2019 was our 7th full year of this thing we do. It’s been an incredible ride – we’ve traveled, adventured, and procreated, with the best yet to come.
We’ve also done a fair amount of tax optimization, paying little tax each year while taking steps to minimize future taxes. How effective have we been with our tax optimization strategery?
Do these optimization efforts actually work, or is this just fantasy? (Caught in a landslide, no escape from reality…)
These past 7 years I’ve worked to minimize our current and future tax burdens, legally and respectfully. Roth conversions, Capital Gain Harvesting, zero-tax Roth contributions, and geographic arbitrage (Foreign Earned Income) are all part of the tax optimization arsenal.
We’ve paid a small amount of tax on occasion, sure, but it helps to look at total tax burden as a matter of perspective.
Even with incomes of $100,000+ per year, our income tax bills have been fairly reasonable:
2013: $0 on $91,752
2014: $0 on $95,654
2015: -$5 on $102,663
2016: $1 on $101,519
2017: $0 on $109,140
2018: $1,187 on $136,866
2019: $10,288 on $206,113
Total: $11,471on $843,707 (1.4% effective tax rate)
Not bad!
Roth IRA Conversions
A Roth IRA conversion is the process of moving $ from a Traditional IRA to a Roth IRA, a taxable event. However, the Standard Deduction gives everybody some amount of 0% tax bracket. If the Roth conversion is smaller than total deductions…. it is tax free.
We have enjoyed these tax-free conversions to the sum of $36,511.
2013: $12,028
2014: $5,744
2015: $0
2016: $6,039
2017: $12,700
2018: $0
2019: $0
Total: $36,511
Good news! The Roth conversions from 2013 & 2014 now meet the 5-year seasoning rule. We can withdraw that $17,772 at any time, tax free and penalty free (but we won’t.) Still, always nice to have the option.
Foreign Earned Income
Because we enjoy life in places outside the United States we are able to claim the Foreign Earned Income Exclusion, paying zero US income tax on any earned income we happen to make.
2017: $45,700 of foreign earned income saving $5,926 in tax
2018: $57,775 of foreign earned income saving $6,552 in tax
2019: $52,480 of foreign earned income saving $5,909 in tax
Total foreign earned income: $155,955
Total tax: $0
Total tax savings: $18,387
Roth IRA Contributions
Because we’ve earned some income via blogging these past few years, we’ve been able to make normal Roth IRA contributions (US income only.)
Additionally, business income can be contributed to a Roth solo 401k (even while using the FEIE.)
Without this income we could increase the size of our Roth IRA conversions, resulting in the same taxable income and same $0 tax bill. In that regard, earning income hurts our long term battle with the RMD.
In total, we have been able to contribute $126,025 to Roth accounts over the past 7 years. If need be, these contributions can be withdrawn at any time, completely tax-free and penalty free. (Roth 401k would first need to be rolled over to a Roth IRA.)
2013: $0
2014: $1,846
2015: $29,000
2016: $29,000
2017: $22,574
2018: $24,285
2019: $19,320
Total: $126,025
The beauty of these Roth accounts is that we’ve paid exactly zero taxes on any of these dollars, and now they will grow tax-free forever.
It’s interesting because the value of our Roth accounts before we “retired” was exactly $0.
Capital Gain Harvesting
Since the stock market has been generally headed northward these past 7 years, we have no shortage of capital gains to harvest. Without going into great detail, this basically means to sell a stock that has increased in value and then buy it back with increased basis. This is a taxable event, but with a tax rate of 0% it just functions as a basis reset.
If you want a real-world example of harvesting a capital gain, I’ve written a template based on the trades I executed in December 2016. Fill out this form and I’ll email it to you.
Over the last 7 years, I’ve harvested $274,316 in long-term capital gains.
$175,452 of this was done completely tax-free. If I had done this while working, we would have been taxed 15% or more with a tax bill of $26k+. Instead, we get to keep that money (and future growth thereof) for our own use.
The remaining $98,864 was taxed at 15%. This was done intentionally to avoid paying 18-22% later (or worse, paying $12,000 extra for going over the ACA subsidy cliff.)
With this higher basis, I’ve also increased the likelihood of being able to harvest a capital loss in the future if that is beneficial.
2013: $44,197
2014: $46,725
2015: $23,737
2016: $28,800
2017: $3,748
2018: $25,850
2019: $101,259
Total: $274,316
Any future growth would still be subject to taxation if/when we sell, but we can always harvest more gains next year.
Self-Employment Taxes
No review of tax optimization would be complete without mentioning Self-Employment taxes. All blog income is self-employment income, which is taxed at 15.3% (or slightly lower since half is deductible.) People who work a W2 job pay a similar tax, with the employee paying half and the employer paying the other half.
So… because we violated the 1st Principle of the Never Pay Taxes Again philosophy (Choose Leisure over Labor) we have to pay this “tax.”
2013: $0
2014: $281
2015: $5,146
2016: $3,965
2017: $7,644
2018: $9,663
2019: $7,979
Total: $34,678
Normally a tax is a tax, you pay it and the money is gone forever. But these payroll taxes are a little different… every $64.26 we pay in SE taxes increases the amount of Social Security income we will receive by $0.48 ($0.32 for me and $0.16 for spousal benefit.) Our $34,678 paid to date will give us an extra inflation-adjusted $259/month in about 17 years. That’s nothing to sneeze at!
In other words, this is more like a (involuntary) annuity payment than a tax, as all of this money will be returned to us. (For more details, I calculated the ROI here.)
Summary
In 7 years, we were able to harvest capital gains of $274,316, convert $36,511 of our Traditional IRA to a Roth IRA, and add $126,0205 to Roth accounts. We’ve also earned $155,955 of foreign income.
This was all done nearly income tax-free (1.4% effective tax rate), and growth on Roth IRAs will be tax-free forever. Sprinkle in a little SE taxes and corresponding higher Social Security income, and this tax deal is still pretty sweet.
Well, what do you know! This stuff works!
For more details, here are our complete tax returns for the past 7 years: 2013, 2014, 2015, 2016, 2017, 2018, & 2019.
Have you had success with early retirement tax optimization?
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2015 is my favorite year. By 2018 you clearly started losing your touch and by 2019 the wheels starting coming off. I hope to see you get back on track in 2020.
Just kidding, I would take 1.4% any day.
Take care,
Max
I’ve definitely been slacking :)
Strangely enough for 2020 we’ll be getting something like $7,400 in tax credits with 2 Child Tax Credits and the CARES Act stimulus so it will be hard to pay any income tax.
Great content! I heard if income is below 72,000$/year, no tax on earned dividend. I m planning to live on dividend on retirement.
Do you have any idea/tax advise for people coming from Europe? (Can soemthing similar be done? Any advice? or any good websites? or EU advisors on tax for FIRE/early retirement.
I don’t know the full answer here, but because social taxes typically apply to investment income (at least for the European countries I’ve looked at) it isn’t possible to get to near zero tax rates. However, if you include US health insurance premiums in total taxes paid a US/Europe comparison can look very similar.
Also, European countries don’t consider you a tax resident if you move to another country, whereas the US taxes its citizens on worldwide income no matter where they live.
Hi Jeremy,
I hope you and your families both abroad and stateside are safe and managing this long covid 19 siege well.
I have been a reader and fan of your blog from its inception year and certainly benefited from your brilliant strategies and experiences on your journey toward and on this FI path. THANK YOU, BELATEDLY!
Thank you
Serious goals right here!! Truly appreciate you sharing all the numbers.
Are there any readers out there who are dual US/Canadian citizens who worked in the US, opened an IRA and 401k, moved to Canada, and successfully converted to a Roth while up in Canada?
From the research I’ve found, it seems my dreams of doing GCC Roth conversions are not feasible up here. Canada and the US have a tax treaty yet it seems like there are many challenges facing dual citizens now living in Canada.
Would love to hear from any dual citizens out there!
Hi Court,
I’m a dual US/Canadian citizen living in Canada with an IRA in the US. I haven’t done a Roth conversion yet, but was thinking of doing one this year.
What is the research you’re finding that says it’s not feasible? Thanks!
Love the Queen-bohemian-rhapsody reference, took me a second to recall why that was so familiar. RIP Freddy.
Pretty amazing tax optimization there, GCC. Kudos.
So, forgive my ignorance here, but it seems to me a big part of your success depends heavily on after-tax investments made while you were working. I would think most readers would have their money tied up in pretax 401k/503b/457 accounts which is my situation. I have some funds in post tax retirement accts and a sliver in Roth. I guess the main goals for such folks will be to have enough post tax income to get the bracket as low as possible so that taxes will be low for eventual 401k/503b/457 withdrawals. I have to revisit your “401k too big?” post I vaguely recall from earlier. I am in a high tax bracket now though so contributing to post tax accts is cringeworthy.
For working stiffs like me, isnt the best option still to max out all pretax stuff and backdoor Roth convert when able?
For most employees pre-tax account contributions are limited to ~19k 401k and ~6k IRA. If you want to retire early, it typically requires saving more than $25k/year/person so inevitably there are investments in taxable accounts. Pre-tax saving still comes first, but it is both not either/or.
For somebody retiring with most of their savings in pre-tax accounts, a common strategy is to build a Roth conversion ladder – fill at least the 0% tax bracket (standard deduction) and as much of 10% and 12% brackets as needed to cover 1 year of spending. This can then be withdrawn tax and penalty free in 4-5 years. (Requires 5 years of spending in a taxable account to start.) Starting at age 59.5 you can just access the Traditional funds directly.
Wait, are you sure that Roth conversions can be withdrawn penalty-free after 5 years of seasoning? The IRS says you have to be over 59.5 years of age, in addition to the 5 years of seasoning (see Figure 2-1 for a quick summary –
https://www.irs.gov/publications/p590b#en_US_2019_publink1000231061) What am I missing here?
If you are age 59.5+ then there is no reason to wait at all – you can withdraw the conversion funds immediately, penalty-free.
Figure 2-1 is for qualified distributions. Look at the box in the lower right hand corner:
“The portion of the distribution allocable to earnings may be subject to tax and it may be subject to the 10% additional tax.”
None of a seasoned Roth conversion is earnings and you already paid tax on the conversion (also called a conversion contribution) even if the rate was 0%.
Contributions and seasoned Roth conversions can be withdrawn any time – see ordering rules for distributions:
First, withdraw regular contributions – the $6k/year or so that you contributed over the years.
Next, withdraw Roth conversions on a FIFO basis.
Last, withdraw earnings – now the qualified distribution rules apply, including the age test.
Awesome. Thanks for sharing.
My pleasure
This is my favorite of all the stuff you write about. You are a wizard, Sir!
You are too kind.
Hi, great website.
According to your tax calculator I have up to 21,000 that I can capital gains harvest. I did a Roth conversion of $19,600. Used H&R Block but not allowing me to do this. Talked to an accountant there and he said It’s not possible. Are most other CPAs familiar with this loophole?
What specifically is not possible?
Roth conversions and Capital gain harvests both had to be finished by 12/31/2020 for tax year 2020.
Great job! Fascinating stuff. What was the tax situation in Taiwan for the blog income? I taught English there in the late aughts. I remember the FEIE being great and the local taxes being really low – maybe 3%? including healthcare?!
Taiwan is a territorial tax country – they don’t tax income sourced from outside their borders unless worldwide income exceeds $200k or so.
Company tax was paid on dividends you received but, unlike withholding tax such as on wages, the company tax was not credited to you.
Year Div Rate Tax
2013 28,139 35% 9,849
2014 33,788 35% 11,826
2015 36,760 35% 12,866
2016 34,199 35% 11,970
2017 36,043 35% 12,615
2018 37,197 21% 7,811
2019 39,657 21% 8,328
Tot 245,783 31% 75,264
Total: $11,471 + $75,264 = $86,735 on $843,707 (10.28% effective tax rate)
Yes, company tax was paid on dividends, but SP500 companies pay only 1/3 to 1/2 the marginal tax rate so it’s somewhat lower than calculated here.
“SP500 companies pay only 1/3 to 1/2 the marginal tax rate”:
I could not find useful reference to other than flat USA corporate tax rates for the period. Can you help? I imagine active company owners would be interested.
In haste to post, I forgot to gross-up:
Year Div Rate Profit Tax
2013 28,139 35% 43,291 15,152
2014 33,788 35% 51,982 18,194
2015 36,760 35% 56,554 19,794
2016 34,199 35% 52,614 18,415
2017 36,043 35% 55,451 19,408
2018 37,197 21% 47,085 9,888
2019 39,657 21% 50,199 10,542
Tot 245,783 31% 357,174 111,391
Total: ($11,471 + $111,391) = $122,862 on ($843,707 + $111,391) = 955,099 (11.66% effective tax rate)
‘Under current law, state and local income taxes are fully deductible for corporations. As such, the effective statutory tax rate for each state is lower than the “headline” tax rate. Four states (Alabama, Iowa, Louisiana, and Missouri) also allow corporations to deduct some portion of their federal tax liability against their state liability, reducing the effective statutory rate even further.’
‘Combined with the federal rate of 21 percent, corporations face marginal rates from 21 percent in states with no corporate income tax to as high as 29.6 percent in Iowa, where the corporate tax rate is 12 percent. The weighted average (by population) combined corporate income tax rate in the United States under current law is 25.7 percent.’
https://taxfoundation.org/us-corporate-income-tax-more-competitive/
I don’t know of a way to see it in aggregate, but the trailing 12-month effective tax rate of 3 of the biggest companies in the SP500 is:
MSFT – 11.4%
AAPL – 14.7%
WMT – 24%
How effective and statutory tax rate difference is effected:
https://itep.org/corporate-tax-avoidance-in-the-first-year-of-the-trump-tax-law/#how
* “accelerated depreciation”
* “excess stock-option tax benefits”
* research, exploration, …
Understanding Apple’s Taxes:
https://fortune.com/2017/10/31/trump-tax-reform-apple-multinational-companies/
‘The answers to both questions lie in the rules that that allow foreign income to be deferred or excluded from U.S. tax. The U.S. is one of the few nations that deploys a “worldwide” tax regime. As a matter of policy, the Treasury imposes our domestic rate of 35% on profits earned abroad as well as earnings generated at home. The U.S. grants a credit for taxes paid to foreign governments; hence, multinationals owe the difference between the local tax and the U.S. levy of 35%, which is extremely high by global standards. (By contrast, multinationals based in most industrialized countries pay tax only in the nation where they generate the earnings, with no additional tax due in their home country.)’
‘But the U.S. code provides ample room for sheltering and avoiding taxes on foreign income, a major reason it needs an overhaul. The rules essentially divide foreign profits into three categories. One bucket of profits is more or less taxed at the full rate of 35%. On a second bucket, the multinational can defer paying the U.S. tax due. And a third category is excluded from all U.S. taxation, amounting to corporate America’s biggest loophole.’
‘It’s the third category that amounts to a big tax break, and explains why Apple’s effective rate is well below the statutory 35%. To be frank, I didn’t know it existed until conducting this analysis with Meyer’s help. Roughly speaking, the other half of that $37 billion in foreign earnings (after subtracting the $4 billion in interest) was also active income, generated from making and selling things. The U.S. GAAP financial accounting rules stipulate that if a multinational either reinvests earnings from operations to grow its business, or intends to do so in the future, it’s required to neither pay U.S. tax on those profits in cash, nor to accrue a tax expense for the future that lowers net income. However, if its plans change, and multinational decides that it will eventually bring those profits back, it has accrue U.S. tax on that income.’
USA did / still taxes world wide corporate earnings but did not tax earnings ‘to be reinvested ex-USA’ and does not double tax ex-USA earnings?
A USA recipient of an USA multi-national dividend has paid ex-USA corporate tax on the ex-USA earnings and USA corporate tax on the world wide earnings less the ex-USA corporate tax paid?
Thus the USA recipient pays the maximum of the ex-USA corporate rate or the USA corporate rate?
Although the effective USA rate might be less than the statutory rate of 21%, after including ex-USA taxes, at least 21% corporate tax has been paid on earnings used to pay dividends?
Is that correct?
A worked example of ‘Table 1 Taxation of Foreign-Source Income of US Multi-nationals:
https://www.taxpolicycenter.org/briefing-book/how-does-current-system-international-taxation-work
USA taxes companies world income but at less than:
(USA_company_tax_rate times world_income) less ex-USA_tax_credits.
Thanks for the links, I’ll read through them this week. Sounds like I have this wrong
I always enjoy these posts, and I always learn something. I had no idea your SE taxes added to SS – very nice!
The ROI is not great, but acceptable.
Great to see real-life examples of Roth conversions. We’re thinking of starting that this year now that we’re in a lower tax bracket and have some bandwidth to focus on this.
Hi Jeremy. I always enjoy reading your contents more than any other FIRE bloggers I follow. I find them very informative and useful as I personally encounter these questions in journey to FIRE. One questions I do wonder is how do you transfer cash flow from US to Taiwan without fees. I have been researching this as we are planning to move to Taipei as well when we reach our savings goal, but haven’t found a good way to withdraw US passive income fee free in foreign countries. Anything you can share would be great. Thanks!
I just use the ATM. This has no “fees” but loses about 1% through the Visa currency exchange network.
Details in this post: The International ATM Bonanza
Thanks for the informative post. But I don’t understand how your Roth IRA conversions were tax free in those four years when the least you made was $91k. The 0% tax bracket is far below that, no?
Standard deduction is $24.4k in 2019 for MFJ. With no other ordinary income, we could convert at least that much to Roth without tax.
Thanks so much for this material. I quit my USA job a decade ago and moved to Asia. Since my new foreign company did not organize a qualified 401(k) pension for Americans I have not been able to make tax-advantaged contributions to retirement savings other than to a Roth IRA (at age 52 I can contribute $6500 a year there). Otherwise, my foreign Provident Fund pension and my managed investment account and the VTSAX fund I started recently are all just vanilla investment funds from a tax standpoint. At this stage I would say that only 35% of my retirement savings are tax-advantaged. I would love to find other ways to optimize under suboptimal circumstances. Grateful for any thoughts you might have.
Have you looked into forming an s-corp to reduce SE taxes? A blogger should only be making $20K ;-) and the rest of the income should be pass-through.
Sure. Alas, pass-through income is not “earned income” and therefore cannot be excluded with the FEIE.
So I increase my costs by $1k/year to save $3k in SE taxes but pay $3k in income taxes. At least with the SE taxes I get a higher SS income down the road.
Best option (if I had no intention of returning to the US) would be to create a HK or Belize corporation.
Makes sense. Gotta keep those options open.
Is it also the case that the SE taxes are necessary to make solo 401k contributions?
Is the business income considered earned in the US? As you mentioned regular Roth IRA contributions need to be US earned income, does the solo 401k have the same restriction?
See this.
Hi, thanks a ton for these detailed posts, we always have something to learn. We plan to be financially independent, starting 2021. Looking at living in France (and becoming resident there), thereon. We have a tax question. If we are living in France on the following: $10K in dividends from US ETFs and stock, and $20K in capital gains accrued from selling US ETFs and stock (from total proceeds of $40K stock), held long-term, more than 2 years, in a US brokerage account. Do we pay double taxes (US and French) on the dividends + cap gains? The dividends + cap gains are not classified as “foreign earned income”. Is there a foreign tax credit, and how does that work? We are both US citizens. We know you folks are not French residents, but thought we’d go ahead and ask. Thanks … and cheers. :)
You will pay taxes in France on worldwide income. You will get a Foreign Tax Credit on your US taxes for any taxes paid to non-US governments.
I am REALLY starting to set aside retirement money and wanted to ask this question. With me being 54, and assuming that I wait until I can draw social security before I fully retire, so much of the investments that I will be drawing will be principal. Should I follow the FI community and put as much money as I can first in tax-sheltered accounts and then other places (Roth, simple investment account, etc)?
Thanks much!
If tax sheltered accounts will save you a higher tax rate now than you would pay in the future, yes. Else, no.