Hi, welcome to Money Matters. This video will show you how you can earn up to 40%, or more,
instantly, guaranteed, and without any risk whatsoever, by taking advantage of the tax
code. I will show you how you may be able to earn up to 40% or more by using adjustments to income,
both to lower your taxable income while increasing your tax credits.
How to qualify for some tax credits for which you would otherwise be ineligible. How to qualify
for the premium tax credit under the Affordable Care Act, even if your income exceeds $100,000.
The tax code provides many adjustments to income, and I will show you the most common
ones, but I will illustrate how effective this technique can be with retirement contributions.
This presentation was published in May 2021.
The ideas I will present here are basic concepts that should apply for any given tax year. However,
the details will change, especially AGI limits, since these are adjusted annually for inflation.
In any case, my objective is to present these basic concepts, not to explain the many details
of the tax code pertaining to these items. The details will vary with different taxpayers,
so you should rely on your tax advisor or tax software when preparing your taxes.
Most people know that they can save in taxes by making tax-deductible contributions to
tax-deferred retirement accounts, but many people do not know that they can increase their returns,
depending on their situation, by using retirement contributions and other adjustments to income
to also increase certain tax credits to yield a much larger tax savings than would be suggested
by the contribution alone. This method depends on income received minus any adjustments to income
which yields the adjusted gross income. Subtracting the standard deduction or
itemized deductions from AGI yields taxable income, but they do not reduce your AGI.
However, because many credits depend on AGI, these credits can be increased by increasing your
adjustments to income. These credits include some of the following, all of which I will discuss:
the Savers Credit, the Earned Income Credit, the Credit for Child or Dependent Care Expenses,
the Adoption Credit, the American Opportunity Tax Credit, the Lifetime Learning Credit,
and the Premium Tax Credit for those buying health insurance under the Affordable Care Act.
Here you can see a simplified formula for calculating the adjusted gross income and
the taxable income. Note that while adjustments to income reduce AGI, the standard deduction or
itemized deductions do not, so your AGI will always be higher than your taxable income,
and tax credits depend on AGI, not taxable income. While there are several adjustments to income,
the range of some of these adjustments is greater than for others. The adjustments to income that
can be increased the most include contributions to retirement accounts, health savings accounts,
cafeteria plans, and, for the self-employed, expenses incurred in their business.
If you are self-employed, you can make much greater contributions to your retirement account
than other taxpayers and you have some flexibility with business expenses, which allows significantly
greater tax savings. Tax credits almost always depend on what the tax code refers to as
modified adjusted gross income or MAGI, which is simply AGI plus certain tax breaks, most often,
foreign earned income exclusions or deductions. However, the tax breaks that are added back will
depend on the specific tax provisions to which they apply, and MAGI is usually defined within
those provisions. So, the definition of MAGI will depend on the tax credits to which they apply.
However, for most people, MAGI will equal AGI. I will now discuss contributions to tax-deferred
retirement accounts. The maximum contribution limit to retirement plans for taxpayers younger
than 50 is $6000 for an IRA and $19,500 for a 401(k) or related type of plan.
A catch-up contribution allows older taxpayers to contribute more, $7000 for an IRA and $26,000 for
a 401(k) or related type of plan. Note that taxpayers can contribute to both accounts each
year, and the limits apply separately to each type of account. The limit for a 401(k) or related type
plan does not include any employer contributions. Note that the self-employed can contribute much
more to their 401(k) accounts or other types of self-employment retirement accounts.
These are the income limits for tax years 2020 and 2021. I want to point out that only contributions
to tax-deferred retirement accounts, such as a traditional IRA or a traditional 401(k) account,
will reduce your AGI. Contributions to a Roth IRA or a Roth 401(k) account will not reduce your AGI.
A saver's credit does apply to those accounts if your income is low enough,
but the contributions will not reduce your AGI, so they will not increase your credit percentage
of the saver's credit or increase the value of the other tax credits. The modified adjusted
gross income for the retirement credit includes any foreign earned income exclusion
or foreign housing exclusion or deduction plus income earned from Puerto Rico or American Samoa.
Note that the income limits depend on filing status,
and the credit percentage depends on MAGI limits, which are adjusted annually for inflation.
This shows 3 examples using the same wages but different retirement contributions,
and how they differ in tax savings, and then the instant risk-free return on investment.
Here are 3 scenarios with the same wages with different traditional IRA contributions.
Larger contributions can yield a higher saver’s credit percentage
even though the contribution base for the credit is limited to $2000. Adding the credit to the tax
savings due to the contribution yields even greater savings. I will show you at the end
of this video how you can increase these savings substantially. This yields instant
double-digit returns with absolutely no risk. Greater contributions save more money but may
not yield the highest rate of return. I will show later how you can almost double this percentage.
I will now discuss the Earned Income Tax Credit. This is a sample EIC worksheet from IRS
Publication 596. Your earned income tax credit depends on both the income you earn from work,
what the tax code refers to as earned income, and your AGI, whichever yields the lowest
credit. So, lowering your AGI may help if it does not go below your earned income.
The EIC depends on the number of qualifying children you have.
You can still qualify for the credit if you have no children, but the credit is much lower and
phases out completely at much lower incomes. To qualify for this credit, your investment
income cannot exceed a certain amount which was $10,000 in 2021, but a much lower $3650 in 2020.
Both the maximum credit and the maximum income limits depend on the number of qualifying
children. The higher limits you see in red are for those who are married filing jointly. This
is a rough schematic diagram of how the earned income credit varies with taxpayer income. At
first, it increases with increasing income, then reaches a maximum for a certain level of income,
and then declines. If the income you earn from work is less than the phase-out amount,
then lowering your AGI will not increase your earned income credit and may even decrease it.
However, if your AGI exceeds the phase-out amount, but it is not too high, and it is greater than
your earned income from work, then decreasing your AGI, but not below your earned income,
may increase your earned income credit. This is a rough illustration of how this works,
but if you want to take advantage of this, then you will need to work out the details either by
checking the EITC tax table in IRS Publication 596 or by consulting with your tax advisor.
There is also a Credit for Child and Dependent Care Expenses for 2020. The maximum credit percent
is applied to a credit base of up to $3000 for 1 qualifying dependent or $6000 for 2 or more
dependents, so the maximum credit is $2100 for someone whose AGI does not exceed $15,000 and
who has 2 or more children. However, for 2020, this credit is limited by your tax liability
so it cannot exceed that amount. For 2021 only, the maximum credit base is increased
to $8000 and $16,000 respectively, and the maximum credit percentage rate will be increased to 50%,
and it will be fully refundable, meaning that it will not be limited by your tax liability.
So, for 2021 only, the maximum credit will be $8000 or $16,000 of qualified expenses for
2 or more qualifying children. Any credit exceeding your tax liability is refunded,
but this only applies to the 2021 tax year. Afterward, it will revert to its previous limits,
unless Congress changes it permanently. As you can see, the dependent care credit
is calculated by multiplying the credit base by the applicable percentage rate,
which is based on income. So, for instance, if you have $1000 worth of qualified expenses and
your AGI does not exceed $15,000, then you will receive a $350 credit equal to 35% of $1000.
The Adoption Credit helps to pay for the qualified expenses of adopting a child.
The MAGI limits for the adoption credit are pretty high, so few people will be
restricted by the income limits, but since this credit is worth more than $14,000,
If your income does happen to be higher than the MAGI limits,
then lowering your MAGI enough to qualify for the credit may provide significant tax savings.
Note that with the adoption credit, MAGI includes any employer-provided adoption assistance.
There are 2 educational credits that could be worth at least $2000:
the American Opportunity Tax Credit and the Lifetime Learning Credit. The American
Opportunity Tax Credit is worth a maximum of $2500 with 40%, or $1000, of it being refundable.
The Lifetime Learning Credit is worth a maximum of $2000. As you can see here, there are MAGI limits,
so if your income is near these limits, then lowering your AGI can save significant taxes.
Also, notice that the income limits for the Lifetime Learning Credit for 2020 are
much lower than the limit in 2021. In 2021, the income limits for both credits will be the same,
and this is the modified adjusted gross income definition for these educational credits.
Here's a great example of how these tax savings can add up to a fabulous risk-free return.
In 2021, a single nurse earned $90,000 and incurred $10,000 of educational expenses
for graduate courses in nursing. Because she earned $90,000, she would not ordinarily
qualify for the Lifetime Learning Credit, but by making a $10,000 contribution to her 401(k) plan,
she reduces her AGI to no more than $80,000, so that she qualifies for the full amount of the
credit. Because she is in the 22% tax bracket, she will save 22% or $2200 for a contribution to her
401(k) plan. However, because she now fully qualifies for the Lifetime Learning Credit,
she also saves an additional $2000 in her taxes, yielding a total tax savings of $4200, an instant
42% return on her contribution to her tax-deferred retirement account, completely risk-free!
If you are eligible for health insurance under the Affordable Care Act, then you may be entitled to
the Premium Tax Credit. This credit depends on the modified adjusted gross income of your household,
so lowering your MAGI, or those of other members of your household,
may increase this credit significantly, depending on your particular tax situation.
This is the federal poverty line for the 2020 tax year. In the first column is the family size,
and the second column lists the federal poverty line for the number of individuals
in the household, and the third column is 400% of the federal poverty line, which is the upper limit
for the credit. However, the American Rescue Plan Act, signed into law in March 2021, suspended the
upper limit for the credit for household incomes above 400 percent of the FPL for tax years 2021
and 2022 only. The Premium Tax Credit increases to a maximum for taxpayers whose income is at the
federal poverty line, which is this level here. The PTC is a refundable credit, meaning that it is
not limited by your tax liability. So, any amount exceeding your tax liability will be refunded.
Note that the upper limit in 2020 for a single taxpayer is $49,960
and since the self-employed taxpayer can contribute up to $57,000,
or up to $63,500 if he is at least 50 years of age, to a solo 401(k) plan, it is possible for
the taxpayer to qualify for the Premium Tax Credit even if his income exceeded $100,000.
Here are some of the sample monthly premiums that I got for May 2021. For the Pennsylvania
marketplace, for policies under the Affordable Care Act based on information
in the lower right-hand corner, even the cheapest bronze plan with a $7100 deductible, costs almost
$425 a month. The most expensive plan is more than $925 per month. And that was for a silver plan,
which is the second cheapest type of plan under the Affordable Care Act! Note also that this was
for someone 48 years old. If you're older than that, then the plans will be even more expensive.
If you are getting insurance under the Affordable Care Act, then reducing your
MAGI will significantly increase your tax savings over and above the marginal rate of the
tax deduction itself! The closer that you could bring your MAGI to the 100% federal poverty line,
the more money you will save so you can either greatly reduce the cost of your premiums,
or, if your income is too high, just qualify for the Premium Tax Credit by lowering your MAGI.
Now we go back to the original example of the saver's credit showing how much is saved with
different contribution amounts to your retirement account. This is another example of how these tax
savings can add up, simply by lowering your AGI. Not only do you save directly by lowering your
AGI with your retirement contribution, but you also get the saver's credit, and if you get the health
insurance under the Affordable Care Act, then you will also be entitled to the Premium Tax Credit,
which will also increase with your contribution to your retirement account, as you can see here in
this table. Since the premium tax credit is fully refundable, you will receive the entire amount
regardless of your tax liability. We noted before that you earn a risk-free 25% on your retirement
contribution instantly, but when we add the Premium Tax Credit, the tax savings and the return
on the investment will increase dramatically. This was the total savings, counting only the
retirement contribution tax savings and the saver’s credit. By adding the Premium Tax Credit,
total savings increases, which increases the total risk-free return on the retirement contribution.