US Tax Code -- Is it possible to maximize the Retirement Saver's Tax Credit?

Discussion in 'Off-Topic' started by WBahn, Dec 6, 2017.

  1. WBahn

    Thread Starter Moderator

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    NOTE: This is a strictly NON-POLITICAL thread. Do not bother responding if all you want to do is inject politics.

    For those not familiar, the US Tax Code allows for a tax credit on your individual tax return that is dependent on how much you saved toward retirement that year.

    A number of years ago I noted a Catch-22, but only now are we looking to claim this credit again. I'm hoping this Catch-22 is a result of my failing to understand some nuance in the code, hence my question here. Perhaps someone like @JoeJester can set me straight and/or verify that I am, indeed, interpreting it correctly.

    For those interested, the IRS form is 8880.

    There are a number of restrictions. Most notably for this discussion are:
    • You can't be claimed as a dependent on someone else's return.
    • You can't make more than a certain amount.
    • The credit is nonrefundable, meaning that you can't take the credit beyond the amount that reduces your tax liability to zero.
    The amount of the credit is a fraction of the first $2000 put away by each person on the return. That fraction is 0%, 10%, 20%, or 50%, which is determined by your adjusted gross income (AGI).

    What I am trying to figure out is how anyone (either single or married-filing-jointly, but I'm not particularly interested in the other two filing categories) can possibly actually take the maximum credit ($1000 for an individual and $2000 for married). I don't think it is possible, but I have found website after website (including the IRS) which touts these numbers as the maximum possible credits.

    The first restriction means that you can claim the personal exemption, so the smallest reduction from AGI to taxable income is (in 2017) $10,400 for an individual ($6,350 standard deduction and $4,050 personal exemption) and $20,800 for a married couple filing jointly ($12,700 standard deduction and two personal exemptions).

    The second restriction means that to get the max 50% credit of the first $2000 saved, your AGI can't exceed $18,500 for an individual and $37,000 for a the couple. Given the smallest reductions above, this means that the individual's highest taxable income would be $8,100 and the couple's highest taxable income would be $16,200. Using the tax tables, this means that the starting tax liabilities would be $813 for the individual and $1,623 for the couple.

    Which brings us to the third restriction and the Catch-22. Even with no other prior credits, this means that neither of these two groups of filers can actually take the full potential amount of the credit that everyone, from the IRS to Forbes, keeps shouting about.

    Unless I am missing something. The only things I can think of would be something that prevents these folks from claiming the standard deduction and/or the personal exemption AND that doesn't render them ineligible for the credit in the first place. But even if that's the case, it seems like it would be pretty rare.

    Any thoughts?

    If you go searching for information, be aware that I ran across a number of errors. Several sites said that the max credit was $4000 for a married couple, which simply isn't true. Forbes had one of the few articles that mentioned the nonrefundability of the credit, but it claimed that families with children had a hard time benefit from the full credit because the Child Tax Credit was applied prior to this credit. This is not the case, it is applied immediately after this credit and I believe it has been that way since it was first enacted. But it IS true that families with kids become severely restricted in the ability to claim the credit, but that's because of the additional exemption(s) that each child gets. A single child makes is to that the biggest credit you can possibly get is just $800.

    Again -- this is NOT a political thread and politics will NOT be tolerated. It is a technical discussion about a particular algorithm. Please treat it as such.
     
  2. GopherT

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    This is exactly what Excel excels at, financial modeling.

    So, set up an excel spreadsheet with 50 rows for the next 50 years and one column for each of the following...
    - for your salary,
    - exemptions
    ...and columns for each scenario
    * cumulative retirement savings
    * annual deposits via each scenario
    * assumed interest on each scenario

    And any additional info.
     
  3. wayneh

    Expert

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    I also recommend software but I’d use TurboTax, since they have done the research and are the de facto tax code.
     
  4. Raymond Genovese

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    It may be that you're looking only at the 50% credit case.

    What about this:

    Your AGI is 31,000 - the 2017 limit for the 10% credit.

    Subtracting the standard and personal deduction, you have a tax burden 31,000-10,400=20,600.

    You put 10,000 into the retirement fund and, at a 10% credit, you have the full $1000 - of which as a single filer, you can take 1,000. [Edited to add, assuming that you are in the 10% or 15% bracket]

    In fact, it looks like the set limits were created not for the 50% credit but the other two (20% and 10%).
     
    Last edited: Dec 6, 2017
  5. WBahn

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    You only get to take the credit against the first $2000 saved (each, in the case of a married couple), so if you save $10,000 then you enter $2,000 on the first line of the 8880 and if your rate it 10% then you only get credit of $100.
     
  6. WBahn

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    Thanks for the thoughts, but that wouldn't answer this question, which is very specific to this tax credit, which has absolutely nothing to do with future (or past) year information.

    I have done lots of Excel models for many things, including debt repayment and retirement savings projections. Some of them are quite sophisticated, particularly without resorting to VBA, in the controls that they include such as a single cell that switches between five different accelerated mortgage repayment strategies and automatically adjusts interest rate and minimum payment using the same projection model the mortgage company uses even though it doesn't take into account extra payments actually made.

    In fact I do have an 8880 spreadsheet set up that calculates the tax credit per the rules. I have a spreadsheet set up for all of the forms that we actually use so that I can not only do the taxes much more easily and eliminate math and transcription errors, but so that I can model the impacts of many different options.

    The problem isn't in understanding the 8880 given its basic input parameters -- AGI, retirement contributions, taxable income -- but in understanding whether it is possible for a combination of AGI and taxable income, given THEIR relationship constraints, that can achieve the maximum credit amount. If you use the standard deduction and personal exemption amounts, you can't. But are there situations in which you would use smaller amounts than these and still qualify for the credit? That is what I'm curious about. Even if there is, it would almost certain not apply to our situation, but it would be nice to know that they didn't set up a credit that no one can actually maximize.
     
  7. Raymond Genovese

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    You're right. That dang line 6

    That seems a bit misleading though:

    "The amount of the credit is 50%, 20% or 10% of your retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on your adjusted gross income (reported on your Form 1040 or 1040A). Use the chart below to calculate your credit."

    So, my thinking was - ok, my contribution is $20,000 and at 10% that's 2,000 and I am good to go with a $2,000 credit, not:

    "The amount of the credit is 50%, 20% or 10% of up to $2,000 of your retirement plan or IRA contributions ($4,000 if married filing jointly), depending on your adjusted gross income (reported on your Form 1040 or 1040A). Use the chart below to calculate your credit."



    Even their example did not dissuade me:

    Example: Jill, who works at a retail store, is married and earned $37,000 in 2017. Jill’s husband was unemployed in 2017 and didn’t have any earnings. Jill contributed $1,000 to her IRA in 2017. After deducting her IRA contribution, the adjusted gross income shown on her joint return is $36,000. Jill may claim a 50% credit, $500, for her $1,000 IRA contribution.

    But when I look at the tables (charts), the heading says says CREDIT RATE, not CREDIT.

    Now, I know how Zulfi sometimes feels :).


    I don't know - it would be interesting to ask the IRS - they must have (well, probably had) something in mind when they set the limits.
     
    Last edited: Dec 6, 2017
  8. Raymond Genovese

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    How about about this:

    You are using 1040NR and filing status single.

    Your AGI is 18,500 - the 2017 limit for the 50% credit.
    You contribute $2,000
    You, potentially, quaify for a credit of $1,000

    Subtracting the personal deduction, you have a tax burden $18,500-$4,050 (personal exemption)=14,000 . Note that as an NR filer, you cannot claim the standard deduction (exceptions apply).

    At the minimum 10% rate, you owe $1,400. You claim the $1000 credit and owe $400. You were able to take the maximum credit.

    I think you saw this when you stated, “Unless I am missing something. The only things I can think of would be something that prevents these folks from claiming the standard deduction and/or the personal exemption AND that doesn't render them ineligible for the credit in the first place. But even if that's the case, it seems like it would be pretty rare.”

    Except, maybe it is not so rare, as the the IRS has made a 1040NR and 1040NR-EZ specifically for those filers.
     
  9. WBahn

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    They've done the research to identify what you qualify for based on the data you enter, and I think they do a good job of that. What they don't do a good job of is figuring out what data you would need to enter to achieve a specific goal. I did a test using TurboTax about five years ago on this very point. I crafted numbers so that I just missed the cut from 10% to 20%. Sure enough, it figured the credit at $400 (10% of the first $2000 for each of my and my wife). It gave absolutely no hint that if I simply chose to increase my Section 179 expense election by $1 on Form 4562 that it would reduce my tax liability by $400 since my credit would increase from $400 to $800. Maybe their software has evolved since then and can do that now, but I rather doubt it because the decision space grows exponentially (I think).

    My wife was working for H&R Block at the time and she ran that same scenario through their system and it did the same thing. When I asked her manager (who was very approachable and interested in the experiment) about their Maximum Refund Guarantee, she said that missing that opportunity would not entitle a client to a refund of their fees because it wasn't an error on their part -- they calculated things correctly based on the data provided.

    I've found a small handful of places in the tax code were tiny tweaks have drastically disproportionate impacts. As far as I know, no software package examines the data on the return to explore the question of whether the return is within reachable range of any of these boundaries. I suggested to my wife that if she were to go into business for herself as a tax accountant, that one thing we could focus on would be to identify these boundaries and make her clients aware of things they might consider doing in order to end up on the right side of them.
     
  10. WBahn

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    Okay. Thanks for finding that.

    I don't know if it makes me feel better, though.

    You have to shake your head when a pair of married non-resident aliens can get the full $2,000 tax credit while a pair of married U.S. citizens can only get $800.
     
  11. JoeJester

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    They are not the defacto tax code. Like WBahn stated, it depends on how you enter the information. One critter went before the tax court and claimed Turbo tax failed to account for the income that didn't appear on his return. He won the case, so he didn't pay extra penalty.

    @WBahn I'll look it up but if you and your wife contributed, your 50% will be 2k. It will be limited by your taxes owed like all non- refundable credits.
     
  12. WBahn

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    Thanks @JoeJester.

    That's the key issue. It seems to me that the AGI threshold set to get the 50% is sufficiently low as to ensure that you can't get the full $2k credit because of the non-refundable nature of it (the best a married-filing-joint couple can do is $1,623).

    Raymond has pointed out that non-resident aliens may be able to get the full $2k credit since they are not eligible to to claim the standard deduction.
     
  13. wayneh

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    That proves my point. If you use TurboTax in an honest, good faith attempt to file your return, your almost immune.
     
  14. WBahn

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    Not really. The IRS is pretty forgiving regarding penalties and interest if you convince them that you made a good faith effort to adhere to the tax rules, whether you used TurboTax or not. If you used the BobsTax software and it made the same error and you went before the court, the same result would have been likely. That would NOT prove that BobsTax is some defacto tax code.
     
  15. wayneh

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    The bottom line is, what are you going to trust, some DIY spreadsheet by an amateur (no offense), or a professionally made commercial product that comes with a guarantee? And by the way already exists and is easy to use. It seems pretty obvious to me.
     
    GopherT and spinnaker like this.
  16. JoeJester

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    No, it means the critter had the wherewithall and resources to challenge the IRS and prove it. Just because you use ANY program, it's still your name on the return and you are responsible for it's accuracy.

    TT had their problems with the education credit a couple of years ago.

    https://www.forbes.com/sites/robertwood/2010/11/18/turbotax-is-no-twinkie-defense/#1c2ca26019f8

    IF you have the correct amount of income, you can have your taxes done free via the VITA program. I have recommended some to go there when they couldn't afford the service by a national chain.

    The VITA volunteers are tested annually on their tax knowledge. Apparently the courts have ruled that tax preparers can not be forced to take tests to demonstrate their knowledge. It's all volunteer now, for preparers to test. so the consumers need to beware.
     
  17. JoeJester

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    @WBahn,

    I read that if your wife is not working and you contribute towards her IRA you can maximize your credit. 50 percent is all one gets.

    The limitations are: Once you compute your tax, They reduce the tax a few of the refundable credits (child care, foreign tax credit, and child and dependent care expenses) to arrive at the maximum you can claim. It's always the lesser of two numbers, throughout the tax system.

    On page two of the form 8880 has a limitations worksheet. The smaller of the two lines 10 and 11 is the actual credit you can claim, 50 percent of the maximum credit or less (taxes owed minus refundable credits.)

    Thats my read after reviewing Pub 590. Form 8880, form 1040, and pub 17.

    Just remember the IRS can disagree with anyone and will try to find a favorable court, favorable to them, when they want to pursue someone.
     
    Last edited: Dec 6, 2017
  18. GopherT

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    Is this a real question that you want to solve or is this just something you want to complain about?

    The SCENARIOS feature and/or SOLVER can be used for these types of questions. It is a solvable problem - you just have to set some windows for your variables and decide what is close enough for your convergence. it is not a random number generator. If you get random results, you are doing it wrong.
     
  19. WBahn

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    @JoeJester. Thanks, Joe, but this merely confirms by understanding of the credit and how it is computed. That wasn't my question. I'll try to make it clearer and more specific.

    Two scenarios:

    #1 -- Joe is single and contributed $5,000 to his IRA. The maximum credit he can possibly take would be 50% of the first $2,000 which is $1,000. Is there any way that he can actually take the full $1,000 credit? I can't find a way for him to take anything more than $813.

    #2 - Bob and Sue are married filing jointly and each contributed $5,000 to their respective IRAs. The maximum credit they can possibly take would be 50% of the first $2,000 each, which is $2,000. Is there any way that they can actually take the full $2,000 credit? I can't find a way for them to take anything more than $1,623.
     
  20. WBahn

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    Actually, I prefer my spreadsheets. Not because they come with a better guarantee, they obviously don't. But I prefer my work even without the spreadsheets at all (which I didn't have as I worked through the last four years of taxes to get us caught up) because I believe that, by understanding the tax code well (or those portions that apply to us) I am in a much better position to minimize our taxes than I would be just blindly punching numbers into a program. Implementing the algorithms that apply to the handful of forms we use enables me to see and exploit opportunities that I wouldn't even know existed otherwise.

    And it goes beyond the tax return preparation phase. By having a pretty intimate understanding of the tax code (as it applies to us) I am in a much better position to make decisions throughout the year that take the realistic tax implications into account.
     
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