The tax code provides leniency to low-income and high-net-worth taxpayers. This begs the question: Which group receives the greatest generosity? Low-income taxpayers can receive refundable credits like the earned income tax credit, which makes it possible to get back more money than they paid. Wealthy taxpayers benefit greatly from step-ups on this basis which wipes out an unlimited amount of capital gains tax. An unlimited tax exemption is rather generous and maximizing is pretty much impossible!
So, who gets what? And what does this mean for each of us?
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Bio: Jean-Luc Bourdain, CPA, PFS, Wealth Advisor
Who gets the most valuable tax breaks?
It would be fun to survey both groups and ask who they think are Uncle Sam’s favorite nieces and nephews. But for a more credible answer, let’s turn to the Government Accountability Office. Goa assessed tax provisions Those that are family-oriented, which benefit taxpayers below certain income thresholds, and compare them with wealth-oriented provisions.
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Conclusion: “Tax expenditures for some provisions that are more beneficial to wealthy families (…) are larger than expenditures for family-oriented provisions.” For example, the table below shows wealth-oriented provisions totaling about $252 billion, while family-oriented credit totaled about $187 billion in revenue loss.
Source: US Government Accountability Office
The GOA states that it has not considered every provision in the tax code. But I’d say it’s enough to give us a general idea.
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What does the tax code mean to you
You might conclude that to get the biggest tax benefits, it’s better to be wealthy than a low-income taxpayer. not so fast. Can’t we be both? Actually, this occasion is quite common. Of course, we’ve all heard of billionaires with low taxable income. But tax loopholes are an exclusive boon for the tycoon. The increasingly normalcy arises as a result of the confluence of broader retirement trends. That means it may be available to the rest of us.
Arriving at the Golden Age of Tax Planning
Let’s consider three elements that affect the modern retirement. First, instead of receiving a pension to pay for retirement, Americans typically deposit money in tax-advantaged accounts, such as a 401(k) or IRA. Second, when applicable, we should begin taking required minimum distributions (RMDs) from retirement accounts at age 72. Third, Social Security may make it tempting to delay retirement benefits until age 70. As a result, there may be several years between the time we retire and the time we should claim Social Security and take an RMD. Indeed, according to Gallup, Americans tend to retire in their early 60s.
During this lag period, retirees may have a higher net worth but manage a lower income. Think of it as reaching the tax-planning golden age to explore some of the tax code’s most lenient provisions. For example, some retirees may enjoy a 0% capital gains tax rate and crop benefits to make the most of it. Some people who retire before they qualify for Medicare at age 65 may also qualify for a larger health-insurance premium tax credit. More generally, this is an opportune time to consider Roth conversions.
Overall, the multitude of options available for retirement savings, including taxable, tax-deferred and tax-exempt accounts, provide various money spigots that can be adjusted as needed to optimize taxation during retirement. Financial complexity fosters opportunity.
Other Low Taxable Income Planning Opportunities
At the end of life, higher Medicare deductions can lead to lower taxable income. Extended longevity and expensive long-term care make this condition very common. Again, fully utilizing the medical deduction can be very valuable. Low income can also result from temporarily taking sabbaticals, starting a business, or taking care of a job. Any time our income drops, the tax code is the juicer to sip the proverbial lemonade.
To get the most generous tax breaks, it’s wise to build wealth and optimize for periods of lower taxable income. Modern retirement often begins and sometimes ends with such a period. Self-funded retirement also demands wealth creation, and the tax code provides considerable incentives for this. As we approach the golden age of planning, wealth-building incentives and low-income tax benefits can powerfully merge, and the tax code gives us the best of both worlds.
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Editor’s Note: This article is for general information and educational purposes only and is not intended to serve as specific financial, accounting, legal or tax advice. Individuals should speak to qualified professionals based on their individual circumstances. The analysis contained in this article may be based on third party information and may be out of date or otherwise removed without notice.
Content reviewed for tax accuracy by a TurboTax CPA specialist.
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