Did you know there’s a completely legal way to make six figures a year, without paying ANY taxes?
It sounds too good to be true, but I promise it’s totally achievable with a little bit of patience. And you won’t even need to channel your inner Tony Soprano money launderer to make it happen.
If you work for a living, know that you’re getting burned.
If you ever want to beat any game, first you have to understand its rules.
So, let’s look at those rules.
For whatever reason, the United States tax laws are laser focused on people who earn their money from a job. A reminder from what’s quickly becoming one of my favorite quotes:
There is no lower, middle, or upper class. There is the investor class and the people who have to work for a living.”
If you have to work for a living, you’re subject to three special taxes, just for you:
1) Social Security tax
Right off the bat, an employee pays 6.2% of their annual income to Social Security.
In a sneaky PR move, this amount is actually applied in addition to your usual income tax rate. Most people don’t realize this, since the tax is automatically withheld from each paycheck, and for whatever reason, the topic tends to get a free pass during the once-every-four-years tax debate.
But if you ask me, 6.2% is 6.2%. So no ignoring allowed.
2) Medicare Tax
Along with the social security tax, Medicare tax represents the last piece to the “FICA” tax rate. In 2018, the Medicare tax rate is 1.45%.
Like social security, this amount is automatically taken out of your paycheck and paid in addition to your typical tax rate.
3) Federal Income Tax
Now we’re to the part where most people start paying attention. With the 2018 tax reform, here’s the latest federal tax brackets:
| Rate | Individuals | Married Filing Jointly |
| 10% | Up to $9,525 | Up to $19,050 |
| 12% | $9,526 to $38,700 | $19,051 to $77,400 |
| 22% | 38,701 to $82,500 | $77,401 to $165,000 |
| 24% | $82,501 to $157,500 | $165,001 to $315,000 |
| 32% | $157,501 to $200,000 | $315,001 to $400,000 |
| 35% | $200,001 to $500,000 | $400,001 to $600,000 |
| 37% | over $500,000 | over $600,000 |
Total Tax Burden
As you can see, it’s hard out there for an employee. By most estimates, the average wage earner pays roughly 31%* of their salary to the American government and its various bureaucracies. To put this in perspective, you can consider every day worked from January 1 to April 24 as your annual service to the government.
If you’re feeling bad, at least you’re not Canadian. They have to work until June 7th every year before they finally start putting money in their own pocket. (Shout out to Liquid for introducing me to the concept of Tax Freedom Day.)
*includes the employer’s portion of the FICA tax, which is another 7.65%.
Maybe you’re like me, and you’d like to avoid giving away all that money. Maybe, you’d like to earn over $100,000 a year and pay no taxes.
Time to become an investor.
The Loophole: Investment Income
You see, if your money happens to arrive in your bank account through the stocks that you own, rather than the labor you traded to an employer, your tax rates are much more favorable.
Just check out the new tax bracket for investment income, which has its whole own table with the 2018 tax reform:
Did you see it? Up there at the top, is our sweet spot. As a married couple, we can earn up to $77,200 of investment income and pay ZERO taxes.
You might be tempted to think this is just a recent policy change that will be revoked as soon as the current businessman is out of the oval office. Not so. Check out the tax brackets from the “old” tax law:
We could keep going, but for nearly all of the recent history, a married couple could earn some serious coin from investments while staying in the 0% investment income bracket.
The Catch That’s Not Really A Catch
Now, you might have also noticed, that these special tax brackets apply only to what’s called “qualified dividend income” and “long term capital gains.”
Qualified Dividend Income:
You probably already know the basics behind a dividend – they’re essentially checks paid out by companies every quarter or so, as a thank you for investing in their stock. They’re extremely steady, and often return 2-5% of the share price annually.
How do we find out if those dividend payments are “qualified” dividends? We have to look towards IRS publication 550, which just might be the most boring publication ever published, even by IRS standards. Leave it to the IRS to explain over 20+ pages that qualified dividends are basically any dividends:
- Paid by a US corporation
- Paid by a stock that you’ve held for at least 60 days.
In other words, pretty much every single dividend ever received by a buy-and-hold investor.
Long Term Capital Gains:
Also defined in the most boring way possible by the IRS, is “long-term capital gains.” This one is even easier. In general, if you held a stock for more than one year before selling, those profits are classified as long-term capital gains.
As you can see, neither of these qualifications are much of a hurdle for an investor who’s not trading stocks like a maniac.
How to Earn Over $100,000 a Year and Pay ZERO Taxes
First off, Money Wizard, your tables keep showing around $70k, not $100,000. And second, you haven’t actually explained how to pull this scheme of yours off.”
Correct and correct. So, let’s fix both of those.
As you remember from the table above, in the latest tax brackets, we can earn up to $77,200 per year without paying taxes. Which frankly, is already a ton of money, and equal to earning over 6 figures in pre-tax salary.
But here’s the cherry on top. We haven’t discussed deductions yet. The tax reform introduced standard deductions of $12,000 per individual, and $24,000 for married couples.
In other words, you can make $101,200 per year, and as long as you keep those earned wages less than $24k, you won’t owe a penny. (You could technically earn even more than $101k, if you had the itemized deductions to offset)
So, what’s this mean for our final strategy?
Step 1) Build up an epic portfolio of stocks
This is where your hustle comes in. Working hard, and more importantly, starting early, are key. My own portfolio is already slated to compound to around $2 million, even if I never invest another cent, just from the hardcore savings done in my 20s.
Step 2) Figure out how to produce $77,200 from the portfolio
With a 4% withdrawal rate, you’ll need a $1.9 million portfolio to produce $77K per year.
As we discussed, you can either invest directly into qualified dividend paying stocks or sell off portions of the portfolio which you’ve held for over a year.*
*If you chose to sell, you actually only get taxed on the amount your stocks gained. Meaning, if you buy a stock for $10 and sell it for $11, even though you’ve got $11 of income flowing in, for tax purposes, only $1 will be taxed as long term capital gains. Without getting into too much math, you could actually be living off even more than $77K of investment income per year while staying in a 0% tax bracket.
Step 3) Get a part time job, just for funzies.
You can make another $24K per year and still not owe any taxes, so time to live out your dream of becoming an amateur surf instructor, greeting Walmart customers, or whatever else lights your fire.
If you really don’t want to do anything, you could always keep saving until your portfolio hits $2.5 million. (Enough to produce $101K per year through a 4% withdrawal rate.)
Final Step: Enjoy Your Tax Free Life
From a tax perspective, investment income has always blown wage income out of the water. This has been the case since the dawn of tax code, and frankly, I’m shocked more people don’t devote their working careers towards building up enough savings to take advantage of this.
If a comfortable retirement is the training wheels goal of the average American, then a nest egg capable of spitting out 100% tax free investment income is the turbo charged motorcycle for the savvy investor.
Knock on wood, but it’s unlikely this will change anytime soon, either. While the highest tax brackets will always be a target for increased rates, increasing investment tax rates on the bottom brackets only serves to keep the “average American” from saving their way to wealth.
What’s this mean? For those few brave souls willing to put the brakes on society’s “never enough” attitude, the lawmakers have paved a path tailor-made for you to live like a king on over $100,000 per year, tax free.
Enjoy!
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Wizard, you just opened my eyes and mind to whole new world, this article is a masterpiece. I’m gonna make this strategy my goal. Good job!
It worked pretty well for my family. We’re living proof this really works.
It takes awhile to build up to that dividend income level obviously, and one of the “tricks” is to carefully manage your income while saving to stay out of the higher tax brackets (really anything over the 24% rate).
You want to avoid things like getting hit with the alternative minimum tax. Like MoneyWiz said — you gotta know the rules!
Mr. Tako,
I am also following your blog for a while now, you and wizard are big influence for me, i will keep grinding!
Thanks Al, glad you liked it!
How can I join
I love this post! This is such a great breakdown of taxable income from passive activity and is a really great motivator to bolster your positions.
Well done!
Thanks!
Love this article! Gotta love those qualified dividends. I’m really not sure why so many people in the personal finance community are so anti-dividend income it seems?
I’m not sure I get that either.
It seems to come in waves. 10 years ago, dividend investing blogs were all the rage. Then, it somehow became cool to hate on dividends?
I’d guess it comes from the die-hard indexers who think it’s too close to individual stock trading. Which is somewhat true, although there’s a big difference between day trading and buy-and-hold dividend investing. That seems to get lost in the debate.
Maybe this post will help make it cool again. 🙂
It’s because its hyped up for no reason. Think about it…
Stock drops but the dividend amount, so you must re-invest it to stay whole and in a brokerage account just adds tax drag.
Other reason: Too much concentration if you just include dividend stocks in portfolio. Not including growth stocks, small and mid-cap exposure. I just stock with total stock index funds.
Thank you, this is really inspiring.
Have you done a post about great companies to invest in then provide dividends?
Glad you found it inspiring!
I haven’t, since I’m still following an indexing strategy. (Which does pay dividends although typically at lower rates.)
I did briefly mention the dividend aristocrats in this post:
https://mymoneywizard.com/income-producing-assets/
MMW,
1. Does this apply to dividend income from REITs? What about a platform like Fundrise?
2. I am interested in doing this stuff but would prefer getting returns of closer to 10% rather than 5%.
My Experience:
I am mid 20’s and used to think I could be a stock picker, and had fun with that. I decided to sell my individual stocks in favor of index funds recently. I found that my 4% dividends came from stocks that did not appreciate much, and most of my other stocks last year did 10-30% (everyone made money in 2017 just about). For this reason I was kicking myself at buying these big cap stocks with a solid dividend payout rather than these other growth stocks with a small or no dividend at all.
Keep up the good work, I’m trying to keep up with you.
Sadly, it does not. REITs and fundrise pay non-qualified dividends, taxed as ordinary income. This would have to be part of your additional 24k as mentioned in the article in order to be living tax free
could you not hold the REIT inside a ROTH IRA and thus avoid and taxes on gain?
Does that work with index funds?
Yes, index funds mostly pay qualified dividends and long term capital gains.
As a Canadian feeling very jealous of how low your tax brackets are!
As an American I’m feeling very sympathetic to how high your tax brackets are! 🙂
I’m Canadian and the feeling is mutual. We’ve (almost) free healthcare here, about CAD$150/month. Was in ER, (kidney stones) some times ago, after a 1 hour shockwave treatment, recovers in a week, the cost $0. Can’t imagine how much it cost if that is happen in US. Friend of mine an American, work in the top 3 largest banks, One ER visit, 15mins ambulance, out of pockets $5K in 4hours. Monthly health insurance $2k pretax $.
For the Canadian above, don’t despair. You are in the best of both world. You can invest US stock market via Interactive Brokers, bank in your hard earned money in CAD, convert it to USD using spot rate and pay $2.50 for the exchange. And you can participate the growth of US economy, say just buy SPY. Or even better, you can sell long term cash secured put on SPY…
Argh! You figured out my strategy Money Wizard.
Haha! Without going into a ton of boring tax detail you’ve presented the strategy that worked very well for me (and continues to do so).
It’s important to remember however — dividends are included in your AGI even though they’re taxed differently (Schedule D is where the magic happens). So while you’re still saving you’ll want to be careful to stay out of those higher tax brackets that get applied to your normal income.
For most people this isn’t a problem while they’re saving — with dividend income they’ll usually sit in the 22% or 24% brackets with plenty of headroom. That said, I’ve goofed it up more than once.
Thanks Mr. Tako! I love reading about people like yourself who are actually pulling off this strategy, and I encourage any curious readers to do the same!
Good points about the nuances. Thanks for sharing.
Very cool. If I needed motivation to ramp up my investing, this was it. Thanks for sharing!
Glad you found it motivating!
Great post! If you are married, couldn’t you technically make an additional $37k a year and still meet your rule? This would assume both spouses maxed out $18,500 in their 401k? Or perhaps, even add IRAs on top of that for an additional $11k? So really $49k +101k? Make $150k and be taxfree?
This sounds about right. Precisely why we max out 3x 457/403(b)’s and 2x tIRA’s. Have a kid or two, and it goes even higher. I think 2 kids reduce your taxable income by $36,500. That would increase your tax-free window to $186,500! In our case, since we have access to 3 pre-tax retirement accounts, 2x tIRA’s +2 kids our window is astonishingly $205k per year.
Yep! I left it out for simplicity, but there’s tons of deductions that can let you earn even more and still stay tax free. It’s good to be an investor!
Great post!
I guess the only wild card is what kind of local taxes you pay based on the state you live in.
I live in California, which doesn’t distinguish between earned income vs. passive income.
Any tricks for avoiding state taxes besides moving to a no income tax state?
Dom
True, Minnesota also does not distinguish, so I’d still be on the hook for some state income tax under this strategy.
Not sure what to do about that. Other than move to any one of the 7 beautiful no income tax states, like you pointed out.
Great article Mr. Wizard (I remember as a kid the cartoon show “Help me Mr.Wizard”) and it seems like you are doing just that. I am NOT going to wait until I have a certain amount of cash saved up, I am just going to start buying about $140.00-$150.00 dollars worth of stock every two weeks ( I have unfortunately started late but intend to make up as fast as humanely possible). Thank you for the great article Mr. Wizard, you have a fan for live here in Pittsburg, CA (yeah there is no H on the end of Pittsburg…)
Quick question, how does this apply to a Traditional 401k/IRA? Once you start pulling out that money, are you being taxed on it regardless if you’re below 77k (married) or not? Traditional 401k/IRA investing is tax-deferred so I’m curious how does that correlate to this article?
If you’re withdrawing from a Roth 401k or Roth IRA, you won’t pay any taxes. If it’s a traditional 401k/IRA, the money will be taxed as regular income.
So, if you had no other income, you should be able to use your $24k of deductions to offset $24k of traditional 401k/IRA withdrawals while staying in the 0% bracket.
So even though we’ve never paid taxes on this 24k IRA withdrawal, we can still offset it with a standard deduction in the future?
Here’s another example. What if we withdraw 50k from Traditional IRA for example? The first 24k is untaxed due to standard deduction, but the next 26k is taxed then, even though some of it are capital gains? Is that because taxes were never paid on the contributions/gains on it, correct?
You should double the Medicare and Social Security rates because the matching employer half also comes out of your paycheck. Along with any disability, unemployment insurance, etc. paid on your behalf by your employer. (Self-employed’s know this already.) Which is why I always laugh at the notion that “low income” folks “don’t pay taxes”.
I just want to say that you share great information with us.keep it up
Thank you Mr. Money Wizard for this wonderful investment/tax article! I have a question, does short-term capital gain count toward the $77,200 of investment income and pay ZERO taxes?
Thanks
No, short term capital gains are taxed as ordinary income. The two keys to this strategy are qualified dividend income and long term capital gains. Just another reason why buy and hold is so great!
Hi Mr. Money Wizard,
I’m confused in the following section were you said: “…The tax reform introduced standard deductions of $12,000 per individual, and $24,000 for married couples.
In other words, you can make $101,200 per year, and as long as you keep those earned wages less than $24k, you won’t owe a penny. (You could technically earn even more than $101k, if you had the itemized deductions to offset)…”
I tried to catch up with this but it seems a little difficult to understand. I’m new to investments and some terminologies are confusing to me. Can you explain this to me? I’m single so the tax brackets are different.
In the case of a single person, you could pay no taxes so long as you earned no more than $38,600 from dividend income and no more than $12,000 from a job.
If instead, you made $38k from the job and only $12k from dividends, you would be taxed higher.
Correct me if I’m wrong but in order for this work correctly, you need to withdrawal from a Roth or brokerage account ( after tax ) or be 59.5 or older to avoid a early withdrawal fee from your 401k account not right?
Say you earn $100k from a job, assume standard deduction of $24k, can you still withdraw up to $77k from investments tax free?
Would it be that $100k-$25k = $75k would be taxed, but the remaining $77k withdrawal from investments be tax free?
No, it works differently than the marginal brackets for earned income. You have to fall in the low investment tax bracket in order to qualify for the 0% rate on investment income. Otherwise you’re bumped to the 15% bracket for all investment income.
The chart above shows that $77,200 of qaulifeid dividends/LTCG is taxed at 0% for joint filers.
Let’s say you withdrew $80,000… Would this mean that the first $77,200 is tax free and the remaining $2,800 is taxed at 15%?
Or is it that the entire $80,000 is taxed at 15%?
love this article, its really inspiring. thank you so much for sharing with us.
I’m a US expat working abroad. I know that FEIE allows me to exclude about $100, 000 of foreign income earned. I also know if I make under $38, 600 I’ll qualify for the 0% on investment income. I’m wondering if I make $50, 000 USD in foreign income but only make $9, 000 in investment income through qualified dividends and capital gains, will that $9, 000 be offset by the standard deduction? Can the standard deduction apply to the income earned through qualified dividends and capital gains in this scenario with foreign income?
USA company tax rate is 21%. If the payout ratio of company profits to dividends is 100%, the dividends have been taxed at 21%. If the payout ratio is less than 100%, the company profits reinvested have been taxed at 21%.
The USA shareholder pays a minimum of 21% tax on their share of their company’s earnings. The dividends received by the shareholder have been taxed 21% and are taxed again (‘double taxed’) as the shareholder’s income, the rate for qualified dividends being 0%.
Thus the minimum tax rate for USA dividends is 21%.
Australia single taxes dividends by crediting company tax (franking credits’) to the dividend recipient and taxing the gross amount at the same rates as all other income.
Thus the minimum tax rate for Australian dividends is 0% (to senior couple income of $A59,217).
Good point from the government’s perspective. But on a personal level, that’s an opportunity cost and not really relevant to someone trying to minimize the taxes they pay. Regardless of what the company pays, the shareholder isn’t writing a check and would still be paying zero taxes.
“shareholder isn’t writing a check”
Correct.
“would still be paying zero taxes”
Incorrect.
The shareholder has had 21% tax deducted before they receive the dividend – just like a wage earner. Results in fewer tax deadbeats.
Sure, but other than writing your congressman, there’s nothing me, you, or anyone can do about the corporate tax rate.
This whole article is about what people can do to minimize their personal taxes. Are you saying there’s a more efficient way to pay $0 in taxes while bringing $101,200 per year?
“nothing me, you, or anyone can do about the corporate tax rate”
Grossing up: ($77,200 / (1 – 21%)) = $97,722 of company earnings.
Tax paid: (92,722 * 21%) = $20,521.
“more efficient way to pay $0 in taxes while bringing $101,200 per year”
Long term capital gains: $0 to $78,750 tax rate 0%.
If you want to play that game, long term capital gains are driven by share prices which are driven by company profits which are still taxed a 21%.
This line of thinking is like trying to calculate the property taxes paid by your employer on their headquarters and subtracting that out from your paycheck. Sure you’d make more if they didn’t have to pay it, but they do and it underscores everything, so it’s not worth worrying about IMO.
“long term capital gains are driven by share prices which are driven by company profits which are still taxed a 21%”
… or increased debt to retire shares, or ordinary capital gains.
“This line of thinking is like trying to calculate the property taxes paid by your employer on their headquarters and subtracting that out from your paycheck.”
It is similar to taxes on wages being withheld by an employer and paid to government without the withheld tax being credited by government to the employee.
“it’s not worth worrying about”
USA 21% company tax avoided on $USA78,750 = $USA16,537 retained.
Australia 27.5% company tax avoided using franking credits on $A59,217 = $A16,285 tax refunded.
Money Wizard,
I like the way you think and the way your pushing this concept. However, there are a lot of holes in this scenario.
Perhaps a how to primer would be nice or how to flip from employee or negotiate status, and is this working out of account…. broker account? IRA? SEP IRA? Solo 401k? (Yeah solo 401k is badass) Solo Roth 401k? Or Roth IRA?
All the blabbing comments here, there are holes but no actual details or numbers. On top of that deductions and useful HSA and filling that lil piggy.
What I’m asking is for a clarifying follow up.
Further craziness – you mentioned that you could earn more with further deductions (or, even better, credits!). For instance, I’m married with two kids which gives $4,000 of tax credits. This means my wife and I could earn $61,025 – with the standard deduction, our two kids would wipe out the federal taxes completely! Wild!
well for some reason i understand thank you