In this post I will explain the basics on saving tax money based on my recent income tax research. Topics such as mortages, childs, and stocks are not covered since I don’t have them.

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tax brackets

The most basic concept is tax brackets, which determines the tax rate. For example, the 2017 (for filing in 2018 Apr) tax brackets are as follows.

Tax rate Married filing jointly Single
10% Up to $18,650 Up to $9,325
15% $18,651 to $75,900 $9,326 to $37,950
25% $75,901 to $153,100 $37,951 to $91,900
28% $153,101 to $233,350 $91,901 to $191,650
33% $233,351 to $416,700 $191,651 to $416,700
35% $416,701 to $470,700 $416,701 to $418,400
39.6% $470,701 or more $418,401 or more

Here the incomes are taxable incomes, not gross adjustable incomes.

Note that the tax rate is progressive, i.e., you are not taxed by a single rate. For example, if a single person’s taxable income is 100k, the first $9,325 is taxed at 10% rate, the next $37,950-$9,325=$28,625 is taxed at 15%, etc. This design ensures that you won’t end up with less money by earning more.

general strategy

Since the tax rate is quite high (at least 10%), it makes sense to lower the taxable income as much as possible. Pre-tax deductions include

  • standard deduction: $12.6k married filled jointly or $6.3k single
  • exemption: $4.05k per person
  • traditional retirement plans
    • traditional IRA: $5.5k max
    • traditional 401k: $18k max
    • 403k
    • etc
  • FSA: $2.6k max
  • itemized deduction
    • mortgage
    • charity
    • etc

Note that standard deduction and itemized deduction are mutually exclusive, only one of them can be claimed.

For retirement plans, 401k and 403k need to be opened by employers (you can also self-employ and file solo 401k) and IRA can be opened by individuals. There is another type of retirement plan with the prefix ‘Roth’, e.g., Roth IRA, Roth 401k. You need to pay tax when contributing to these plans.

The idea behind retirement plans is that you can either pay tax now (Roth) or after retirement (traditional). Thus strictly speaking, the traditional retirement plans are not ‘tax deductible’, but ‘tax deferred’. The benefit of the Roth plans is that any interest earned will not be taxed.

Also limitations apply to IRA

  • Traditional IRA is only available for individuals making under $60k or married couple under $95k
  • Roth IRA is only available to individuals making under $132k or married couple under $194k
  • The sum of traditional and Roth IRA is limited to $5.5k.

There are also after-tax credits which eliminate tax dollar by dollar, which is much better than tax deduction. They typically only apply to relatively low income families. Some relevant ones are as follows:

  • Child and Dependent Care Credit
  • Mortgage Tax Credit
  • American Opportunity Tax Credit (only for college tuitions)
  • Lifetime Learning Credit