You've probably heard about the famed 44% of Americans who pay no income taxes at all. How do you join this club? Here are several ways you can avoid paying federal taxes.
One easy way to pay no income tax is to have little or no taxable income. About half of the Americans who pay no income tax do so because their incomes are too low. As a result of the Tax Cuts and Jobs Act, which took effect in 2018, single taxpayers receive a standard deduction of $12,950, and married taxpayers filing jointly receive a $25,900 standard deduction (2022), subject to annual adjustments. Personal and dependent exemptions were eliminated. If your income is below these levels, you won't have to pay any income tax.
Lower-income working families with dependent children can avoid paying income taxes because they're given special tax breaks: the child tax credit, the earned income tax credit (EITC), or the child and dependent care credit. For example, a family of four (two spouses and two children over six) with an income of $30,000 would receive $3,000 tax credits for each child and a $5,980 earned income tax credit (2021). When combined with their standard deduction, they end up with no income subject to income tax. Indeed, because the child tax credit and EITC are refundable, they get money back from the IRS.
Families like these account for one-seventh of those who pay no taxes.
More than one-fifth of those who pay no income taxes are retirees with relatively modest incomes, although not living in poverty, who benefit from tax breaks for seniors. The most significant exemption among these is the tax exemption for most Social Security benefits.
Taxpayers with high incomes can avoid paying income taxes by having lots of itemized deductions. Unfortunately, as a result of the Tax Cuts and Jobs Act, itemized deductions are harder to come by than in the past. They only include deductions for:
As a result of these changes, only about 11% of taxpayers will be able to itemize instead of taking the standard deduction. Still, higher-income taxpayers who make substantial charitable contributions and/or have large uninsured health expenses can still avoid paying income taxes.
Finally, it is quite easy to pay no income taxes if you're extremely rich. In our tax system, money is only subject to income tax when it is earned or when an asset is sold at a profit. You don't have to pay income taxes on the appreciation of assets like real estate or stocks until you sell them. Moreover, there is no tax on consumption or on borrowed money. So, the simple strategy of the super-rich is to buy assets like real estate and stocks and hold on to them, and to borrow against them when needed to finance their lifestyles. They don't have to pay any taxes at all on their borrowed income. Some politicians have proposed imposing a tax on assets owned by the wealthy, but so far, it hasn't happened.
The rich also avoid paying taxes by earning substantial interest income from tax-free municipal bonds. They also sock money away in individual retirement accounts where it grows tax-free. There aren't that many rich people, so the number of super-wealthy taxpayers who actually take advantage of these strategies is quite small.