How I’ll Pay 5% in Income Taxes This Year (And How You Can Too)

U.S. Capitol at Night

New year, new changes to the tax code.  Unless you’ve been living under a rock for the past 6 months, you’re aware that there’s a new law of the land for U.S. income taxes.  As part of my planning for 2018, I tried to estimate my total tax burden as that’s one of the three main uses of earnings (the other two being spending and saving).  After doing all the math, I was somewhat shocked to see that my federal income tax would only be 5% of income.  Combined with Social Security/Medicare and state and local taxes, my total tax burden will only be about 15%.

I’ll walk you through my math for how I’m able to pay such a low rate and then the strategies you can use too.  I’m explicitly avoiding the politics of the tax changes in this discussion, and you should too.  We can only play the hand we’re dealt.

Quick Recap of Changes

This is been covered ad nauseum pretty much everywhere, so I’ll keep my remarks here brief and focused on the changes that impacted me.

Changes in Tax Brackets and Rates

While the number of tax brackets stayed the same, the tax bill tweaked the rates charged and the income levels they would apply to.  For married filing jointly tax payers, everyone has lower marginal rates except for a small section in the $400,000-range.  The difference in marginal rates for those earning between $238,000 and $316,000 is massive!

Married Filing Jointly Marginal Tax Rates

When you look at effective tax rates, you can really see the impact of the changes.  For a given dollar of taxable income, the rate paid now will be lower than it would have been under the old law.  The challenge is how you get to taxable income, which almost certainly changed under the new law.

Married Filing Jointly Effective Tax Rates

Change in Standard Deduction, Limits on Deductions, etc.

The other big changes in the tax bill impact how you get to taxable income.  The standard deduction doubled from $12,000 to $24,000 (again, married filing jointly) and a number of other deductions were reduced if you itemize.  You can only deduct state and local taxes up to $10,000 and mortgage interest on new loans up to $750,000.  With the state and local taxes limited to $10,000, married couples will need to come up with $14,000 of additional deductions before it makes sense to itemize.  Unless you have a huge mortgage, donate a lot to charity or have other large deductions, it just won’t be worth it.  The net impact will be a lot more people will just do the standard deduction.  We will fall into this camp despite itemizing every year up to this point.

Elimination of Personal Exemptions, Expanded Child Tax Credit

With the higher standard deduction, personal exemptions were eliminated as well.  This somewhat offsets the increased standard deduction, but child tax credits were expanded as well.  In prior years, the credit was $1,000 per kid and was non-refundable, meaning that the credit could only reduce your tax liability to zero not take it negative.  The credit also was subject to a phase-out starting at $110,000 for married couples (generally $75,000 for others).

Under the new law, the credit increases to $2,000 per kid, $1,400 of which is refundable.  The phase-out limit also increases to $400,000 for married couples ($200,000 for all others), which means this credit will become available for a huge new swath of people who previously made too much.  This credit will be new for us this year, and with two kids is a big driver of how our tax bill will be so low.

How We’ll Have A 5% Effective Tax Rate


My wife and I are both professionals with good jobs in high-paying fields (I’m in finance, she’s in healthcare).  Our combined gross earned income is about $160,000 and I’m happy to say we each contribute about half of the total.  In addition, we have a small amount of taxable interest from checking/savings accounts, $1,000 in non-qualified dividends (primarily REIT income) and $4,000 in business income (primarily real estate crowdfunding).  We also expect to have about $3,000 in taxable dividends based on prior years’ experience.  Given where our income tax bracket shakes out, we’ll pay 15% on those.  While I don’t anticipate selling any investments that would generate capital gains, we have loss carry-forwards from prior years that would eliminate any tax liability.

2018 Income Table

If we just took gross income with no deductions or credits other than the standard deduction, we’d have paid over $23,000 in income tax for a 14% effective tax rate.  That’s more than double the rate we’ll ultimately pay, which really shows the value of those deductions and credits.


As you no doubt guessed, we are able to take advantage of a number of deductions which all reduce our taxable income.  Without them, we’d be in the new 22% tax bracket, so every dollar of income we can shield from taxes will save us $0.22.

2018 Deductions Table

The first big deduction is from 401k contributions.  My wife and I will both max out our 401ks this year, which will reduce taxable income by $37,000.  By prioritizing saving for retirement, we saved over $8,000 in taxes.  I know we’ll have to pay those taxes eventually, but deferring them as far into the future as possible reduces their present value.

We’ll also each make a $5,500 contribution to Roth IRAs, since our adjusted gross income will be just over the $121,000 phase-out limit for deducting traditional IRA contributions.  If our adjusted gross income were lower, we would make deductible contributions to traditional IRAs, which would lower our tax bill even further.

Next up are two payroll-related deductions.  We pay about $2,100 per year for medical, dental, and vision insurance.  Our total is relatively low because we use a high-deductible plan for medical insurance.  Because they come out of my paycheck, they reduce our taxable income.  We also contribute $5,000 to a childcare flexible spending account (FSA), which we then draw on throughout the year to pay for daycare bills.  It’s not enough to cover all our childcare, but I like to think of it as Uncle Sam picking up $1,000 of the bill for us.

We are also able to apply $3,000 per year of a previously earned capital loss carry-forward against earned income.  It would have avoided 15% capital gains tax had I used it to offset capital gains, so I’m really only picking up the 7% spread between that and my 22% marginal tax rate.  This if obviously more valuable the higher your marginal tax bracket, but it’s small relative dollars at that point too.

Finally, we have the $24,000 standard deduction that we will use this year instead of itemizing.  I just don’t see a scenario where we would have enough itemized deductions to exceed that level.  Take all of these together and our approximately $165,000 of total income is reduced to $94,000, which means we were able to avoid or defer more than $15,000 in income taxes.

Federal Income Tax Estimate

With $94,000 of taxable income, we’ll still be in the 22% tax bracket but at the bottom of the range instead of the top.  Combined with 15% tax on qualified dividends, we’ll owe just over $13,000 in federal income tax.  But wait, I have two kids and am well under the new $400,000 phase-out for the child tax credits.  Those are worth $2,000 a piece and are a dollar-for-dollar reduction in my tax bill.  Factoring those in, we’ll pay only about $9,000 in taxes on $168,000 of total gross income, for an effective tax rate of 5.4%!

2018 Taxes Table

Strategies for Reducing Your Tax Bill

  • Maximize contributions to retirement accounts.  This one should be obvious, but every dollar you can save in a 401k will push your tax bill out to retirement instead of today.  The tax reduction is guaranteed, whereas it isn’t necessarily with an IRA unless your adjusted gross income is low enough.
  • Take advantage of employer-provided coverage.  If you have access to programs like a flexible spending account through work, use them.  Think of your marginal tax rate as the discount you’ll get on the things you pay for with those funds.  For the hour or so a year of paperwork, we put over $1,000 back in our pocket by using the childcare FSA.
  • Tax loss harvest your investment portfolio.  Some robo-advisors do this for you or you can DIY, but having loss carry-forwards will allow you to save the spread between capital gains and income taxes on up to $3,000 of income per year.
  • Have more kids (I’m joking).  But seriously, there is a more value here now and it’s open to a lot more people.  The $4,000 we’ll save in taxes at our 22% marginal rate is the same as shielding more than $18,000 in income through deductions.  In other words, just by having two kids I was able to save the same in taxes as by maxing out my 401k!
  • Move to a lower-cost state (still joking).  That seems like the tail wagging the dog, but there is no doubt people in higher cost and higher tax states may have some pain coming their way as a result of the reduced state and local tax deductions.  Everyone’s situation is different, but the changes to the federal tax law will make some areas relatively more expensive due to the reduced deductibility.

Where will your taxes come out in 2018?  What other strategies will you use to reduce your tax bill?

John started Present Value Finance in 2017 to share his experiences and insights on personal finance to help people make better decisions and take control of their financial lives.  

He achieved financial independence in 2016 by walking away from the high stress world of corporate finance to focus on his family. He’s a husband, father, family CFO, and all around finance geek.


    1. Thanks. When you have the discipline to save a lot of your income, it’s almost like the government is subsidizing it by having such a small tax burden relative to income. Probably should have mentioned that in the post. 😊

  1. Excellent! Really clear exposition, I found this really helpful. Tax is not my strong point, but this helped my understanding.
    You said that you have a high deductible health plan, but you don’t mention an HSA. Am I missing something there?

    1. You’re not missing anything. My employer doesn’t have an HSA option, but rather an HRA. They contribute money to it, but it’s technically theirs not mine. It’s not portable, but any unused does roll over to the next year. I have a standing quarterly call to complain to our HR department about getting one. I do have an HSA left over from a prior job however. I can draw money from it, I just can’t contribute.

  2. Nice post, John .

    I got here from your question in my post on the Rockstar Finance Forum.

    It’s my first time checking out your blog.

    You certainly seem to be a finance geek (in a good way)!

    Your tax insights and conclusions are pretty spot on.

    The only thing I would add since you seem to want to get it down to the dollar is that you should also be eligible for a bit of a child and dependent care credit.

    If you contribute $5,000 to your FSA, you should still have $1,000 in child and dependent care expenses that would be eligible for the credit (typically 20% of child and dependent care expenses up to $3,000/ child for up to 2 children, but less any amounts contributed to an FSA).

    So, your net tax liability should be $200 less.

    Other than that, I came up with the same amounts.

    Well done.

    -Howard (The Online Biz Tax Guy)

    1. Hi Howard, thanks for taking a look at everything and glad that I’m pretty spot on. That’s good to about the additional child and dependent expenses above the FSA contribution. Every little bit helps!

  3. We are tax nerds (particularly the Mrs.) at the Need2Save household. She has already run the numbers and we should be saving around $8k a year in federal taxes. Nowhere near your 5% effective rate, but an improvement.

    A few strikes against us:
    – We live in Maryland –> high SALT rate
    – Our kids are 18 and 19, so no child tax credit
    – Higher income pushes us up into the 32% marginal tax rate. Some relief though with the changes

    1. $8k lower taxes is nothing to sneeze at. Assuming you redirect that to savings, does it shave much off your time to reach FI?

      1. Yes, those savings will be invested. It could shave between 6 and 9 months off our FIRE date. We are looking at approximately $60k per year (today’s dollars) in spending during our ‘gap years’ before we start pulling from our 401k and IRA accounts.

    2. One of the changes to the child tax credit is that their will now be a $500 credit for dependents that are not “qualifying children”. So, assuming you still claim them on your tax return, that should be another $1,000 for you.

      1. Yeah, we need to look into that a bit more. We will not be claiming the 19-year-old on our return, but we are claiming the 18-year-old. Thanks for the reminder on the ‘non-qualifying children’.

  4. I read this thoroughly and just fully absorbed that I will pay substantially lower taxes in 2018. – yipeeee!!! It is also the first year that I won’t itemize and I won’t miss it one bit.

    1. Glad to hear. The trick is to save the difference use to make progress towards FI versus spending on random stuff. My employer just told us they got new payroll withholding tables which will be reflected in our first February checks. This is about to get real…

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