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The 2017 GOP Tax Bill: How To Pay Zero Taxes

Now that we have a final version of the 2017 GOP tax bill, it’s time to talk for reals about the impacts on FIRE (financial independence and early retirement).  After the final tweaks to the bill were done in the House-Senate reconciliation process, the result is further moderation of the tax reform.  In fact, on the individual tax side, I wouldn’t call this a “reform” at all – more like tweaking of the existing structure.

 

But there is one big impact that folks in the FIRE community will love: The 2017 GOP tax bill dramatically raises the roof on how much money you can make, and still pay no taxes.  It’s a massive expansion of the zero tax bracket, or how much money you can make without paying taxes! Here’s how to pay zero taxes under the 2017 GOP tax bill:

 

First, What’s New

If you want to do your own homework (highly recommended), see the full text of the conference agreement here (whiskey, not beer).

 

There are a few things I think the FIRE community should know about what’s coming on the individual tax side. Specifically, things that impact what I call the zero tax bracket, or how much money you can make, and still pay zero income taxes.  Here are some highlights:

  • There will be minor reductions to the tax brackets. Most people will see a 2-4% decrease in their marginal tax rate.
  • The Standard Deduction is (nearly) doubling to $12,000 individual / $24,000 couple.  Doubling the standard deduction means very few of us will itemize our deductions in the future.
  • Personal Exemptions will be eliminated.
  • The Child Tax Credit is not only doubling in size, but it is becoming way more refundable.  That means those damn kids might finally start to pay for themselves! In fact, taxpayers with kids can make a lot more money, and still pay zero taxes.
  • No major changes to retirement accounts (Yay!).
  • The New Pass-Through Deduction is a pretty big deal if you’re a freelancer, consultant, side-hustler, or self-employed.  It’s going to make self-employment income much more attractive.
  • The Zero Tax Bracket increases for all types of taxpayers (Yay!)

 

(Mostly) Lower Tax Brackets

There are some minor decreases to the tax brackets – we still have seven of them.  There’s generally a 2%-4% decrease for most brackets, but virtually no change in the bottom 10% bracket, and an expansion of the 35% bracket. Here’s a comparison of 2017 tax brackets to the new 2018 brackets for single filers:

 

New 2018 Tax Brackets Single Filers 2017 GOP Tax Bill

And for joint filers:

 

New 2018 Tax Brackets Joint Filers 2017 GOP Tax Bill

Deductions and Exemptions

The big change here is that the standard deduction is (nearly) doubling to $12,000 single / $24,000 couple.  This means that even more people will be using the standard deduction, instead of itemizing.  At the same time, the personal exemptions are being eliminated.  The impact of these two changes offset each other.

 

For people with three or more personal exemptions (e.g. a family of three or more), these two changes would appear to be a tax increase at first glance.  However, the child tax credit is also increasing, and will more than offset any increase herein for nearly all taxpayers (see more on that below).

 

Regarding itemized deductions, the original House bill proposed to severely limit the mortgage interest deduction and the state and local tax deduction (SALT).  That didn’t really happen in the final version of the bill.  The mortgage interest deduction will be limited to interest on mortgages up to $750k (previously $1M).  But existing mortgages are grandfathered in.  The SALT deduction will be limited to $10k total of property tax and state income tax or state sales tax.

 

Those limitations are rather generous, but with increase in the standard deduction, around of 90% of taxpayers are expected to use the standard deduction.  I know I probably will.

 

Increasing The Child Tax Credit + Refunds!

The Child Tax Credit is doubling from $1,000 per child to $2,000 per child.  But, what’s more, it’s going to be refundable up to $1,400 per child.  Previously the refund on the child tax credit was much more limited.  The new law will mean refunds to far more taxpayers.

 

In fact, you can make more than the median household income and still get a refund! A family of four would get a refund (i.e. pay negative taxes) if they make $60,508 or less.  That’s nearly 10% higher than the U.S. median household income!  See the new zero tax brackets below to find out how much you can make and still pay zero taxes.

 

The New Pass-Through Deduction

Perhaps the most enticing change in the 2017 GOP tax bill is the new pass-through deduction.  The press coverage I’ve read about it focuses on its benefit for high-income earners, but the deduction can also be used by small businesses, freelancers, independent contractors, and side-hustlers as well. And that’s is why I really like it.

 

The pass-through deduction will give a 20% deduction for income earned by partnerships, S-corps, LLCs, and sole-proprietorships.  Essentially, any small business, consultant, freelancer, or side-hustler that is not incorporated as a C-corp will be able to use it. It’s like getting a 20% discount on your small business or consulting income.

 

If you have a service-oriented business, the deduction can only be taken in full for income below $157,500 individual or $315,000 couple, and is phased-out above those thresholds. As defined, “service businesses” includes the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or any service provider “where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners”.

 

This new pass-through deduction is a huge bonus for 1099 consultants, side-hustlers, freelancers, and sole-proprietors.  Yet another reason to start a side-hustle or just completely leave the employee life behind.  In my case, my wife has a small home business, and I also plan to seek temp/contract work in the future (early retirement is dead to me).  So, this could be a huge benefit to us.

 

Retirement Accounts

The 2017 GOP Tax bill makes no major changes to retirement accounts (Yay!).  Probably the biggest change is that Roth recharacterizations will no longer be allowed for Roth conversions.  A recharacterization is essentially “undoing” or reversing money you converted into a Roth. If you perform a Roth conversion, and subsequently decide that you made a bad choice – perhaps because your taxes are higher than you anticipated – you could undo the conversion in the same year via a recharacterization.  These takebacks will no longer be allowed for Roth conversions.

 

Of note, recharacterizations will still be allowed for Roth contributions or rollovers – just not conversions.  As a refresher, a “contribution” is the new money you put into retirement accounts each year.  A “rollover” is when you move money from a 401k or similar employer-sponsored account into an IRA, and a “conversion” is when you move money from a pre-tax IRA to a Roth IRA.  Recharacterizations are still allowed for contributions and rollovers – just not conversions. See more about recharacterizations here.

 

The New Zero Tax Bracket

So, with all those changes, here’s what the new zero tax brackets will look like – i.e. how much money you can make and still pay zero taxes.  It makes sense to consider the zero tax brackets while including the impact of the child tax credit, because that’s a credit that you essentially don’t have to do anything to receive – just be who you are.  So, I’m presenting this for various taxpayer types, considering whether they have qualified children.

 

The Zero Tax Threshold (including child tax credit)

Taxpayer StatusOld Law, 2017New Law, 2018
Single$10,400$12,000
Single, 1 child$24,450$30,254
Single, 2 children$42,550$48,508
Single, Over 65$11,650$12,000
Married, no child$20,800$24,000
Married, 1 child$34,500$43,842
Married, 2 children$48,900$60,508
Married, no child, over 65$23,300$24,000

Note: Zero Tax Threshold including the child tax credit is calculated as Standard Deduction + Exemptions + (child tax credit)/0.10 for current law, and Standard Deduction + ((child tax credit)/marginal tax rates) under the new GOP tax bill.  Assumes children are qualified for child tax credit.

 

The more (qualifying) dependents you have, the more the zero tax threshold increases when we consider the child credit.

 

Impact On My Own Personal Taxes

My own personal taxes are going down for sure.  My family of four plans to make about $50k or so next year through a combination of side-hustles and part-time or temporary work. With the refundable child tax credit, I’ll qualify for a refund of around $1,200 under the new law.  Under the old law, I would have paid zero taxes, but no refund.  So this is a nice tax decrease in my case. That’s great, because it means I can work even less and still cover my costs!  Yay!

 

Or, I can work more (boo!).  I could make about $10k more and still pay no taxes.  Beyond that, nearly all of my income will qualify for the new pass-through deduction.  That means my marginal tax rate will still be quite low. If I have an opportunity to make more money (without working too much), I may want to take it.

 

The 2017 GOP tax bill means a massive increase in the zero tax threshold for nearly everyone.  That’s a huge boon to early retirement dreamers who may want to continue earning a bit on the side or through part-time work.  Not only does the new tax law keep the dream alive, it gives it a massive boost!

 

Cheers,

Jojo Bobo

 

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24 Responses
  • CRMT
    December 18, 2017

    When you say that the pass through deduction phases out for income over $157/$315k, do you mean it goes away altogether or that it scales back? If the latter, to what extent?

    • JoJoBoBo
      December 18, 2017

      It’s a limitation (not a phase-out) on the deduction that is introduced over a range $50k single / $100k joint above the thresholds. That means someone making above the threshold can still take the deduction, but the deduction is increasingly limited as income goes up (it will be something less than 20% of any pass-through income above the thresholds). When you reach $207,500 single or $415,000 joint, the limitation is fully in place. Every additional dollar you make from pass-through income may still be deductible, but it will just be a smaller percent. The math on calculating the limitation is rather complicated, and is unique to your own situation. It takes into account any W-2 wages your business pays, and compares the difference between that number with the raw 20% deduction number. The limitation is meant to prevent people from under-allocating income to W-2 wages from pass-through businesses. It’s discussed at page 556 of the conference agreement. Cheers! JB

      • Hank
        December 19, 2017

        Here’s my big question: does that 20% pass-through deduction count against self-employment tax, too? Or only income tax? That would make a big difference to me I’d I can deduct it from income used to calculate my self-employment tax. I’ve read things that imply contradictory answers.

        • Hank
          December 19, 2017

          The reason I ask is I’m a sole proprietor who will now be eligible for the deduction, but I pay the 15.3% on ALL my income at the moment. Which is back-breaking.

          • JoJoBoBo
            December 19, 2017

            Hank, the deduction is going to be after AGI. The conference agreement clearly says so on page 562. That means it won’t reduce your self-employment tax, because self-employment tax is calculated prior to AGI. I hear you that the self-employment tax is a bear. But I’d rather take this deduction than not take it!
            -JB

    • JoJoBoBo
      December 21, 2017

      CRMT,
      I want to further clarify / correct this. There are two important limitations that begin at the $157,500 individual / $315,000 joint thresholds. The first one, is a wage and capital limitation, which I described in my earlier comment. This applies to all pass-through businesses. Your deduction will be limited by the lessor of a) 50% of W-2 wages paid by your pass-through business or b) 25% of the W-2 wages plus 2.5% of your unadjusted cost basis of qualified business property.

      The second limitation is for service-oriented businesses only, which get a complete phase-out. If you have a service-oriented business, you will not qualify for any deduction if you are above the phase-out range of $50k single / $100k joint above the thresholds.

      Both limitations use the same thresholds and the same phase-in range.
      -JB

  • Hank
    December 19, 2017

    JoJo– Yes, I saw that it was after AGI, but I’ve also seen where it was done that way for a variety of reasons, and that other will be a “special deduction” from AGI. There was an implication that the nature of the deduction might remove it from the calculation of SE tax, because that was part of the reason behind it. The idea was, this will put people like me on equal footing with those who take a salary and then take the rest of their Corp income as dividends or pass through not subject to SE tax. I just haven’t been able to find a definitive answer. One CPA said it will depend in how the regs are written. Thanks, though.

    • JoJoBoBo
      December 19, 2017

      I don’t see how it could reduce self-employment tax, since it is clearly post-AGI. In order to impact SE tax, it would have to impact AGI also, by definition, because SE tax impacts AGI. IRS would have to take a big liberty in the regs to make it impact SE tax, IMHO.
      -JB

  • Robert
    December 19, 2017

    I really wish they would have eliminated taxation of U.S. expats living abroad. I am a self-employed freelance translator, and I would have tremendously benefited if they did away with taxation of U.S. expats altogether. Up to $103k of my income is already excluded from taxes due to the foreign earned-income exclusion I take, but I still pay 15.9% self-employment tax…and I just read in the previous comment that this new 20% deduction for pass-through businesses won’t include that, so the net effect for me is nil. Was hoping to just worry about the taxes of the country I’m currently living in and not that of the U.S., too.

    • JoJoBoBo
      December 19, 2017

      Well, you could always renounce your U.S. citizenship…. No, I know it’s an unfortunate situation. They don’t make it easy. Unfortunately U.S. expats are not a big voting block. If you have the flexibility to earn your foreign income through a C-corp, you might want to look into the new territorial tax rules for corporations. I understand there are some complicated exceptions, and I haven’t looked into it, but the idea is that any income earned abroad by a corporation would not be subject to U.S. tax at the corporate level, only when paid out as a dividend or wage to a U.S. shareholder or employee (like you would be).
      -JB

    • JoJoBoBo
      December 20, 2017

      Hi again Robert. I noticed today that the new pass through deduction looks like it will only apply to income generated in the U.S. or Puerto Rico. It appears it won’t be available if your pass-through income was generated abroad. Sorry to bring you down.
      -JB

  • james
    December 19, 2017

    Well done. Awesome blog; I can’t believe it isn’t more popular yet. I’ve already turned a few people on to it. I’ve been reading every post in order the last couple weeks and I think I just caught up to July…

    Anyway, one thing I find interesting for someone at the (new) crossover between itemized and standard deduction if I’m understanding this correctly… having the Exemptions go away effectively bumps your Taxable income up significantly (especially with kids). I’ve been saving as hard as it takes in pretax accounts to get down to the 15/25 Marginal tax bracket and then splitting my next dollars 50/50 between Roth and traditional to stay right at the threshold. So even though the Marginal bracket thresholds are lower I’m effectively thrown into the next higher bracket due to having a higher taxable income. In my case married filing jointly with two kids and the doubled child tax credit more than compensates for this, but I just find it interesting that, all other things being equal and while not re-optimizing my savings strategy, I am now easily 10k into the 22% bracket having come from the 15% marginal tax bracket.
    For what it’s worth, it looks like my hypothetical 2017-GOP plan total tax vs actual 2017 federal tax is about $515 less (7%). I also realize that since I am right at the bubble of still itemizing in the next few years as I slip into the new standard deduction I will realize a further decrease in tax liability.
    p.s. for any interested, I use a kickass excel workbook every year to optimize my tax strategies. I have no affiliation… just wanted to share https://sites.google.com/site/excel1040/

    • JoJoBoBo
      December 20, 2017

      Hi James,
      Thanks for the vote of confidence!
      So, you’re saying that you have around $24k of itemized deductions (or maybe a bit more), and so raising the standard to $24k really doesn’t help you. But, eliminating the exemptions hurts you. And now your taxable income is higher as a result, even pushing you into a higher tax bracket (but with the child credit, your total tax will still be a bit lower). Do I have that right? Just a wild guess –
      you probably live in one of the high COL states like CA, NY, or NJ…. I’m actually in a similar situation myself in that my deductions are right around $24k too. But, what saves me is that my income will be very low next year, and will continue to be low for the foreseeable future, since I’m not working full time.
      Perhaps the new tax plan makes it even less attractive to make money, in some cases. In your case, you have a higher marginal rate, and I probably would to if I were still working full time. If you consider all the things that become more expensive with higher income – taxes (including SS), healthcare, college.. you can easily have way more than a 50% drag on your income if you make much more than the U.S. median. That’s not a lot of incentive to work! That’s a big reason why I’m going to keep my income below that threshold going forward.
      Thanks for the link to the spreadsheet. I’ll take a look at it when tax time roles around in a few weeks. It looks interesting!
      -JB

      • james
        December 20, 2017

        You got it exactly right. I scratched my head for a minute when I looked at your graph and followed a horizontal line of Taxable Income from current plan to proposed and didn’t end up in the 12% bracket I had fully expected to do.

        Most of my itemized deductions come from my mortgage interest. So, it is likely in the next couple years as I pay less interest I will start taking the standard deduction and enjoy a bit less tax burden. We also donate quite a large amount of things such as kid clothes so I’ll probably get a bit less lazy and try to sell those outright in the future instead.

        We actually live in a low cost of living area (St. Louis MO). We bought more house than we need. Breakdown on Sch. A is 18% income taxes, 21% real estate taxes, 52% mortg. Int., 8% cash and donations which all totals to 26k for current year.

        Your post on the FAFSA optimization is very good. I’ve forwarded to quite a few folks and really got them to think a little harder at this FI thing. I’d already done some preliminary scratching of the surface and had many of the same ideas, but haven’t got into full optimization mode yet as my kids are quite a bit younger than yours. One thing I need to get my head around is how having rental property affects the optimization and if doing an upREIT might have benefits here. Furthermore, if all goes well, my wife will get a pension the first day we can buy it out early. This is another wrinkle (aka good problem to have) come college time.

        Re spreadsheet: it is great. For some reason, he locks it down and some of the formulas are a bit challenging to follow but if you unprotect it and dig around a bit to get a feel for how he writes the logic it is an incredible tool to do what-if and sensitivity analysis. He does do a good job with named ranges so con+G is very handy to move between the tens of sheets.

  • Eric
    December 20, 2017

    Very good blog!
    Is the vehicle tax deductions touched at all?

  • Eric
    December 20, 2017

    Follow-up-

    Just wondering if I should buy a new vehicle by the end of the year or if I can wait till next year since I am a 1099 and I use my vehicles more then 80% for business?

    • JoJoBoBo
      December 21, 2017

      Eric,
      The EV credit survived – did not get eliminated. But, if you want my advice, I recommend buying used EVs, rather than new. They aren’t eligible for the tax credit, but there is a massive glut of used EVs for sale that nobody wants to buy. You can get a really good deal. Just my $0.02
      -JB

  • Chris
    December 21, 2017

    Hi,

    Great posts, very helpful. How is the $157,500 (single) and $315,000 (married) phase out limit for the pass through deduction determined? Is it based on business income only or total income? For example, if one has $400k of wage income from an employer but moonlights as as a consultant to make an additional $150k, is the income used $550k or $150k?

    Thanks Chris

  • JoJoBoBo
    December 21, 2017

    Chris,
    If your total income from all sources is above $315k, then you’ll be subject to the limitations. In your case, you are probably a service-oriented business, and thus your pass-through deduction will be totally phased out above $415k total income.

    There are two important limitations that begin at the $157,500 individual / $315,000 joint thresholds.  One is that service-oriented businesses get a complete phase-out.  If you have a service-oriented business, you will not qualify for any deduction if you are above the phase-out range of $50k single / $100k joint above the thresholds.  The second limitation is a wage and capital limit that applies to all pass-through businesses, which looks at the W-2 wages paid by your business and also the unadjusted gross basis of qualified business property.
    -JB

    • Fred
      December 22, 2017

      Hi,

      Very helpful information. I am an independent financial services professional and would definitely be classified as a service business. Are you saying if my total income is above $207,500 ($157,500 + $50,000 in phase-out range) as a single filer then I am not allowed to take any deduction whatsoever, or I would be allowed to deduct the full 20% up to $157,500 and then some deduction based on a formula for the incremental $50,000?

      Thanks so much!

      • JoJoBoBo
        December 22, 2017

        Hi Fred,
        No deduction in your case if your income is above $207,500, as a service business. If you have no W-2 employees in the business, then I believe the deduction disappears completely at $157.5k – it seems like it could be a hard cutoff, with no gradual phase out if you have no employees. Although that aspect of the phase-out is not clear to me, and we may need to wait for the IRS regs later in 2018 to clarify. But clearly, above $207.5k you’d have no deduction.
        -JB

  • Jeff L
    December 22, 2017

    Hi:

    Thanks for clarifying that the pass-thru deduction is against AGI and does not reduce business income and thus does not affect the self-employment tax. Your site has been the only place I could find this clarification!

    Along this line, if you take the 12000/24000 standard deduction and therefore do not itemize, are you still allowed to take a home office deduction?

    Under current law, for example, mortgage interest that is allocated to the home office deduction reduces the Schedule A mortgage interest deduction. For anyone whose Schedule A deductions plus home office deduction are close to the standard deduction, the standard deduction will be pretty useless, because you will not want to give up the reduction in self-employment tax that would occur if you give up the home office deduction.

    Jeff

    • JoJoBoBo
      December 22, 2017

      Hi Jeff,
      You are currently allowed to take the home office deduction, whether or not you itemize on schedule A. You allocate mortgage interest to the home office for the home office deduction, and then the remainder can go towards schedule A if you itemize. But, there’s no requirement that you itemize. The rules for the home office deduction should not change.
      -JB

      • Jeff L
        December 22, 2017

        Thanks for your reply. This would be great!
        Jeff

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