How to Pay Less Taxes on a Six-Figure Income

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I want to introduce you to some friends of mine. They are comfortable, middle-class professionals with a decent income, yet they pay zero federal income tax. There's no need to call the IRS, though. What they're doing is completely legitimate because they take advantage of enough tax deductions and credits to get their income to a level that results in zero taxes. Here's how to pay less taxes.

A Real-Life Case Study

You might have friends with jobs just like my friends'. Amy is an engineer, and Jason is a teacher. They live in an adorable (paid-off) house that started off as a starter home and grew into a forever home.

Even after their first child arrived, they didn't feel a need to leave their quiet little corner of the neighborhood behind in search of something bigger (and more expensive).

They worked hard to pay off their house, and the idea of a new mortgage payment didn't seem appealing at all!

Let's Take a Look at Their Financials

Amy earns $65,000 per year at an engineering firm, and Jason earns $45,000 per year teaching third grade at a rural public elementary school in North Carolina. Their combined salary of $110,000 is much higher than the median household income for their community, yet they tend to live just like everyone else around them.

Amy's Financials

They are really focused on paying as little tax as possible right now, and they take advantage of every opportunity to reduce their taxable income. Amy's job offers a 401(k), and she puts the maximum of $18,000 into her account each year.

Amy also contributes $1,000 to her employer-sponsored healthcare flexible spending account (FSA) to cover their typical medical and dental bills for the year. To cover childcare costs for their toddler, Amy funds her childcare flexible spending account with $5,000 to cover most of the costs during the school year (Jason turns into a stay-at-home dad during his summer breaks from school).

Jason's Financials

Jason's government job offers a 401(k) and a 457 plan. It's a little-known secret that you can contribute the maximum amount ($18,000 in 2017) to both a 401(k) AND a 457 account. Jason defers $36,000 into his 401(k) and 457 plan, making his paychecks embarrassingly small. Thank goodness for Amy's more robust take-home pay!

On top of all their other savings, Amy and Jason each fund a deductible traditional IRA with the maximum amounts ($5,500 each in 2017).

Here's the breakdown of their financial situation and proof that they pay $0 income taxes.

  • By participating in all of the tax-deferred savings options available to them, Amy and Jason manage to reduce their income by $71,000! Their income shrinks from $110,000 to $39,000.
  • After subtracting their standard deduction ($12,600) and three personal exemptions ($12,000 total), they are left with a taxable income of just $14,400. This leaves the couple in the 10% tax bracket with a tax bill of $1,440 before applying for any tax credits.
  • At Amy and Jason's income level, the Retirement Savings Contributions Credit amounts to $800. With one child, they are entitled to a $1,000 Child Tax Credit (taken as a $640 Child Tax Credit and a $360 refundable Additional Child Tax Credit).
  • Together, these tax credits completely wipe out the couple's tax liability and result in getting a refund of $360 (plus any federal income tax withheld during the year). That's better than $0 tax!

No Kids? You Can Still Pay $0 in Taxes

It's no doubt that having kids is a great way to lower your taxes. But Amy and Jason could still earn a six-figure salary and pay zero taxes without that cute little tax deduction chasing them around the house.

Here's another variation of the above scenario, if Amy and Jason didn't have kids.

42-year-olds-taxes-no-kids

Let's give the couple a slight pay cut to a combined salary of $102,000 and remove the $5,000 deduction for the childcare FSA contribution (no kids = no childcare).

In this case, the couple is left with a net income of $36,000 and a $1,540 tax liability before tax credits. The Retirement Savings Contribution Credit would wipe out the entire tax liability, leaving Amy and Jason with a $0 tax bill.

The Retirement Savings Contributions Credit could be as high as $2,000 for Amy and Jason; however, it's limited by the actual tax liability ($1,540 in this case).

The Cost of Spending vs. Saving

You might object to the level of income that Amy and Jason take home each month. In the first example (with one kid), their income after deductions is only $36,000. That might be plenty in rural North Carolina where Amy and Jason live, but won't be enough to survive in higher cost of living areas like New York City or Silicon Valley. That's a valid criticism.

What if Amy and Jason didn't take advantage of any options to lower their taxable income? Their taxable income would be $85,400 (after standard deduction and personal exemptions). The couple would owe almost $12,000 in taxes at that income level.

In other words, Amy and Jason can save $12,000 on their taxes by maxing out their tax-deferred savings accounts and participating in flexible spending accounts.

Paying $0 Taxes on a Six-Figure Income

So how do you pay $0 taxes when you make six figures? The net result of clever tax moves has been proven. Here's the exact method to follow:

  1. Max out tax-deferred savings plans such as 401(k)s, 457s and IRAs
  2. Funnel medical and childcare expenses through HSAs or FSAs
  3. Don't miss out on common tax credits like the child tax credit and retirement savings contributions credit

Want to make sure you're taking advantage of all the tax benefits you can and paying as little taxes as possible? Get your accounts reviewed by a licensed professional like Personal Capital

Want to learn more about how to save on your taxes, even if you don't have a six-figure income? Check out Cofield's Concepts, an educational site from financial advisor Carter Cofield. In his tax course, you'll learn everything you need to know about how to take advantage of deductions and how taxes on investments work.

Further Reading: Our Cofield's Concepts review

Justin McCurry

At age 33 Justin retired from a career in civil engineering to spend more time with his family and pursue his other interests and hobbies. Justin founded RootofGood.com where he shares advice on reaching financial independence and enjoying the early retired life. After graduating NC State University with degrees in Civil Engineering and Spanish, Justin earned a Doctor of Jurisprudence degree from the School of Law at the University of North Carolina, Chapel Hill.

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17 Comments

  1. Please take in to consideration paying FICA taxes when considering the (take home pay) of $39,000 or $36,000. In the first example of $110,000 only the dependent care and FHA contributions are exempt from FICA so $110,000- $5,000 – $1,000= $104,000 * 7.65% = $7956.00. This would leave the family with only $31,044.00 to live on.

    In example 2 they would only have $28273.50 to live on.

    Even without a mortgage most people’s budget exceeds these amounts. Especially with childcare expenses.

  2. I’m admittedly being lazy and not reading any of the comments so I apologize if this has been mentioned.

    This article, unfortunately, mentions nothing of a possible AMT scenario, in which then what does one do? I can grasp most laws, as tedious and ambiguous as most of them are, but AMT ranks right up there in terms of number of words with a bare minimum amount of useful and applicable information.

    Could you guys expand on that as an article? Hell, I’d be willing to continue to “learn” more and more about it, and write one up as a guest article–but even then, it seems the most informative article one could write about the AMT would be a first-hand experience, or a few of them at that.

    Other than that, thanks for the write up. Don’t forget one other potential option: if you’re in this salary range and you go to school, tuition costs paid directly to the school is also a write-off– a fairly significant one at that, regardless of whether it’s undergrad tuition (as that wage amount would disqualify you from financial aid), or masters or beyond.

  3. They would be better off saving more in their health savings account and less in their 401(k)s, right?

    That would allow them to avoid (rather than defer) more taxes.

  4. My wife and I are almost identical with the 2nd variation… however we live in North Jersey and do not have access to a 457… in addition, we have a mortgage payment… after running the numbers its not even close as we are about 10K short of getting from the 15% to the 10% tax bracket, and would result in us not having enough money every month for the mortgage payment.

  5. Great article but completely misleading title. Household income of six figures is different than an individual income. Title should be “get married and file jointly to save money!”.

  6. It’s going to be sad sad day for the people that keep locking in their hard earned income in 401(k)’s and IRA’s when one day the government changes the rules on those and to top of it all the tax rates in 20+ years will be much much higher than they are today.

  7. Thanks for the great article.
    Just remember that you will have to pay the piper at some point. Retirement comes more quickly
    than seems possible. From friends and my own personal experience I got to see up close and
    personal how important it is to approach PRE-retirement with a balanced monetary situation
    and not have everything in tax deferred accounts. My casual observation is that by 55 you need
    several years of living expenses in already taxed accounts. After age 50 you are fair game to get fired,
    by 55 you can expect it. If you are prepared you can still moderate your taxes.

    1. That’s right! When you withdraw, you have to pay! Also, you lose the use of your money while it’s tied up.

  8. Love the idea and concept behind the article! Although, much of the tax is deferred rather than avoided completely. Uncle Sam always comes knocking eventually! Great information how you can max both 401k as well as 457 plan since it is non qualified.

  9. I love posts like this because they stretch my mind. However, I’m curious what this couple would do if they needed to install a new roof, buy a new car, etc. Would they tap into savings (would they even have savings with only $36/$39K of discretionary income?)? Would the borrow money, thus creating monthly payments?

  10. Awesome article! So many people forget about mileage. You can claim mileage for both health expenses and driving to and from church and making charatable donations. Don’t forget about charatable donations! I sell things on eBay and I also donate lots of things. In some states you can claim personal property tax and vehicle registration fees (I’m in VA). So cool!

    1. Good point, Crystal! We rarely managed to exceed the standard deduction ($12,600 for married filing jointly in 2015) so we couldn’t take advantage of deducting charitable contributions, mileage for driving to charity events, etc. But it pays to keep track of those and deduct if you can itemize.

  11. Great job Amy and Jason. You sound similar to Jason and his family at Root of Good who also live in North Carolina.

    Currently I am single without any kids living in NYC so lowering my taxes to zero is impossible right now. I am phased out of the traditional IRA tax deduction, but take advantage of maxing out my traditional 401k and come close with my HSA (work funds a portion which unfortunately counts towards your contributions). I unfortunately have to itemize just from paying so much state and local income tax living in NYC. But this allows me to deduct things like charitable contributions which helps.

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