t1larg.tax-forms.t1largIt is that time of year again. Time to pay the tax man. At least for most people.

For the past two years we have shared our tax returns (2013, 2014), showing investment income of nearly $100,000 and a Federal Income Tax bill of $0.

This year is a little different because we violated Principle #1, Choose Leisure Over Labor, and this little blog accidentally earned a few bucks. Apparently I’m a business owner now. While that opens up all kinds of interesting tax opportunities, which I certainly capitalized on, having earned income changes the game a bit.

So earlier this year I shared how International nomads like us can have earned income over $100,000 while still paying zero Federal Income Tax. Which is pretty cool.

But you are probably thinking, “Yeah, yeah, they earned $100k and paid zero income tax. Again…” *yawn*

I agree, that is sooo 2013. Which is why this year, I had the IRS pay us.

Using actual tax documents, let’s go through line by line and figure out how.


Income in 2015 came from multiple sources. Multiple streams of income!

We received interest from a savings account, a seller financed mortgage, and tax-free municipal bonds.

Long term capital gains were realized while rebalancing the portfolio to our target asset allocation.

Dividend income was up 9% over 2014 and 30% over 2013, with zero effort on our part. Thank you business leaders of the world!

And still a complete shock to me, this little blog earned nearly $100/day. Thank you!

Filling out the 1040 Form:

Interest (Line 8a): $5,747
Tax-free Municipal Bond Interest (Line 8b): $1,335
Qualified Dividends (Line 9b): $33,967
Non-qualified Dividends (Included on Line 9a): $2,793
Blog profit (Line 12): $36,419
Capital gain (Line 13): $23,737
Total income (Line 22): $102,663

2015 Form 1040 Income

2015 Form 1040 Income

Adjustments, Deductions, & Credits

Before calculating tax we subtract adjustments and deductions.

Some of these are fixed entities, such as the Standard Deduction (Line 40, $12,600) & Personal Exemptions (Line 42, 3*$4,000.)

Others are based directly on income or actual expenses. For the self-employed (Hey, that’s me!) health insurance premiums are deductible (Line 29.) Also a deduction, the “employer” portion of FICA taxes (the Self-Employment tax, Line 27) is a fixed percentage of blog income.

Still other deductions are optional, such as contributions to a Traditional IRA (Line 32) or to a qualified plan for the self-employed like the Individual 401k (Line 28.) We will tune these contributions to optimize our tax bill.

2015 Form 1040 Adjustments, Deductions, & Credits

2015 Form 1040 Adjustments, Deductions, & Credits

Once we calculate our total tax, we apply tax credits.

Since we hold most of our International stock index funds in our brokerage account, we can claim the Foreign Tax Credit (Line 48) for any tax withheld by foreign governments. In 2015, this was $469.

In addition, because we are the parents of a happy little tax deduction we qualify for the Child Tax Credit. This is a whopping $1,000! (Line 52.) We also paid a small amount for child care, so we get another credit of $39 (Line 49.)

All credits total $1,508; any tax due will be reduced by up to $1,508.

A detail worth understanding on Line 56, which reports the total tax bill after credits: “If Line 55 (total credits) is more than Line 47 (total tax), enter -0-.” In other words, if you can’t use all of your credits, you lose them.

IRA & 401k Contributions

With earned income we are each able to contribute up to $5,500 to an IRA.

I can also contribute up to $18,000 to my Individual 401k, and my business can make a profit sharing contribution of up to $6,769 (20% of net business income minus half of self-employment tax.)

IRA contributions and employee Individual 401k contributions can be either Traditional (pre-tax) or Roth (post-tax), but business profit sharing contributions are always Traditional (pre-tax.) If we choose to make Traditional contributions of $6,769 or less, these should go to the Individual 401k, so 100% of our IRA and employee 401k can be Roth.

With up to $35,767 in potential contributions, we have a classic Traditional vs Roth trade off.

Traditional vs Roth (vs Brokerage)

The standard Traditional vs Roth argument goes as follow:
– If today’s marginal rate is higher, than a Traditional IRA is the better choice.
– If the future marginal rate is higher, than a Roth IRA comes out ahead.

With no Traditional contributions, Taxable Income (Line 43) is $74,989. This is $89 beyond the upper edge of the 15% marginal tax rate ($74,900.) The effective tax rate on this $89 is 25%.

Will our future tax rates be less than 25%? Considering we’ve paid 0% the past two years, I think it is fair to say yes. We should definitely contribute at least $89 to Traditional accounts, after which all of our Qualified Dividends and Long Term Capital Gains ($57,704 total) are completely tax free.

All of our regular income is now firmly in the 10% tax bracket, and an additional $2,146 +/- Traditional contribution would completely eliminate our Federal Income Tax obligation, as determined by experimentation in Turbo Tax.

But will our future tax rate be less than 10%? This is a harder call. I forecast that we could easily convert all of our Traditional accounts to Roth with zero tax over the next 30 years, so the odds are good that our future marginal rates are lower. But then again, if we spend time in the US the ACA makes even small Roth conversions subject to 25% marginal rates.

Since $2,146 +/- is a negligible percentage of our existing Traditional accounts, and I like paying no tax, I decide to make this contribution. Hello zero dollar tax bill!

Additional Child Tax Credit

But wait, we can do better.

The Additional Child Tax Credit (Line 67) is a refundable credit. If the Child Tax Credit (Line 52) is greater than the amount of total income tax owed, then some of the credit becomes a refund.

We could make Traditional retirement contributions up to an additional $10,000 and receive the maximum ACTC of $1,000 as a refund. Or we can make an additional $10 smart ass contribution, and have the IRS pay us $1. Which is what I would do.

But thanks to the IRS using Tax Tables rather than math, and the tax tables implemented in $50 income / $5 tax increments…

Screen Shot 2016-03-27 at 10.40.42 PM

2015 Tax Table ($1503 or $1508 due)

…all I had to do was increase my contribution by $1 and we get a refund of $5. Attention to detail earns a 500% return.

Final 2015 Tax Forms

Our 1040 Form 1040 as it appears in Turbo Tax.2015 f1040 Page1-22015 f1040 Page2-3And the Qualified Dividends and Capital Gains tax worksheet, which is used to calculate total taxes.

QD and CG Tax Worksheet-1Not shown on the 1040:
– we contributed $5,500 each to two Roth IRAs
– I contributed $18,000 to my Individual Roth 401k

This is exactly how to use a Roth; we pay 0% tax on $29k in contributions, and all growth will be tax free.

Self-Employment Taxes & Other Potential Improvements

aka, things I wish I had done sooner / differently.

Self-Employment Taxes

Someone will comment that we didn’t really have the IRS pay us this year, because we had to pay self-employment taxes.

Indeed. However, whereas income tax payments are gone forever, the self-employment taxes proportionally increase future Social Security income.

I could eliminate the SE taxes as well, by employing myself at Go Curry Cracker, a Belize company. Initial discussions I’ve had with the legal types suggest this isn’t of sufficient value (yet.) (i.e. the tax savings don’t outweigh the costs and management overhead.)

– As a redeeming feature, I paid all of the self-employment taxes on two new credit cards to meet our minimum spend requirements, and the fee is a tax deductible business expense in 2016. This is part of how we are getting $10,000+ of free European travel (tax free.)

Health Reimbursement Arrangement

By formally employing my lovely spouse and providing her with a Health Reimbursement Arrangement (a IRC Section 105(b) plan) we could make all health care and health insurance costs pre-FICA. In a year like 2015 with child birth costs, this would save thousands of dollars instead of just hundreds.

Ask: If anybody has expertise in this area, please email me.

Tax Penalty

You may have noticed that Line 79 includes a tax penalty of $6. With self employment income we are supposed to make estimated payments throughout the year.

I didn’t do that… something to do with starting to earn blog income around the time GCCjr was born. $6 isn’t a lot of money, but I’d still rather use it to buy lunch.

Although… with SE tax of ~$5k, by not making quarterly payments to the IRS, and instead keeping those funds in our Capital One 360 account earning 0.75%, we made at least $36 in interest. Maybe I’ll have lunch after all.

After-tax Contributions to Individual 401k

I opened my Individual 401k with E-trade, since they are one of only two custodians I found offering Roth accounts (the other being Vanguard.) Unfortunately neither of these plans allow non-Roth after-tax contributions (although the E-trade plan docs are so sparse, maybe…)

Had I instead decided earlier* to be my own administrator, I could have contributed an additional several thousand in after-tax dollars to the Individual 401k. This is known as the Mega Backdoor Roth. And since our tax rate is 0% (actually negative) this is an ideal match for Roth contributions. Although I’m quite happy saving these dollars in the brokerage account, since clearly gains and dividend income are still tax free.

* I didn’t get around to opening the Individual 401k until late December, and Ascencus had already stopped processing new docs by then. Full credit and thanks to The Finance Buff for figuring this all out.

Final Thoughts

Overall 2015 was a great tax year. We continue to live beneath our means in part thanks to a zero/low/negative tax load.

In addition to a negative tax rate, we contributed $29,000 to Roth accounts for tax free growth and harvested ~$24,000 in tax free capital gains. Thanks to the self-employment tax, we will also receive increased Social Security income in about 20 years.

While there is always room for improvement, we have a negative income tax bill today thanks to mistakes of yesteryear. I now have a short list of things to learn and new potential optimizations for the future. Doing our own taxes all of these years has had great return.

So there you have it… even with accidental income in early retirement, Taxes are Optional.


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