Never Pay Taxes Again

Some time ago I received an email from one of the big brokerage firms, titled “Savvy Year-End Tax Strategies.” It contained much advice on how to minimize taxes and how to reduce taxable income, such as “Consider contributing as much as you can to a 401(k)” and “Be careful when selling highly appreciated assets, such as stocks, land, fine art, precious metals, or antiques.”

This might be considered good advice by some, but I just call it, “Boring!”

Benjamin Franklin once wrote that nothing is certain except death and taxes. I beg to differ. I personally expect to never pay taxes again, legally and respectfully.

Perhaps you would like to do the same?

How to Pay Zero Taxes

There are many reasons to reduce or eliminate taxes. Some may have political, moral, or philosophical reasons for doing so. Maybe you don’t want to pay for wars, for example. But the reason that is strongest for me is also the most straight forward: If you are able to pay zero taxes, you don’t need to earn or save as much to live well.

[A brief aside: if you do have to pay some taxes, be sure to get a FREE vacation out of it!

Hint: try the generous welcome bonus on the Chase Sapphire Preferred card.]

Let’s use our example to make this clear.

Over the past 7 years, we have had taxable income of about $100,000/year and paid close to $0 in income taxes.

During that time, we have lived extremely well, spending an average of $75,000/year. But if we were chasing the normal American dream, working hard to advance our careers and grow our salaries, how much job-related income would we need to afford our same standard of living? $100,000? $125,000?

Try closer to $210,000, paying as much as $75,000 in taxes for the privilege (nearly our entire current cost of living!)

Paying zero taxes has its rewards.

So how do we eliminate taxes? All we need to do is follow 4 simple rules:

Choose leisure over labor

Live well for less

Leverage Roth IRA Conversions

Harvest Capital Losses AND Capital Gains

Choose Leisure Over Labor

The tax laws in the US target people who work for a living. If you get a paycheck, the US government classifies that paycheck as Earned Income, with special payroll taxes just for you. This is one part of the reason that Warren Buffett says his secretary pays more tax than he does. Social Security and Medicare taxes are only applied to Earned Income, 15.3% tax in total for most people.

The only way to avoid paying these taxes is to not work. Now leisure comes with an added bonus. I intend to never have earned income again, completely eliminating this tax.

Live Well For Less

The more a person or family spends a year, the more likely they will be required to pay income taxes due to the graduated tax brackets that exist in the US and many other countries. More spending = more income = more taxes.

Using the 2019 tax rules, a married couple can earn up to $24,400 a year without paying tax. This is because the government allows us a standard deduction of $24,400. Other deductions can be applied, such as for 401k contributions which reduce taxable income / increase the amount of tax-free income. (That advice from the big brokerage firm hit the spot on this one.)

Once income and spending exceed this level, taxes must be paid. Unless…

Unless that income comes from qualified dividends or long-term capital gains. In this case, a married couple can have $24,400 a year in income AND $78,750 in investment income, TAX-FREE (if that isn’t a strong signal to not work, I don’t know what is.)

(The standard deduction & income tax brackets and capital gains tax brackets are increased every year with inflation or some arbitrary level decided by Congress. Check links for the latest numbers.)

If income and spending are kept below these levels then we can avoid capital gains tax.

But wait, there’s more

Leverage Roth IRA Conversions – the Ultimate Early Retirement Tax Strategy

If we follow normal tax advice during our working days, we will retire early with a 401k or IRA or two. Except under special rules, this money can’t be spent until we turn 59.5, upon which it is taxed. But there is a way to avoid this, by converting it to a Roth IRA. Withdrawals from a Roth IRA are tax-free for life.

Once we’ve chosen leisure over labor, we can convert our 401ks and IRAs to a Roth IRA, a small amount each year. Any dollars converted to a Roth are considered income, but we can offset this with the $24,400 standard deduction. This is why we always contributed to Traditional IRAs while working, and never to a Roth (which seems to be a big controversy.)

Other income sources can contribute to this $24,400 limit, such as interest on bonds, rental income, short term capital gains, and earned income. Some deductions can also be made, such as capital losses and HSA contributions (a common option for people buying health insurance through the new government exchanges under the ACA.)

We reduce taxable income and pay zero taxes on the Traditional 401k / IRA contributions. We pay zero taxes on the Roth conversion. And we pay zero taxes on any growth within the Roth.

Harvest Capital Losses AND Capital Gains

Harvesting Capital Losses is a common practice. If you sold a stock for less than what you paid for it, you’ve had a capital loss. This loss can be used to offset capital gains and, if it is big enough, even up to $3,000 per year of Earned Income. There is a special rule for Wash Sales that needs to be watched out for, but the Mad Fientist wrote a great article about harvesting capital losses that can guide us.

For stocks that have gone up in value, normally taxes must be paid on the gains. But… not if those gains and total taxable income are less than $78,750 (again, 2019 values, MFJ. – latest numbers here.)

In our own case, if we had investment income of $40,000 per year from Qualified Dividends and Long-term Capital Gains, then we have an extra $38,750 in tax-free capital gains to play with. Why not sell some extra stock, locking in that $38,750 gain, and immediately buy it back to raise our basis.

For example, let’s say we bought some of the VTI ETF over 1-year ago for $50,000, and it is now worth $88,750. It must be over 1 year ago in order to be considered a Long Term Capital Gain, an important time frame. Short Term Capital Gains are taxed at the normal marginal rate. Our basis in the stock is $50,000, with a $38,750 long term gain. When we sell it, we will pay NO TAX since we are keeping our total investment income below $78,750 (which also includes our qualified dividend income.) When we buy the VTI ETF back, our basis is now $88,750. The gain is locked in tax-free, forever.

For even more detail, I’ve written a Tax Gain Harvesting Template, with a step-by-step example of how we harvest capital gains. Enter your info here and I’ll email it to you.





Conclusions

Do you want to pay zero tax? Can you too Never Pay Taxes Again?

Following these 4 simple rules, it is possible for any US Resident to reduce taxable income and avoid paying taxes.

Choose leisure over labor

Live well for less

Leverage Roth IRA Conversions

Harvest Capital Losses AND Capital Gains

Maybe following these tax strategies will help you retire earlier and live better.

Never Pay Taxes Again!

—

A key part of our tax optimization is being able to quickly and efficiently view our full financial and tax picture. Personal Capital is a great FREE online financial management tool. Give it a try

Update (1):

One item to be careful of is new with the Affordable Care Act. It is possible for an early retiree to get massive health insurance subsidies, as long as income is less than 400% of the Federal Poverty Level ($83,120 for a family of 3 in 2019 – latest numbers here.) At our $75k per year spending level, we qualify for several thousand dollars of assistance. Being aware of this threshold is important when deciding size of a Roth IRA Conversion or Capital Gain Harvest.

Read an in-depth review in our post on the Affordable Care Act and its tax implications.

Update (2):

It is one thing to understand the theory, and another to see it in practice. Check out our actual tax returns from 2013, 2014, 2015, 2016, 2017, & 2018. Or just view the summary, 6 Years of (Nearly) Income Tax Free Living.

Update (3):

If you have to pay some taxes, be sure to get a FREE vacation out of it! See how Uncle Sam paid for our trip to Hawaii.

A personal favorite card for getting free vacations is the Chase Sapphire Preferred.

Update (4):

Be sure to explore the other posts from the Never Pay Taxes Again series:

A special note:

Taxes are used for many useful and good purposes for the collective good, such as building roads, the filming of Sesame Street, and helping the disadvantaged. Isn’t it part of our moral obligation to help pay for these things?

I believe this is true, although it isn’t necessary to pay it annually. The taxes we paid during our working years were many, disproportionate to our use of roads (we bike and walk instead of drive) or our viewing of Sesame Street (we don’t own or watch TV.)

When it comes to helping others, there are many ways to help. The government helps in some ways, but other organizations do as well, more so even. Those organizations are very receptive to donations of both time and money. I encourage the giving of both.

As an added bonus, donations of cash or capital assets are tax-deductible :) And the donation of appreciated assets eliminates all capital gains taxes for both parties. Win-win. If this sounds intriguing, check out a post by JL Collins about making the most of your donations, How to Give Like a Billionaire.

Last updated: November 15, 2019