Taxes can be a substantial annual expense, with the average federal income tax liability coming in at $10,845, according to the latest IRS data.1
Of course, this varies widely by income, given the progressive tax system for income taxes: The more you make, the higher the tax liability.
Regardless of how much you earn, is it possible to reduce your taxable income to result in a $0 tax bill? Careful tax planning could significantly reduce your tax burden, even if you have a relatively high income. Some examples below.
How much do Americans pay in federal income taxes?
During the most recent fiscal year, the IRS collected more than $4.9 trillion in taxes and issued more than $641.7 billion in tax refunds.2
Most of the federal tax burden fell on the highest income earners. According to the latest assessment of federal income tax data from the IRS,1 the top 50% of all taxpayers paid 97.7% of all individual income taxes, while the bottom 50% paid the remaining 2.3% in 2020.
The state of the tax code
The Internal Revenue Code is complicated. However, the basic framework is simple: Your tax rate gets progressively higher as your income increases. The complexity arises from, among other things, the various types of income, as well as deductions and credits available to taxpayers who take advantage of them. Another consideration is that deductions and credits phase out as incomes increase.
The federal tax system is complex for many reasons, including the ongoing creation of new rules and policies that can make it challenging for the average taxpayer to keep up.
How to reduce federal taxable income
So, let’s get to the point: Can the average American pay no federal taxes?
Indeed, some taxpayers, even those with income over $100,000, could pay zero federal income taxes. Regardless of your income or net worth, it’s financially prudent to consider available tax deductions and credits you may qualify for.
John: 23-year-old recent college grad
In the first example we have John, a 23-year-old who wants to keep his tax bill at zero. John just finished college and recently started full-time employment at an entry level salary of $30,000. He managed to live frugally while in school and is willing to maintain the college student lifestyle for a few more years. Fortunately for him, he is familiar with the power of compounding investment returns: He knows that investment contributions made while he is in his twenties have the potential to grow for decades to come, thereby setting him on the right track to retirement income.
Since John has roommates that split the rent and utilities, John feels comfortable living on $1,300 per month total out of his $2,500 monthly compensation. John participates in his employer’s 401(k) planby contributing $1,000 per month. This leaves $200 from each paycheck to cover other tax withholding requirements including those for Social Security and Medicare.
23-year-old single person, no children | |
Annual salary | $30,000 |
401(k) contributions | -$12,000 |
Adjusted gross income | $18,000 |
Standard deduction | -$13,850 |
Taxable income | $4,150 |
Federal taxes | $415 |
Retirement savings contributions credit | -$415 |
Total 2023 tax bill | $0 |
For tax purposes, what started out as a $30,000 salary becomes $18,000 in adjusted gross income (AGI) after subtracting the $12,000 John contributes to his 401(k) during the year. For tax year 2023, an individual taxpayer will owe $415 on $4,150 of taxable income. Since John funds his 401(k) accountthroughout the year and manages his income to a qualifying level, he is entitled to take the Retirement Savings Contributions Credit. John’s credit will be $415. This credit will reduce his tax bill to zero.
The Retirement Savings Contributions Credit, or Saver’s Credit, offers taxpayers a credit of 10%, 20% or 50% of contributions to retirement savings accounts such as a 401(k) or an IRA.
Here are the Adjusted Gross Income (AGI) limits for claiming the Saver’s Credit in for filing your 2023 taxes.3
2023 Saver’s Credit
Married filing jointly | ||
50% of contribution | 20% of contribution | 10% of contribution |
AGI of $43,500 or below | $43,501- $47,500 | $47,501 - $73,000 |
Head of household | ||
50% of contribution | 20% of contribution | 10% of contribution |
AGI of $32,625 or below | $32,626 - $35,625 | $35,626 - $54,750 |
Other filers* | ||
50% of contribution | 20% of contribution | 10% of contribution |
AGI of $21,750 or below | $21,751 - $23,750 | $23,751 - $36,500 |
*Single, married filing separately, or qualifying widow(er)
The amount of the credit is limited to the total tax owed by the taxpayer. In John’s case, he qualifies to receive up to $1,000 for the credit. Since his tax bill without the credit is only $415, his credit is limited to $415. Unlike some credits (such as the Earned Income Credit and the Additional Child Tax Credit), the Saver’s Credit is not refundable if the credit exceeds the taxpayer’s tax liability.
John may be able to keep his tax bill at zero even if he gets a raise. If he can increase his 401(k) contributions by the amount of his raise each year, his adjusted gross income will remain at $18,000, and he would continue qualifying for the Retirement Savings Contributions Credit.
John’s tax bill: $0
The Smiths: married couple, 40 years old with two kids
The Smith family is our second example of a household that can fully offset their federal income tax. The Smiths are both 40 years old and they have two kids in elementary school. Together, they earn $130,000 per year from their full-time jobs.
The Smiths put a strong emphasis on retirement savings by contributing the maximum to their 401(k)s ($22,500 each in 2023)and traditional IRAs ($6,500 each in 2023). In total, they contribute $58,000 to their retirement accounts.
Since the Smiths have two children in elementary school, they pay for after-school care during the school year and some childcare during the summer months. The total childcare costs amount to $8,000 per year. The Smiths contribute $5,000 to their childcare flexible spending account, which is provided by Mrs. Smith’s employer; this amount is taken out of her paycheck pre-tax. The balance of their childcare costs is paid out of pocket.
Similarly, Mrs. Smith contributes $3,050 per year to her healthcare flexible spending account, which is also deducted from her paycheck pre-tax. With the family’s typical medical and dental expenses, they are certain to use the $ 3,050 in full.
Married couple, 40 years old, 2 kids | |
Annual salary | $130,000 |
401(k) contributions (x2) | ($45,000) |
Traditional IRA contributions (x2) | ($13,000) |
Healthcare flexible spending account | ($3,050) |
Childcare flexible spending account | ($5,000) |
Adjusted gross income (AGI) | $63,950 |
Standard deduction | ($27,700) |
Taxable income | $36,250 |
Federal taxes | $3,910 |
Dependent Care Credit | ($200) |
Child Tax Credit | ($3,310) |
Retirement Savings Credit | ($400) |
Refundable child credit | ($687) |
Total 2023 tax refund | $687 |
After taking these deductions from their gross income, their $130,000 combined salaries are reduced to an adjusted gross income of $63,950. The standard deduction of $27,700 further reduces that sum to taxable income of $36,250. A married couple filing jointly will owe $3,910 of federal income tax on $36,250 of taxable income. The Smiths qualify for part of the child tax credit (a non-refundable credit with maximum of $2,000 per child). Along with other credits, $3,310 of the Child Tax Credit is permitted as a non-refundable credit that offsets their income tax liability. They also qualify for another $687 as a refundable Child Tax Credit and a Retirement Savings Credit of $400 with income at this level.
Their tax credits totaling $4,597 offset the tax liability they would otherwise have and generate a refund of $687 representing the refundable portion of the Additional Child Tax Credit for which they qualify. Even though the Smiths enjoy a six-figure gross income, they still manage to bring their federal income tax bill down to zero by taking advantage of several tax credits and deductions.
Mr. and Mrs. Smith’s tax bill: $0, and total tax refund of $687
The Jacksons: married couple, 55 years old, empty nesters
The Jackson family will serve as our third example of how ordinary households can avoid paying federal income tax. The Jacksons’ total annual salaries sum to $113,750.
The couple raised two kids and are now looking forward to retirementwithin five years. The two Jackson children have finished college and are no longer dependents of their 55-year-old parents. The Jacksons have also recently paid off their 30-year mortgage on the house they bought as newlyweds.
With the kids out of the house and the house paid off, the Jacksons find themselves with more disposable income. Since the Jacksons are nearing retirement age, they want to put the disposable income to work for themselves by turbocharging their retirement savings.
The Jacksons choose to make “catch up” contributionsto their 401(k) plans and IRAs, meaning that as workers who are 50 or over, they can make an additional $7,500 catch up contribution to their 401(k), and an additional $1,000 catch up contribution to their IRAs in 2023.
This means taxpayers married filing jointly age 50 or over can contribute a total of $30,000 per year to a 401(k) and $7,500 to an IRA at the Jacksons’ income level. The Jacksons contribute the maximum (including catch up contributions) to their 401(k)s and their traditional IRAs, which amounts to $75,000 for their 2023 taxes.
Married couple, 55 years old, no dependents | |
Annual salary | $113,750 |
401(k) contributions (x2) | -$60,000 |
Traditional IRA contributions (x2) | -$15,000 |
Capital loss carryforward | -$3,000 |
Health Savings Account contribution | -$8,750 |
Adjusted gross income (AGI) | $27,000 |
Standard deduction | -$27,700 |
Taxable income | $0 |
Federal taxes | $0 |
Total 2023 tax bill | $0 |
The Jacksons don’t have any significant health issues right now, but they want to ensure they have adequate savings to pay for healthcare expenses in retirement. Mr. Jackson contributes the maximum of $8,750 to his Health Savings Account (HSA).
Most families can contribute a maximum of $7,750 to a health savings account. However, the catch-up provisions for taxpayers aged 55 or over allow an additional $1,000 contribution for a total maximum contribution of $8,750. Amounts contributed to an HSA remain in the account year after year if they are not spent (in contrast to flexible spending accounts whose remaining balances are mostly forfeited at the end of the year).
The Jacksons have some investments in a brokerage account that they manage on their own. Mrs. Jackson enjoys overseeing the individual holdings and she performs tax-loss harvestingnetting at least $3,000 of realized capital losses per year from these taxable investments.
After deducting the 401(k) and IRA contributions, the health savings account contributions, and the capital loss, the Jacksons manage to reduce their $113,750 earned income down to an adjusted gross income of $27,000.
For a married couple filing jointly, a standard deduction of $27,700 further reduces their AGI of $27,000 to a taxable income of $0.
The Jackson’s total tax bill: $0
The Millers: 30-something married couple, 3 young children
The Millers, a couple in their 30s with three young children, earned approximately $150,000 in 2023 between salaries and some moderate investment income.
In this table, their gross salaries are shown along with all the deductions from their salary for retirement savings, childcare flexible spending account, health savings account, health insurance, and dental insurance. After all the deductions, their $150,000 combined gross salaries are reduced to a taxable amount of $77,150 (almost a 52% reduction):
Salaries & deductions | Husband | Wife |
Annual salary | $69,000 | $81,000 |
401(k) contributions | -$22,500 | -$22,500 |
Dependent care FSA | $0 | -$5,000 |
Health Savings Account (HSA) | -$7,750 | $0 |
-$12,600 | $0 | |
Dental insurance | -$2,000 | $0 |
Vision insurance | -$500 | $0 |
Federal taxable wages | $23,650 | $53,500 |
Since the Millers have three children, they qualified for $3,054 of non-refundable child tax credits. They also had $300 foreign tax withheld on their investment income, thereby generating a $300 foreign income tax credit and qualified for a Retirement Savings Credit of $400, along with a refundable child tax credit of $2,943.
The Millers had a taxable income of $41,450 which means that any Long Term Gain or Qualified Dividend income included in that sum qualifies for a tax rate of 0% for married taxpayers filing jointly. In this situation because of the combination of non-refundable credits, they were able to zero out their tax liability, and in addition, they received a refund of $2,943 representing the refundable portion of the additional child tax credit.
2023 taxes, 30-something married couple, 3 children | |
Federal taxable wages | $77,150 |
Interest | $500 |
Dividends ($6,500 qualified dividends) | $7,500 |
Allowable capital loss for current year | -$3,000 |
Total income | $82,150 |
IRA contribution (x2) | -$13,000 |
Adjusted gross income (AGI) | $69,150 |
Standard deduction | -$27,700 |
Taxable income | $41,450 |
Federal tax before credits | $ 3,754 |
Nonrefundable Child Tax Credit | -$3,054 |
Foreign Income Tax Credit | -$300 |
| Retirement Savings Credit | -$400 |
Refundable Child Tax Credit | -$2,943 |
Total tax credits | -$6,697 |
Total tax refund | -$2,943 |
Effective tax rate | 0% |
Tax on $6,500 of qualified dividends | $0.00 |
How to lower taxableincome
With some planning, it isn’t impossible to file a 1040 that shows zero tax liability. The four examples highlighted in this article show illustrate hypothetical taxpayers with varied circ*mstances who managed to take advantage of available provisions to fully offset their respective tax liabilities – in some cases, despite earning six-figure salaries.
How did these taxpayers reach a zero-dollar tax bill and how could you pay less in taxes? Consider:
- Contributing significant amounts to deductible retirement savings plans
- Participating in employer-sponsored benefit plans including those for childcare and healthcare
- Paying attention to items like child tax credits, the retirement saver's credit, the foreign tax credit and the dependent care credit.
- Managing investment income in a tax-efficient manner
Careful tax planning can potentially slash your tax bill, even if you have a fairly high income.
