Updated for 2008 Taxes: Turning a $57,000 Salary into a Zero Tax Liability

Originally was "Turning a $55,000 Salary into a Zero Tax Liability."
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This is all perfectly legal—just use the government’s own tax code against them, as you can learn to do for yourself.

Here’s what Joe Taxpayer did:

• Got married and stayed that way—this earns him $19,500.

• Contributed the max to a 401k plan—this earns him $15,500.

• Contributed the max to two IRAs (his & his wife’s)—this earns him $8,000.

• Because he contributed so much to savings, he got the saver’s credit—this covered what little he did owe after all deductions and other credits. This could’ve earned him up to $2,000, but only earned him $1,148.

• He contributes to his employer’s pension plan and opted for a PPO plan—this earns him $2,550 in pre-tax dollars.

• He used a commercial tax preparer for his return—they cost him $159 to use, but got him over ten times that amount for a refund. They do this consistently.

These are completely legal tax shelters, folks. These are also the most obvious ones.

He has a non-working spouse and no kids. If he had kids, he’d have even more deductions and credits. What he and his wife do have, and will always have, is the ability to live a frugal enough lifestyle to make it on half his salary. They could do even better if it weren't for recent large rent raises, food inflation, and high gas prices.

After his taxes were done, he visited the IRS’s W-4 withholding calculator (as he does every year) to re-balance his exemptions—he should owe zero taxes and should receive zero refund, so his 2008 refund told him that he wasn’t using enough exemptions. The IRS calculator told him he should double his exemptions to avoid that refund—this would get him his own money back during the year (when he needs it) instead of at the end. Now, he’ll owe a very small amount to the IRS, but the saver’s credit should wipe that out for him. If not, he can easily afford to pay whatever he owes.

In the meantime, re-balancing his federal withholding exemptions earns him a $175 monthly increase completely tax-free. He now has a raise and doesn’t have to work any more or harder for it. He didn’t even have to negotiate with his boss for it.

By the example shown above, Joe is technically not a “taxpayer”—this means if the economic stimulus package currently being bandied about ever came into existence, and followed the Bush plan for distribution, Joe and his wife could expect to receive nothing because of their careful and diligent tax planning. They didn’t owe taxes, so they didn’t “pay” taxes, regardless of what was taken out of his paychecks in the form of payroll deductions. Anybody who’s entitled to a refund also falls into this category of non-taxpayers, as well as people who didn’t earn an income and didn’t file, and those not making enough money to pay federal income taxes at all. What this “taxpayer” term actually refers to is EXCESS taxes owed beyond what you have deducted in the form of federal income and payroll taxes. You can think of AMT payers, and anybody who still owes each year after diligent tax planning, as the real taxpayers.

Joe wonders how high his annual salary can go before he runs out of government-given deductions and credits—it seems that every time he starts to get into owing-the-IRS territory, some new credit or deduction comes out, making him even more relieved he uses a paid tax preparer (just to keep track). He knows that if he gets involved with itemized deductions or business deductions, his rising salary could go on being tax-free for a very long time (until he hits the AMT threshold), but he thinks this is just too much hassle. He figures that when he starts to owe the same amount in taxes that his tax preparer charges each year, then he’ll begin working a little harder at creating deductions and qualifying for credits.

If you would like to re-balance your own W-4 withholding allowances, see the IRS calculator. See instructions and Form 8880 for the saver's credit.