Article Highlights:
- Adjusted Gross Income
- Taxable Income
- Graduated Individual Tax Rates
- Take IRA Distributions
- Redeem Government Bonds
- Defer Deductions
- Convert Traditional IRA Funds into a Roth IRA
- Zero Capital Gains Rate
- Business Expenses
- Affordable Care Act
If your taxable income is exceptionally low this year, or even if you expect not to be required to file a tax return this year, a number of tax opportunities may be available to you. But time is running short, since these opportunities will require action on your part before year’s end.
However, before we consider actual strategies, let’s look at key elements that govern tax rates and taxable income.
Adjusted Gross Income (AGI) – This is the sum of all of your income that’s subject to tax, such as wages, interest, dividends, gains from sales, net self-employment income, and retirement income, minus items that are specifically deductible without having to itemize your deductions, including contributions to traditional IRAs and self-employed retirement plans, interest paid on student loans, contributions to health savings plans, and a limited number of others.
Taxable Income – To be simplistic, taxable income is your AGI less the greater of the standard deduction for your filing status or your itemized deductions:
AGI XXXX
Deductions <XXXX>
Taxable Income XXXX
If the deductions exceed your AGI, then you can end up with a negative taxable income, which means that to the extent it is negative, you can actually add income or reduce your deductions without incurring any tax.
Graduated Individual Tax Rates – Ordinary individual tax rates are graduated. So as your taxable income increases, so does your tax rate. Thus, the lower your taxable income, the lower your tax rate will be. Your income tax is the result of multiplying your tax rate by your taxable income (but to simplify the computation for those with taxable income up to $100,000, the IRS figures the tax by income range and provides look-up tables, so for most taxpayers, their tax rate is not apparent). Individual ordinary tax rates range from 10% to as high as 37%. For 2018, the taxable income amounts for the three lowest tax rates – 10%, 12%, and 22% – are:
| Filing Status | Single | Married Filing Jointly | Head of Household | Married Filing Separate |
| 10% | $0–9,525 | $0–19,050 | $0–13,600 | $0–9,525 |
| 12% | $9,526–38,700 | $19,051–77,400 | $13,601–51,800 | $9,526–38,700 |
| 22% | $38,701–82,500 | $77,401–165,000 | $51,801–82,500 | $38,701–82,500 |
So for instance, if you are single, your first $9,525 of taxable income is taxed at 10%. The next $29,174 ($9,526 to $38,700) is taxed at 12%, and the next $43,799 ($38,701 to $82,500) is taxed at 22%.
Here are some strategies you can employ for your tax benefit. However, these strategies may be interdependent on one another and your particular tax circumstances.
Take IRA Distributions – Depending upon your projected taxable income, you might consider taking an IRA distribution to add income for the year. For instance, if your projected taxable income is negative, then you can actually take a withdrawal of up to the negative amount without incurring any tax. Even if your projected taxable income is not negative and your normal taxable income would put you in the 22% or higher bracket, you might want to take out just enough to be taxed at the 10% or even the 12% tax rate. Of course, those are retirement dollars; consider moving them into a regular financial account set aside for your retirement. Also, be aware that distributions before age 59½ are subject to a 10% early-withdrawal penalty even if there is no tax liability, so this strategy isn’t recommended for those younger than 59½.
Redeem Government Bonds – If you have invested in U.S. government bonds, such as Series EE or I bonds, and you’ve been deferring paying tax on the interest from these bonds until they mature, you may want to cash in the bonds prior to the year when they mature, if that maturity date is within the next few years and to the extent that adding the bond interest to your other income for the year won’t push you out of the zero or 10% tax bracket and into a higher bracket. This strategy isn’t advisable if the interest you would earn on the bonds if you held them to maturity would be more than the tax you can save by cashing in the bonds during a low-income year.
Defer Deductions – When you itemize your deductions, you may claim only the deductions you actually pay during the tax year (the calendar year, for most folks). If your projected taxable income will be negative and you are planning on itemizing your deductions, you might consider putting off some of those year-end deductible payments until after the first of the year and preserving the deductions for next year. Such payments might include house of worship tithing, year-end charitable giving, tax payments (but not those incurring late payment penalties), estimated state income tax payments, and medical expenses.
Convert Traditional IRA Funds into a Roth IRA – Roth IRAs provide tax-free accumulation and tax-free retirement distributions. So to the extent of any negative taxable income or even just for the lower tax rates, you may wish to consider converting some or all of your traditional IRA into a Roth IRA. The lower income results in a lower tax rate, which will provide you with an opportunity to convert to a Roth IRA at a lower tax amount.
Zero Capital Gains Rate – There are three capital gains rates depending upon your taxable income. When your taxable income is in the lowest range, as shown in the table below, you will actually pay no tax on your long-term capital gains. Thus, if your taxable income is within the zero percent long-term capital gains rate bracket, this is an opportunity for you to sell some appreciated securities that you have owned for more than a year and pay no tax on the gains.
| Long-Term Capital Gains Rates (2018) |
| Filing Status | 0% | 15% | 20% |
| Single | $0–38,600 | $38,601–425,800 | $425,801 & Above |
| Head of Household | $0–51,700 | $51,701–452,400 | $452,401 & Above |
| Married Joint | $0–77,200 | $77,201–479,000 | $479,001 & Above |
| Married Separate | $0–38,600 | $38,601–239,500 | $239,501 & Above |
Business Expenses – The tax code has some very liberal provisions that allow a business to currently expense, rather than capitalize and slowly depreciate, the purchase costs of certain property. In a low-income year, it may be appropriate to capitalize rather than expense these current-year purchases and preserve the depreciation deduction for higher-income years. This is especially true when taxable income is negative in the current year.
Affordable Care Act – On the negative side, if you have obtained your medical insurance through a government marketplace, employing any of the strategies mentioned above will increase your taxable income and could impact the amount of your allowable premium tax credit. As a result, you would likely have to repay some or all of any advance premium tax credit that was used to reduce your health insurance premiums; the credit is reconciled on your tax return.
If you would like to discuss how these strategies might provide you with tax benefits based upon your particular tax circumstances or would like to schedule a tax-planning appointment, please give the office a call.
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