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 Benefits | MFJ | QW | HOH | Single | MFS |
| 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 |
| $53,000 | $26,500 | $39,750 | $26,500 | $26,500 | |
| 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:-)
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Copyright © 2008 Achievement Catalyst, LLC
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2 comments:
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.)
@ 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.
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