Friday, April 04, 2008

Taking Advantage Of Tax Saving Benefits In 2008

As we are wrapping up our 2007 tax return, I realized we will have a new tax opportunity in 2008. The majority of our 2008 income, consisting of dividends, interest, capital gains and conversions to Roth IRAs, will not have any taxes withheld. Therefore, we need estimate our 2008 income to pay both state and federal quarterly estimated taxes for 2008. Otherwise, we may owe penalties and interest for underpayment of our 2008 tax liability.

Being an engineer, I tried to estimate the optimal balance of income and tax liability for a family of three with a young child. There are three tax credits, the education credit, the child tax credit and the saver's credit, for which we could qualify in 2008, depending on income level. In addition, below certain income levels, one can qualify for a 0% long term capital gains tax rate, or conversions to Roth IRAs. This tax benefits and income limits are summarize below.

2008 Limit For Maximum Benefit by Filing Status*
Credits or BenefitsMFJQWHOHSingleMFS
Child Tax Credit$110,000$75,000$75,000 $55,000$55,000
Education Credit$114,000$57,000$57,000$57,000$57,000

Saver's Credit

0% Long Term Capital Gains Tax$65,100**$65,100**$43,650**$32,550**$32,550**
Conversion to Roth IRA***$100,000$100,000$100,000$100,000$0

*MFJ-Married Filing Joint QW-Qualifying Widow(er) HOH-Head of Household MFS-Married Filing Separate
**Taxable income after deductions and exemptions
***Special add backs to calculate MAGI, but does not include Roth conversion amount

Using an Excel spreadsheet, I identified a scenario that allowed us to qualify for all the tax benefits except the Saver's Credit. However, it is likely we won't have any qualified 2008 education expenses for the Education Credit. Therefore, in 2008, we will get the Child Tax Credit of $1000 and have tax free long term capital gains. Finally, we will be able make conversions to a Roth IRA in a 15% tax bracket. Net, estimating 2008 income and taxes in advance has been very helpful to maximize the tax savings we may get:-)

For more on Reaping the Rewards, check back every Friday for a new segment.

This is not financial or tax advice. Please consult a professional advisor.

Copyright © 2008 Achievement Catalyst, LLC


Anonymous said...

I'm an engineer, too, and I think you can do even better. Arrange for most of your income to be qualified dividends rather than taxable interest. That way you can use the sum of your deduction and exemptions to shelter the Roth IRA conversion and keep it below the taxable threshold. (Or at least make sure that your tax credit offsets any taxable Roth IRA conversion amount that exceeds your deduction-exemption shelter. I don't have the pleasure of receiving the Child Tax Credit yet, so I haven't examined that scenario closely.)

Super Saver said...

@ Anonymous,

Great point on using qualified dividends to enable trying to make Roth conversions with 0% taxes.

I had considered the option of using exemption and deduction to offset all the Roth conversions in 2008. However, we would have to reduce our Roth conversions by over 50% in this year. Given that I expect tax rates to increase after 2010, I think paying the 15% income tax rate on part of the Roth conversions is reasonable.

However, I will consider your approach for 2009, since we may be able to shift to more 0% tax bracket income in the future. Thanks for your comment and the insight.