I love taxes, and by that I mean I love legally avoiding paying them. I have come up with a scenario of a hypothetical single tax filer with no kids that only have one income from their job, and they take the standard deduction. Said named individual is very passionate about achieving financial independence and retiring early (FIRE). In this scenario the individual’s creative frugal ways allow him to pay $0 in federal taxes in 2019.
If you are on the path to financial independence, and your situation is similar to this hypothetical individual then you too could pay $0 in federal taxes in 2019. The first step is estimating what your gross income is. Then you can calculate your adjusted gross income (AGI) by subtracting traditional 401K contributions and traditional individual retirement account (IRA) contributions. After you figure out your adjusted gross income you will see that you qualify for the retirement saver’s credit based on your contributions. It is because of that credit your new tax bill will be $0 based on your taxable income.
For my hypothetical single person, they have earned an annual combined gross income of $47,150. This is a pretty decent income for a single young person depending on where you live. Most likely this single worker fits into the category of still being young into their career
If we were to divide that annual gross income by 52 weeks in a year, then that would put our weekly gross income at $906.73 per week before deductions.
Furthermore, if we were to turn that weekly income into per hour pay based on a 40 hour work week then our hypothetical person would be making about $22.67 per hour.
Keep in mind that this person’s gross income not only includes wages from employment, but it also considers any interest, dividends, and other reportable income earned throughout the year. Their gross income does not yet take into account many different withholdings from their paychecks. Also keep in mind that this individual is highly driven to reach financial independence at a young age, and so they live a very optimized frugal lifestyle such as living with roommates, cooking their own food, and driving a low-cost vehicle, etc.
Traditional 401k And IRA Contributions
On their first day of eligibility at work, this hypothetical individual has been rigorously contributing to tax-advantaged individual retirement accounts. They know that in order to not owe any federal taxes at the end of the year, they must vastly reduce their taxable income.
For the 2019 tax year, An employee may elect to withhold and contribute up to $19,000 to an employer-sponsored 401k. This is exactly what our person did, and after the total deduction of $19,000 to their income, they know that it means that $19,000 of their income is not eligible to be taxed for federal income taxes. So as it stands, their taxable income now looks like it is $28,150.
In addition to the 401k deduction, our individual is able to contribute to a traditional IRA. For the 2019 tax year, an individual may elect to contribute up to $6,000 of their income into the traditional IRA. As you guessed it, this is exactly what our person did and because of it, their taxable income now looks like $22,150.
Adjusted Gross Income
The $22,150 of taxable income is known as adjusted gross income or AGI. There are other things that can reduce AGI further, but our hypothetical individual does not have any other deductions for simplicity sake.
It is important to note that our individual’s disposable income has been slashed down by $25,000. This is over half of their income and some would say impossible to live on. Through various ways of optimizing their single lifestyle, our individual can easily “survive” off of this amount of spending because they are fierce in their determination of financial independence. They also are lucky (or smart) enough to live in a low cost of living area.
Retirement Saver’s Credit
As a result of contributing so much money into traditional retirement accounts, our happy individual now has a very low AGI. Their new AGI is $22,150 and this makes them eligible for the Retirement Saver’s Credit. This credit is offered as an incentive for low-middle income Americans to contribute to their retirement.
The credit makes our individual’s contributions eligible for a 10% match up to $1,000. Being that it is a credit and not a deduction it is very useful. Our individual qualifies for the maximum credit of $1,000 off of their tax bill. If there was not a $1,000 limit, our individual’s credit would be $2,500 because they contributed $25,000 into tax-advantaged retirement accounts and would be eligible for a 10% match. $1,000 is just what though, but that’s not all, our individual also can take the standard deduction.
Being that AGI is now $22,150, in 2019 the standard deduction for a single filer is $12,200. Subtracting that deduction from our AGI leaves our individual with only $9,950 in taxable income. So they went from a gross income of $47,150 all the way down to a taxable income of only $9,950 and that is amazing. The tax structure in 2019 is a laddered tax meaning that income is taxed in brackets.
The first $9,700 of our individual’s income is taxed at 10% which leads to a tax of $970
The next $250 that is left is taxed at 12% which leads to a tax of $30
In total the two tax brackets add up to $1,000 even. This is where we bring in our retirement saver’s credit that wipes out the tax bill, leaving it to be $0.
Other Things To Keep In Mind
The $47,150 was not chosen as the gross income by accident. It was the maximum amount that would lead to a $0 tax bill in 2019 for our single filer assuming they were seeking to invest $25,000 of it. It also assumed that they had no other deductions that they could have taken. There are however other deductions that can be taken while still utilizing the standard deduction. Some examples:
- Student interest loan deduction
- Health savings account contributions
- Self-employment deductions
- Early withdrawal interest penalties
- Health insurance withheld
- Dental insurance withheld
- Life insurance withheld
The moral of the story is that you can earn more than $47,550 as a single filer taking the standard deduction with no kids and still end up not paying any money in federal taxes in 2019. If that sounds good to you, go forth and legally not pay any taxes in 2019!