A few weeks ago, in a blog post about income tax brackets, I pointed out that some people who make $100,000 a year pay zero income taxes.
That “pay zero income taxes” angle struck a chord with readers.
For a few days, we had a surge of traffic to the blog. That was sort of exciting!
Note: The aforementioned blog post appeared here: Income Tax Buckets Not Income Tax Brackets
But you know what? Let’s do this right. Let me provide detailed recipes for three situations where someone with $100,000 of income either pays zero income taxes or pays nearly zero in income taxes. Surprisingly, a number of people are able to arrange this happy situation. And understanding how some people pay zero income taxes on $100,000 of income tells you something about how our tax laws work.
Pay Zero Income Taxes Gambit #1: Qualified Dividends and Long-term Capital Gains Income
A first, easy case: Where someone earns most of their income via qualified dividends and long-term capital gains.
Suppose you are one half of a married couple filing jointly. If you receive $100,000 in qualified dividends and long-term capital gains and file your tax return using the standard deduction, you pay $600 in income taxes.
That’s nearly zero, though not quite zero… so you need one other little loophole to drive your income taxes down to nothing.
Fortunately, several things will do that. All you need is another dependent (a son or daughter for example) or to itemize your deductions and thereby claim $17,000-ish of itemized deductions instead of roughly $13,000 of standard deduction.
Obviously someone with $100,000 of income from qualified dividends is doing really well. One would guess this person has at least $2,000,000 in their investment portfolio if the income comes from both dividends and capital gains. If the income comes entirely from qualified dividends, the person probably has around $5,000,000 in their investment portfolio (based on a 2% dividend yield).
Two important notes (just to provide perspective): Someone in this situation has probably paid income taxes on the money they’ve accumulated in their portfolio of stocks generating qualified dividends and long-term capital gains. Further, the companies they’ve invested in (through those stocks) have already paid income taxes at the corporate level.
Summing up, you definitely pay zero income taxes in this situation. But you’ve already paid lots of income taxes to get to this position. And federal and state governments are surely taxing the profits of the businesses you own shares in.
Pay Zero Income Taxes Gambit #2: Foreign Earned Income Exclusion
Here’s another way to pay zero income taxes while making $100,000 a year.
If you earn $100,000 working outside the country and you meet the rules for the foreign earned income exclusion, you can exclude $100,000 of foreign earned income from US taxes. Which means you own’t pay any U.S. income taxes on your income.
To be precise, you can actually earn and exclude up to $102,100 in 2017 by the way… and this amount annually adjusts for inflation.
The easiest way to qualify for the foreign earned income exclusion is to be outside of the US for the entire year. (For more information, you can read more here.)
One wrinkle to the foreign earned income exclusion: If you are working outside the country, you may owe some other country income taxes on your earnings. But that isn’t always the case. Some countries don’t have income taxes.
Pay Zero Income Taxes Gambit #3: Real Estate Income Sheltered by Depreciation
Here’s a third way to pay zero income taxes while making $100,000 a year.
Let’s say you inherit (or for some other reason own) a $2,500,000 apartment building. Assume this building produces $100,000 a year of income.
If you’re a real estate investor you might describe this as a 4% capitalization rate because $100,000 divided by $2,500,000 equals 4%.
The big loophole available in this situation is the depreciation deduction for the non-land part of the $2,500,000. If $2,000,000 of the $2,500,000 is building, for example, you might be able to put a roughly $73,000 depreciation deduction on your tax return.
In other words, even though your apartment may be appreciating in value, you’ll be depreciating the apartment house and thereby adding about $73,000 of depreciation deduction to your annual tax returns.
With $100,000 of income, a $73,000-ish depreciation deduction, and then married filing joint status, the standard deduction and a dependent, your tax bill will be right around $250 annually. That’s pretty low. Not quite zero. But close.
Note: We’ve got another blog post that talks in more detail about the tax loopholes that real estate investors enjoy here: Real Estate Vs IRA and 401(k) Accounts, Part I.
Some Final Comments
Okay, let me stipulate that not many readers will be able to take one of these three gambits and zero out their income tax bill.
But can I offer a general observation? What you should realize is that our crazy tax law is riddled with loopholes—preferential tax rates, giant exclusions and surprising deductions—that let even very wealthy taxpayers pay zero income taxes.
And these two important clarifying comments: Usually, the “pay zero income taxes” situation isn’t quite as good as it seems at first blush. Do a careful accounting, for example, and you’ll see that this wealthy taxpayer may have already paid substantial income taxes to get to the situation where they now pay zero income taxes. Or someone else (like the businesses they own shares in) may be paying substantial income taxes. Or some other country may be taxing the wealthy taxpayer on their income.
And then this final important note: The more middle-class your or my income, the more loopholes we’ll find available. Which means the easier it becomes to pay zero income taxes.
I had to create awkward scenarios to show how someone can make $100,000 annual income and pay zero income taxes. But it’s easy to create commonplace scenarios that show how someone making an average income can pay zero income taxes. (I’ll talk about how someone making an average income can easily pay zero income taxes in next week’s blog post.)