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This isn't one of those posts that tells you to cut your cable to save an extra $1,000 a year. Nor is this post going to give you 100+ ways to increase your income by signing up for online survey sites.
Today I'm going to talk to you instead about a sustainable way to put more money back in your pocket. One that doesn't require you to cut back too much on your spending and doesn't take a bunch of time.
Over the past two years (2018 & 2019), our family has saved several thousand dollars of our income by optimizing our taxes.
We are being smarter with how (and when) we are earning our income. By using the federal tax code, we are calculating the best ways to maximize our income and optimize both our current and future taxes.
For example, just this year (2019) I was able to max out my 457b contributions at my workplace plan for a total of $19,000.
That is $19,000 of deferred income that we can invest now and give it time to grow. Next year when the contribution limits increase by $500, we will contribute $19,500 to this same plan.
This is just one simple and effective way to grow our net worth through tax optimization.
In order to plan out our income and taxes for 2020, it is that time of year once again, where I calculate what is known as our FREE Money.
Each and every year this FREE Money value is different for our family.
This term refers to the amount of income our family can earn before any federal taxes are taken out.
Let's explore a little further about how you too can calculate your FREE Money by looking at our current situation.
How to Calculate Our 2020 FREE Money
The goal of our 2020 FREE Money calculation is to figure out how much income we can earn while minimizing our federal taxes.
Note - It is a bit more complicated optimizing our State taxes, so for now we just focus on federal.
Back in 2018, running this calculation helped our family optimize our income and investments resulting in a $0 federal tax obligation.
And even though 2019 isn't officially over yet, it appears our FREE Money calculation that we ran last year will produce the same results.
Looking forward into 2020, running our FREE Money calculation will allow us once again to optimize our income and investments. However, unlike the past two years, we have some new challenges to account for.
I don't want to sound like we are complaining ... the challenges we face are good problems to have. That is the beauty of running these calculations ... it allows us to be prepared and make sound financial decisions for our future.
2020 Tax Information
Before we get started, let's list the information we need to calculate our FREE Money –
The first piece of information we need are the number of children we have that are eligible for the Child Tax Credit.
My wife and I are a single income household with 3 children. The past two years we have been able to take advantage of the Child Tax Credit for all 3 of our kids. However, since our oldest will turn 17 before the end of 2020 ... he will no longer be eligible for this credit.
So the first challenge of 2020 will be to figure out how much this loss of tax credit will impact our bottom line.
The second piece of information we need is our filing status.
Just like last year (and since we've been married), my wife and I will file our taxes as Married Filing Jointly.
Now that we have our required information, let's take a look at the updated 2020 tax brackets.
2020 Tax Brackets
The 2020 tax brackets are out and there has been a slight increase in the income amounts, just like in the past couple of years.
For more information on your specific tax bracket, check out the 2020 Tax Rates.
For our family, my wife and I file as Married Filing Jointly (MFJ).
Based on our filing status, the following are the tax brackets we are concerned with for 2020. Please note that your filing status and income levels may be much different than ours.
Note - Keep in mind there are several other tax brackets past 22%. However, based on our current income levels ... our family is really only concerned with the 10% and 12% brackets. However, there is a slight chance we could get close to the 22% bracket ... which is why it is included in the list above.
Now that we know our different tax brackets ... the next step is to figure out our deductions.
1. Standard Deduction
Up until 2018 ... my wife and I had always taken the itemized deduction on our tax return. Ever since we have been married and owned a home, we have paid property taxes and mortgage interest.
In addition, every year we typically donate a bunch of clothing (mostly children's) and household items to local charity.
Combined ... these deductions were well above the old standard deduction (around $13,000 in 2017). But now with an increased standard deduction ... it no longer makes sense to itemize.
So instead ... for the 3rd year in a row (2018, 2019, and 2020) we will take the $24,800 standard deduction for married couples filing jointly (MFJ) next year.
The standard deduction for married couples filing jointly went up by another $400 for 2020 ... so this is a good start towards earning more FREE Money.
2020 Standard Deduction = $24,800
What does this mean for our taxes?
It means that our first $24,800 of taxable income is exempt from any federal tax!
2. Child Tax Credits
Having kids is great. But I won't lie ... they are expensive ... or can be if you don't watch out.
The one exception, where they can help save money is when we file our taxes. Starting in 2018, the child tax credit doubled from $1,000 to $2,000 per kid. That meant a huge tax break for family's with kids. And the more kids a family had ... the more tax break!
Guess what? The $2,000 child tax credit will remain the same for 2020!
But the bad news (for us) is that our oldest child will no longer be eligible ... since he will turn 17 before the end of 2020. So starting in 2020, we will only have 2 Child Tax Credits available instead of 3.
Let's take a look at how the Child Tax Credits work for our situation (or any MFJ with 2 kids under 16) -
Credit #1 – $1,975 on the first $19,750 of income in the 10% bracket
The first credit of $2,000 covers the entire 10% bracket, plus a bit leftover in the 12% bracket. This is a great start!
Tax Free Income = $19,750
The good news is that we still have another $25 in credit that can be carried forward into the 12% bracket.
Credit #1 – $25 in the 12% bracket
The remaining $25 of our 1st child tax credit will help us get more free money in the next tax bracket at 12%. This is on the income we earn between $19,751 up to $80,250.
So with our remaining kid #1 tax credit, we now get an additional $416.67 of tax free income in the 12% bracket. We calculated this by - ($25 / .12) = $208.33.
Tax Free Income = $208.33
Now we can bring in our second child tax credit which will fill up even more of the the 12% tax bracket!
Credit #2 – $2,000 on the next $16,666.67 of income in the 12% bracket
Our second $2,000 credit in the 12% bracket will get us an additional $16,666.67 of tax free income based on this calculation - ($2,000 / .12) = $16,666.67.
Tax Free Income = $16,666.67
Credit #3 – Goes Away in 2020 for Our Family
I will mention it again ... our 3rd Child Tax Credit will go away in 2020.
Since our oldest will be turning 17 before the end of next year ... we can no longer take advantage of this tax credit.
Total Child Tax Credits
After calculating each child tax credit, we can wipe out another $36,625 of income that won’t be taxed next year!
Child Tax Credits in 2020 – $36,625
Remember when I mentioned we will have some challenges this year managing our income and taxes? Well, it all starts with losing out on our 3rd Child Tax Credit.
Back in 2019, our Child Tax Credit would have covered $53,233 of income. This year (2020), we will only cover $36,625 of income ... a drop of ($16,608) of income!
Our 2020 FREE Money
So now that we know where our deductions and credits will come from in 2020, we can easily calculate our income that won’t have any federal tax.
Total Tax Free Income 2020 - $61,425
Overall that is a decrease of ($16,208) in FREE Money that we need to account for in 2020 compared to 2019 ($77,633).
Just like last year, I would suggest checking out the 2020 Free Money Tax Tables by The Millionaire Educator. If you are at all confused about how the credits and tax breaks impact your situation, these tax tables will really help you understand.
What Does This FREE Money Calculation Mean Anyways?
So we now know that our total tax free money for 2020 has decreased to $61,425.
But what does that really mean?
Well, it is actually very simple ... our first $61,425 of adjusted gross income will not have any federal income tax.
Anything earned over that amount would be taxed. So if we were to earn $80,000 in adjusted gross income next year ... we would pay 12% tax on any income earned between $61,426 all the way up to $80,250.
If our adjusted gross income was $90,000, then we'd pay 22% tax on the amount between $80,251 and $90,000 ... plus the amount mentioned earlier in the 12% bracket.
Unlike the past two years (2018 & 2019) where we paid (or will pay) $0 in federal taxes, the upcoming year (2020) will be much different. Because we no longer have our 3rd Child Tax Credit ... our goal is to keep our taxes within (or as close to) the 12% tax bracket. It won't be an awful thing to pay a portion of our taxes in the 22% bracket ... but we'll try to minimize that as much as possible.
This is where the real fun starts when it comes to tax optimization.
One scenario my wife and I have would be to max out all of our pre-tax investment buckets like our 457b, 401K, and IRA accounts so we have less taxable income if we like.
Another option would be to keep our income in the 22% tax bracket, which would mean we would owe some federal taxes in 2020. So instead of maxing out an IRA for example, we would max out our Roth IRA accounts. The benefit here would be future tax savings by investing in a Roth while paying a little bit of taxes next year.
Our options are endless and will be unique to our family. That is why it is so important to calculate your FREE Money totals.
Now that we know our 2020 FREE Money, stay tuned for a future post on our plans for optimizing our taxes next year.
Have you calculated your FREE Money amount for 2020? I strongly suggest you calculate it out so you can maximize your taxes.