 2015 look like this:

Filing Status	Deduction
Single	$6,300
Married filing separately	$6,300
Married filing jointly	$12,600
Head of household	$9,250

Because the Savers file under “Married – Jointly” their standard deduction is $12,600. That means the government looks at their $100,000 in income and when considering how much they owe in taxes calculates it at $87,400. Their upper tax bracket is 25% meaning cutting their income by the standard deduction saves them 25% of $12,600, or a total savings of $3,150. Not bad, and we’re just getting started!

The 401k

Through his workplace, Dad Saver receives a 401k option for investing. His employer offers 3% matching and Dad is no dummy; instead of losing $1,000,000 or more on his 401k he takes advantage of it! In addition to the 3% matching from the employer Dad maxes out all of his 401k for a total of $18,000 in tax deductible income. His company match doesn’t count towards the $18,000 personal limit established by the IRS, so all told the 401k reduces the family’s $87,400 in taxable income all the way down to $69,400 and bumps them from the 25% tax bracket to the 15% tax bracket. Their total amount saved on taxes? $7,650.

The Health Savings Account (HSA)

In addition to being offered a 401k through work Dad Saver takes advantage of the HSA his employer offers too. As the most powerful retirement account available to average Americans, Dad maxes it out to the tune of $6,750. That’s the maximum amount he’s allowed to put into it on the family health insurance plan he takes advantage of (the individual limit would be $3,350) and it pays off when it comes to taxes. The HSA reduces the Savers’ total taxable income to $62,650 and brings their tax savings up to nearly $10,000.

The 403b

While Dad Saver is off making a living in the private sector Mom Saver does her civic duty as a public servant. That lets her get access to a type of retirement account for public employees called a 403b. It works almost exactly like a 401k meaning it counts against your taxable income when you invest in it and it has a cap of $18,000 in 2015. By maxing it out Mom manages to drop her family’s taxable income down to $44,650 for a tax savings of $13,837.50.

The Student Loan Deduction

Mom and Dad Saver took on a bit of student loan debt while they were finishing their degrees. In 2015 they turbo-charged paying off that debt after reading a great article about getting their finances in order on the internet and wound up getting a notice that they had earned a student loan tax deduction for the interest they paid off. The maximum deduction they can earn in a year is $2,500 whether they filed independently or jointly but because of all that debt repayment they did earn the maximum and get to deduct the full $2,500. That means they’re down to $42,150.00 in taxable income and a savings total on their taxes of $14,462.50.

How did the Savers pay off so much of their student loans you ask? First they took advantage of the most powerful financial tool in the world (and it was free!). Then they cut some expenses. Finally they decided on turning debt repayment into a game or using the most powerful debt repayment method in the world to turn their debt into tax savings.

The Traditional IRA Deduction

In addition to maximizing their 401k, 403b, and HSA the Savers take advantage of yet another tax sheltered retirement account: the traditional IRA (not to be confused with the Roth IRA). The maximum an individual can contribute to their traditional IRA in a year is $5,500 but Mom and Dad each count as an individual so they can each sock away $5,500 giving them a total amount of IRA savings that’s $11,000. Baby Saver doesn’t get to participate because you have to earn income in order to qualify, but $11,000 still isn’t too bad. With their IRAs the Savers have managed to drop their total taxable income to $31,150, less than a third of their actual income! They’ve saved over $15,000 in taxes by taking advantage of all of these programs Uncle Sam offers them!

Even if the Savers hadn’t opened up their Traditional IRAs during 2015 they actually have until April 18^th, tax day, to open the accounts and put money into them. Even though it’s 2016 as they do their taxes Mom and Dad could put aside $11,000 (or whatever they could afford) and save themselves tons of tax dollars. They can even file taxes as though they have their Traditional IRAs opened and the government will give them the tax break even if they don’t have open IRAs provided the Savers open the accounts by April 18^th. Pretty crazy! The Bill Stark Blog still recommends the Roth IRA for most folks and you can only put away a combined total of $5,500 into your Roth/Traditional IRA.

The Dependent Deduction

In addition to marking the year they started taking an interest in their personal finance wellbeing, 2015 also marked another momentous occasion for the Savers: the birth of Baby Saver. In the government’s eyes that’s a dependent meaning a savings of $4,000 in taxable income. That translates to a savings of $600 in taxes and drops the Savers’ taxable income down to $27,150.

The impact of deductions

Mom and Dad Saver did pretty well with their use of deductions on their taxes. They took their $100,000 salary and managed to drop it all the way down to $27,150 in taxable income saving almost $18,000 in taxes and even dropping themselves down a full tax bracket. That’s pretty incredible, and by using programs offered directly by the government to incentivize certain behaviors (like saving for retirement) the Savers managed to do it all legally. While the deductions they took are nice, they’re not the only way to save on your taxes. There’s one more set of things to consider: tax credits.

While a tax deduction reduces your taxable income, a tax credit straight up reduces the amount of taxes you owe. For example, a $1,000 tax deduction means a savings in taxes of 15% or 25% of that total depending on your tax bracket ($150 or $250 respectively). A tax credit of $1,000 reduces your overall amount of taxes owed by $1,000. With taxable income of $27,150 the Savers owe $922.50 in taxes for the 10% portion of the tax bracket up to $9,225 in income and $2,688.75 for the 15% portion of the tax bracket on the rest of their income giving them a total of $3,611.25 owed in taxes. Let’s see which credits the Savers qualified for in 2015 and how that impacts their total tax burden.

Lifetime Learning Credit

In addition to her full-time job with the government Mom Saver has gone back to school part-time. To help her pay for these expenses the government offers her the Lifetime Learning Credit. The Savers just sneak under the income requirements of $100,000 when filing jointly and can get up to $2,000 off their taxes. Mom manages to qualify for the full amount meaning they knock their $3,611.25 in taxes owed down to $1,611.25.

Child and Dependent Care Credit

To help people with children go to school and work the government provides a tax credit for families who have to pay for child care (or for dependent care for elderly/incapacitated family members). The credit scales progressively meaning the more you earn, the less you can get from the credit. At $100,000 Mom and Dad’s adjusted gross income is too high, even with qualified deductions, to get more than the minimum amount of the credit. Still that’s $600 in taxes that they get to save which brings their billable total from $1,611.25 down to $1,011.25. They also note that unlike other credits, the Child and Dependent Care Credit doesn’t earn you money back from the government. Instead if it reduces your tax total into the negatives the government considers your tax burden to be $0 but doesn’t pay you any money for going negative.

The Child Tax Credit

In addition to getting an exemption from having Baby Saver in 2015, the Savers get a tax credit for their child of $1,000 every year until the child turns 16. Of course that credit starts to scale downwards once their combined income reaches more than $110,000 but because it’s not at that threshold yet the Savers are doing just fine and get to drop their taxes all the way down to just $11.25.

The Government Doesn’t Want You to Pay Taxes

Seriously! They offer so many savings, deductions, and credits that the Savers, a family that earns $100,000 a year managed to drop their total taxable amount of income from $100,000 down to $27,150 and their total amount of taxes owed from $16,587.50 all the way down to $11.25. That’s so freaking insane it makes you want to run out and hire a CPA right this second!

So what’s the moral of the story? If you’re the type of family that can afford to maximize every single tax advantaged savings vehicle that comes your way then you can save yourself a lot of money in taxes you don’t have to pay now. Critics will be quick to point out that eventually Mom and Dad Saver will have to pay taxes on most of their retirement accounts but only after years of tax-free investment growth and probably at a time when their tax bracket is lower than the 25% their $100,000 in income puts them in. More critics will point out that it’s unlikely many families can actually afford to live on the salary left over from $100,000 in income when you account for how much of it is locked into savings for retirement. But instead of second guessing how our hypothetical family manages to survive on $30,000ish each year while turbo charging their savings for later shouldn’t we ask ourselves, “Why are we willing to give up so much free money in order to spend?”

After all, if you’re not taking advantage of 100% of the tax advantaged savings vehicles provided to you by the government you’re essentially paying an extra fee for every dollar you spend. You pay sales tax on the item you’re purchasing and because you used your income to make that purchase the government takes its 10, 15, or 25 percent cut at the end of the year during tax season. You might have to make some of those purchases but in context of how much you COULD be saving you really have to ask yourself: do I need that thing, whatever it is, instead of maximizing my tax savings by putting away money for the future?