2020 was an interesting year in many ways including all things taxes… I mean, we paid $0 in income tax (again) on ~$143k income.
This was in part because dividends and blog revenue were lower due to COVID-19, which is a bummer. But it is also because we welcomed another child tax credit into the family, which is nice. Plus, he’s kinda cute.
But that’s not all… for all of you tax aficionados, this year’s tax return offers some good examples of both short and long term tax minimization, including use of the Foreign Earned Income Exclusion, the Child Tax Credit (with phase out), capital gain harvesting, Roth conversions, the Foreign Tax Credit (on International equities), and more.
Let’s explore, shall we?
The Go Curry Cracker 2020 Taxes
Executive Summary
Per usual, we had multiple streams of income totaling $143,290.
The marginal income tax rate (on additional income) was 15% for qualified income and 27% for ordinary income, with an effective (overall) tax rate of 0%. Total income tax was $0.
Because I violated Rule #1, Choose Leisure over Labor, I paid $4,891 in self-employment taxes (sort of an involuntary annuity purchase.) This brings the effective tax rate to 3.4%
Key to getting the numbers right is a good tax calculator that understands the beauty of tax-free Roth conversions and Capital Gain Harvests. I have written such a calculator: GCC Income Tax Calculator
Form 1040
- Income
- Gross Income: $143,290
- Adjusted Gross Income: $102,432 (Line 11)
- Taxable Income: $77,631 (Line 15)
- Tax:
- Income Tax: $4,470 (Line 16)
- Self-employment Tax: $4,891 (Line 23)
- Tax Credits: $4,470 (Line 21)
- Child Tax Credit: $3,917 (Line 19)
- Foreign Tax Credit: $483 (included on Line 20)
- Credit for child and dependent care expenses: $70 (included in Line 20)
- Income tax after credits: $0 (Line 22)
This is how it all looks on the 1040 ->
Foreign Earned Income Exclusion
We have claimed the foreign earned income exclusion for several years now, which allows us to exclude most/all of our blog income from US taxation.
This year the FEIE is applied to $32,166 of blog income. This is derived from the Schedule C blog profit ($34,612) minus the deductible portion of self-employment taxes ($2,446, no double deduction.)
Determining the benefit is.a 2-step process shown below on the Foreign Earned Income Tax Worksheet.:
First, calculate tax on total income of all types, foreign and domestic. (Line 4c)
Second, calculate tax on only the excluded income. (Line 5)
Subtract this amount from the tax calculated in step 1 to yield total tax (Line 6, Form 1040 Line 16.)
Total savings = $3,466.
Roth Conversion
In Mach 2020 when the stock market was way down I did a Roth conversion worth $17,423, moving funds from a Traditional IRA to a Roth. This is shown on the 1040, Line 4a and Line 4b.
At the time I had no idea what our annual income would be for the year, and I wasn’t optimistic. But I knew for sure that earned income would be way down and I would be able to do a Roth conversion with an effective tax rate of 0%.
To determine the exact amount I used a time honored tradition that has been handed down from generation to generation. I guessed.
Considering how much the market has rebounded from those lows, I should have guessed more forcefully. Oh well, at least the tax rate was right.
Savings estimate: 12% of conversion amount, $2,091 (or much more since growth is now tax free.)
Capital Gain Harvesting
Back in March 2020 I sold a bunch of bonds, some of it at a loss, in order to buy stock at a discount. In total I realized a loss of $6,984.
By December of 2020 I had a pretty good idea of what our income would be for the year (also a guess), and we still had about $60,000 worth of 0% tax bracket to fill with long-term capital gains, including the capital loss from March.
As such, I sold ~$60k worth of VTI and then immediately bought $60k of VTI, for a total realized long-term capital gain of $53,078 (Form 1040, Line 7.)
We now own the same number of shares of VTI just with a higher basis, which will reduce our future tax burden.
Want to know more about how this works? Plug your email address in here and I’ll send you our capital gain harvesting template based on actual transactions.
Savings estimate: 15% of cap gain value, $7,962
Child Tax Credit
As I highlighted above, both the Roth conversion and capital gain harvesting values were based on (educated) guesses. Alas, I guessed wrong and left some money on the table. $83 to be specific.
We are eligible for 2 Child Tax Credits totaling $4,000, but we are ineligible for the Additional CTC (the refundable part) because we claim the FEIE. After applying other credits to our total tax, our remaining tax burden is only $3,917… limiting our CTC to the same $3,917.
To get the remaining $83 I would have had to increase the Roth conversion by $307 or increased the capital gain harvest by $553. Honestly I’m kind of impressed I got so close.
This won’t be an issue for 2021 as the Child Tax Credit is fully refundable due to the American Rescue Plan. This is for 2021 only unless future legislation extends it.
Related:
- Maximizing the Child Tax Credit (even without earned income)
- GCC Income Tax Calculator (to fine tune Roth conversion and capital gain harvest values)
Stimulus Income
Because we welcomed our 2nd child in 2020 we were able to get additional stimulus income based on our larger family size. This includes $500 from the CARES Act and $600 from the Coronavirus Response and Relief Supplemental Appropriations Act of 2021, or $1,100 total (Form 1040, Line 30.)
Our other 3 family members already received those “recovery rebate credits.”
Because our 2019 income was too high to qualify for the stimulus income provided by The American Rescue Plan Act of 2021 (married households with income in excess of $160k get $0), I had some motivation to file our 2020 taxes early.
We would get the $1400/person in any case, but I prefer to have it now vs getting it on our 2021 tax return.
Filing early worked out – we have already received the full $5,600 ($1,400 via direct deposit and $4,200 via check and the post office.)
Tax on Credit Card Rewards Points
An interesting thing, nowhere on our 2020 tax return does it show the $4,500+ we received for cashing our a bunch of credit card rewards points. (tldr: we weren’t planning to travel for some time and I’ll just get more points before we do.)
If you earn award points through credit card usage or signup bonuses, the IRS just treats these points as a refund on your purchases. There is no income and therefore no taxes. (See our Award Travel Series on Transferrable Currencies.)
Ironically, we actually got a lot of these points by paying taxes – we pay self-employment taxes quarterly, and I often use that “opportunity” to meet the minimum spend on a new credit card.
If you are going to have to pay some taxes anyway, you might as well get a nice vacation out of it.
Related:
- Aloha Uncle Sam (paying taxes with a credit card to get a free Hawaii honeymoon)
- Award Travel Series: Getting to Hawaii for Free with Ultimate Rewards
Summary
2020 was a good tax year – $143,290 in gross income / $0 in income tax / $4,891 in self-employment taxes.
This means zero income tax on dividends and blog revenue today, and thanks to capital gain harvesting Roth conversions, zero-ish income tax on future retirement income as well. Social Security income will even be higher due to the self-employment taxes.
Overall I think we did alright with a conservative savings of $13,435 over what we would have paid were I still working for a living.
To get the numbers right, I created my own tax calc that highlights optimum values for tax-free Roth conversions and capital gain harvests. Check it out: GCC Income Tax Calculator
Until next year…
How about taxes in your country of residence?
$0
Many countries don’t charge residents income tax
Woah! That’s amazing!
Do you still live in Taiwan? Could your blog income be considered Taiwan-sourced income?
not by definition – no local employees, vendors, contractors, distributors, etc…
I suspect the Canadian government would disagree with your conclusions with your tax status given your social ties to Canada… should we ask them?
Yes! We should ask them. Will you take point on this, John?
I am genuinely curious what they will say
I thought you incurred a fee of almost 2% when you pay taxes via credit card?
1.87%
Pay $3,000 in tax at a fee of $56 –> Get $1,000 worth of points.
How about state taxes?
He doesn’t live in the US, no state tax
I still have a driver’s license, etc… from Washington State. No income tax in Washington
Can’t you only take $3k per year, per couple, of short/long term losses on your portfolio? How did you take almost $7k?
There is only a limit if losses exceed gains.
If you have $60k in gains you can subtract up to $63k in losses.
You must net together your capital gains and losses for the year. Long term gains, long term losses, short term gains, and short term losses for the year are all netted together, also netting together a maximum $3000 loss from prior years. If for this year your new net is also negative, then you can carry over all of it to subsequent years, but only $3000 to be netted against the subsequent years at a time.
How early did you need to file to get the stimulus money in 2021 instead of 2022? I wasn’t aware that was possible and now I need to wait until next year I guess.
I don’t know for certain. I started doing my return as soon as the legislation came up to a vote, and submitted it a day or two after the bill became law.
Unfortunately I don’t have the benefit of Child Tax Credits, Foreign Earned Income Credit, or just about any possible credits for that matter. Since I did a lot of trading during 2020, particularly when the market tanked, I had a lot of gains and not nearly enough losses in my accounts to offset them. So I am one of those “rich” people who will be paying through the nose when I file my return in May, to the tune of $62K. Everyone receiving “stimulus” $ – you’re welcome (I don’t sound too bitter, do I?)
I’ll trade you profits and associated taxes if it will help ;)
Isn’t the American Rescue Act $1,400 per person?
And I think the 27% regular income bracket is 24%?
Waiting for your FTC to be above $600 so you need to fill out the horrendous form 1116 :) Would be happy to help you out on that, when the time comes.
If you use the FEIE you also have to use Form 1116 for the FTC. We did pay more than $600 in foreign taxes but had to carry forward some of it.
The 27% number comes from $1 of ordinary income at the 12% tax rate also pushing $1 of qualified income from 0%->15% tax rate. 12+15=27
ARP is $1,400, yes. I misremembered when writing, but just changed it now, thank you.
I thought theirs the 30 day wash sale rule for capital gain harvesting?
There is no wash sale rule for gains.
Selling and making a capital gain is a taxable event (usually…) so the government actually encourages doing those. No wash sales!
My favorite kind of GCC post. Taxes. I always learn something. Good stuff!
BTW, is the reason you don’t do HSA contributions because you don’t carry the kind of U.S.-based high-deductible health plan insurance that would allow you to qualify? Just curious.
yeah we don’t have an HDHP so no HSA for us.
Thanks Jeremy, always love your tax posts. You are the tax guru.
Tried the GCC Income Tax Calculator and have a question.
After completing calculations the bottom of summary section shows options. However, it is only showing one option ( Capital Gain harvest). I believe there should be two or more ( Roth Conversion). It seems like the field is out of space and doesn’t scroll. Is that true?
If it doesn’t show a Roth conversion option, that just means you are unable to do one at a 0% tax rate with the income you entered.
Hi GCC! Do you do you always do your taxes line by line? Or what general strategies do you use to do them yourself? I’m getting to that point where I don’t really trust basic tax software to get everything right by asking me a couple questions. Thanks!
Basic tax software just crunches the numbers (and does a great job at it) but it does nothing for planning or optimization purposes. For that it can be very much worth hiring a competent CPA for a year or 3.
Or it is unlikely that your tax return is more complicated than mine – going through this or prior year returns can help you figure it out. I just made it a point to learn one new thing a year or as something became relevant
Awesome post! I noticed that your foreign housing deduction is 0. Is there a reason you can’t or haven’t taken advantage of that deduction?
The foreign housing deduction is in addition to the FEIE. If you aren’t already excluding $107,600 (2020) then the housing deduction doesn’t do anything.
i love me some capital gains harvesting. we harvested about 20k this year at the 0% fed rate. and…we’re still working. the tax code really does favor the middle class.
of course filthy ny state takes 6% as all gains and div’s are taxed as ordinary income right from the first dollar. we gotta get out of this state.
great article.
We will probably end up in California in a couple/few years. I’ll pay a bit of Cali tax but I think of it as another line item in the budget -> However, I will be less aggressive with the tax stuff since the numbers will be different
Hey Jeremy, I’ve been a long-time lurker here for ~7 years. My fiancee and I are from California and planning to FIRE abroad.
What are some things drawing you back to living in the states, particularly CA?
At the heart of it is we have 2-culture kids and we would like them to live in both cultures.
I wrote about this a little here: Finding Our Forever Home
Brilliant. I am aiming towards $0 tax this year in my first full year of FIRE, and I was surprised at the amount of gains that we can take and still achieve $0 tax. Kind of amazing all in all.
It is pretty wild. If you have ACA health insurance then the premium subsidy phaseout acts as a tax so just be aware of how that works.
“Total income tax was $0.”:
Your companies paid 21% tax on your share of profits paid as dividends.
=(21% / (1 – 21%)) * $32,122
=$8,538.76
Had you been employed by them you they would have paid tax on your gross wages and you would have been credited with the tax paid. A low income wage earner would have a tax rate of 0% on their gross wages.
But, unlike wages, USA does not credit tax paid on gross dividends so small shareholders pay a minimum of 21% tax on gross dividends.
The USA tax system disadvantages the small shareholder.
This is why I can’t understand people that are so adamant about raising corporate income taxes. Corporations don’t pay taxes — people do. In this case, it’s every shareholder paying 21% tax on their dividends (and possibly higher if Dems get their way). Every retired teacher and other pensioner, everyone with a 401k and IRA, etc. While these people think they’re sticking it to corporations for paying their “fair share,” all they’re doing is taxing nearly every middle class American.
If it was up to me, we would have no corporate income tax (no more corporate tax lawyers or accountants!) and the dividends would be taxed at our normal income tax brackets. That’s how you get the “evil rich” to pay higher taxes without screwing over the middle class.
“If it was up to me, we would have no corporate income tax (no more corporate tax lawyers or accountants!) and the dividends would be taxed at our normal income tax brackets.”:
That would result in untaxed profit being paid to foreigners, esp those beyond USA jurisdiction.
Australia taxes profits at 30%, non-tax residents do not get the 30% as a tax credit, tax residents do. Grossed up dividend (divided + tax credit) is added to dividend recipient’s other income and tax assessed on that total. Tax credit in excess of assessment is refunded to the dividend recipient.
Thus an individual in the 0% tax bracket (eg Senior $0 to $30,592 assessment) tax = $0 and all dividend tax credits are refunded to said individual (eg $9,177).
Person A earns $125, pays $25 in tax. They then give that $100 to Person B.
Would it be common practice to claim that Person B paid that $25 in tax?
Bear in mind that in the United States, corporations are persons.
Person A is Person A’s [self] employer who paid $25 tax to government which assigns to Person A a $25 tax credit.
Person B owes no tax on the $100 gift from Person A and government receives no tax payment in respect of Person B and thus does not assign any tax credit to Person B.
USA taxes small shareholders dividends at larger rates than if they earnt the same amount in wages from the same company. It also double taxes dividends for some tax payers, the only partial relief being qualified dividends.
Person A is unemployed
Person A might be unemployed and receive interest with no withholding tax deducted and be assessed for $25 tax which they are required to pay.
USA Person A might be unemployed and receive $100 dividends on which 21% tax has been deducted from a gross dividend of $125. Person A did not pay $25 tax, the dividend issuing company did. Government does not assign a tax credit for taxes paid on dividends to Person A.
Due to double taxation of dividends, USA companies seek to reduce profit by paying owners in wages or interest. Companies increase debt to buy outstanding shares to reduce profit and dividends.
Wow, that income tax calculator is NICE! Thanks for that.
I used it to check the result of the worksheet I’d built and it confirmed I’m on track for another year of $0 tax liability.
Thank you so much for all you’ve taught us about tax optimization in early retirement.
My pleasure :)
Amazing as always!
This looks like magic compared to my 20% dividend tax from $0, my 22.5% capital gains tax rates and 45% marginal income tax rate. All for the privilege of no government services worth using, lol. At least the housing is super cheap!
Nice work, do you think there will be any changes to the tax regime going forward with the new US president?
We’ve already seen this administrations tax proposals -> no change for households under $400k income, except maybe more benefits (larger child tax credit, etc…)
Hi Jeremy, long term reader here.
In the FEIE paragraph, one question though:
“First, calculate tax on total income of all types, foreign and domestic. (Line 4c)” I did not make the calculation, but the amount looks small to me (7.9k out of 109k of revenues, vs., line below, 3.4k out of 32k of foreign income excluded).
Also, not sure what the 15k in line 4b are about (sounds more like the tax amount out of 109k, but then, it does not work with the final tax amount that you calculate, at 4.4k).
My wife being a US citizen, and us living abroad, this section is of interest for us.
Thanks as always for the insightful post !!
The $15k number on 4b can be disregarded. That is Turbotax calculating tax as if all income was ordinary (no 0% for qualified dividends and long term capital gains.)
The ~$7.9k number is correct. ~$81k is qualified income, over half of it taxed at 0%.
Thank you for this post! So were your self-employment taxes from blog income? Do you have a blog post on how to minimize self-employment tax?
Yes, from blog income.
You can reduce SE taxes by making less money… that’s it.
See:
Write it All Off
Uncle Sam Helps Pay Our Rent
If you make a ton of money in the US, you can setup your business as an S-corp.
Or if you are outside the US, as a non-US corp.
Probably spent more than 183 days in Canada…
That is surprising close to the actual number of days we spent in Canada. Or as I like to refer to it, Up North
Is it a good idea to convert Traditional IRA to Roth IRA if I anticipate low or no income this year?
If so, what is the amount you suggest I should convert?
Can I convert it at any time?
Thank you!
It can be. See our fed income tax calc, which provides guidance on Roth conversion and cap gain harvesting size.
If you have non-ACA health insurance and no income, then you could Roth convert up to the size of the standard deduction and pay zero federal tax.