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I’m trying to figure how regular income interplays with long term capital gains.

For example, and using the 2019 married filing jointly brackets (hope I have them correct), let’s say I have $43,800 of regular income. I would owe 10% of 43800 – 24400 which is 1940.

Given the above regular income, how much could I have in capital gains and owe nothing in capital gains taxes? The 0% bracket goes up to $78,750. But is that figure for just capital gains? Or for regular income? Or for adjusted total income after the standard deduction?

Thanks ahead of time.

No. of Recommendations: 19

Hi Scoopshot

follow this algorithm

1. Add up all of your gross ordinary income. This will include taxable wages, taxable interest, non-qualified dividends, pension amounts, Traditional IRA withdrawals, from 0% to 85% of your Social Security benefit, any net short term capital gains and self-employment income...to name the most common.

2. Add on top of this all of your net Long Term Capital Gains (LTCG) plus Qualified Dividends (QD). Net LTCG come from the total of LTCG minus any LTCLosses. If you have short term CGs and CL, net these out. If the result is negative, subtract these too from LTCG. You can combine LTCG and QD because they are taxed exactly the same way. 'Stack' this total on top of #1.

3. Subtract from the bottom of this stack any self-employment expenses not related to self-employment operations, such as premiums you paid for medical insurance, contributions to an HSA, contributions to your own retirement plan including to your Traditional IRA (if eligible), 1/2 Self-employment tax along with any qualifying student loan interest. Most will not have deductions here. What you have after subtracting these is your Adjusted Gross Income or AGI.

4. Figure the greater of your itemized deductions or standard deduction. Subtract the larger one from the 'bottom' of #3. This will be your "Taxable Income", and is made up of ordinary income on the bottom of the stack and LTCG + QD on top of it.

5. If this total stack falls under $38,700 (Single filer) or $77,200 (Married filing jointly), which is the top of the 12% bracket, then all of the LTCG + QD will be taxed at the 0% rate. (note: for 2019 these values will likely increase with inflation, but we'll not know by how much until later in the year)

6. Any amount of the LTCG + QD that sticks up above those 12% bracket caps will be taxed at 15%. In very large taxable incomes, $425,800(S) and $479,000(MFJ) the tax rate on QD + LTCG will be 20%. In addition, household modified AGI > $200,000 (S) and $250,000 (MFJ), all investment income will be subject to an additional 3.8% tax....but that's another topic.

Example:

H&W have $90,000 in pension, TIRA withdrawals, 85% of their Social Security and some interest. They also have $20,000 in net LTCG + QD, and no above-the-line deductions, for an AGI of $110,000.

Both are 65 or older and so their standard deduction will be $26,600 ($24,000 + $1,300 + $1,300), which is greater than their itemized deductions of $18,000.

subtracting $110,000 - $26,600 = $83,400 of taxable income. This is made up of ordinary income of $90,000 - $26,600 = $63,400 plus the $20,000 of LTCG + QD stacked on top of it.

The LTCG + QD sticking up above $77,200 = $83,400 - $77,200 = $6,200 will be taxed at 15%. The remainder of the LTCG + QD below the $77,200 ceiling, $20,000 - $6,200 = $13,800 will be taxed at 0%.

Actually drawing this out as a stacked bar on paper makes conceptualizing it much easier.

Hope that makes sense

BruceM

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Awesome reply, thank you.

One quibble. Aren't the tax brackets for 12% vs. 22% AGI and 0% vs. 15% Capital Gains slightly different? And what was the logic for doing it that way?

No. of Recommendations: 5

*And what was the logic for doing it that way? *

Tax law is not based on logic. It is based on politics.

No. of Recommendations: 0

Agree on politics vs. reasonable logic. But what political logic led to them being different?

Here's my example using Bruce's algorithm. Using 2018 married filing jointly brackets. Please check for errors.

I have $43050 of ordinary income.

I can have 77200 + 24000 - 43050 = 58150 of LTCG and pay zero LTCG tax.

The 43050 will have 1905 of tax = (43050 - 24000) * 10%

Now ignoring the very slight difference in tax brackets (77400 for AGI and 77200 for cap gains).

An additional dollar of ordinary income will be taxed at 12%

An additional dollar of ltcg will be taxed at 15%

Is this correct?

No. of Recommendations: 4

If you have $43,050 of gross ordinary income, then you'd deduct your MFJ standard deduction from it = $43,050 - $24,000 = $19,050. Subtract this from $77,200 = $58,150 of 'headroom' in the 12% bracket. So we arrive at the same number, just not sure why you did the math as you did :-) And the 0% rate for LTCG + QD goes from $0 taxable income to $77,200....that is, its not just the 12% bracket. So if I have $0 ordinary income, I could have $77,200 of LTCG + QD in the 0% bracket.

I didn't talk about ordinary income bracket taxes, but the ordinary income on the bottom of the stacked bar AFTER deductions, for MFJ, ....

the first $19,050 is taxed at 10%, as you have shown

From $19,051 to $77,400 is taxed at 12%

$77,401 to $165,000 is taxed at 22%

and so on

Yes...adding $1 of ordinary income when the LTCG + QD is in both the 12% bracket and 22% bracket, will be taxed at 12% + 15% = 27% at the margin. That is, the $1 of added ordinary income is taxed at 12% and the $1 of LTCG + QD 'lifted up' into the 22% bracket will be taxed at 15%, as you've noted.

And yes, there is a $200 discrepency between the top of the 12% tax bracket and the top of the 0% bracket for LTCG + QD. Mike Kitces thinks this is an oversight that should be corrected when there is the usual (?) corrective legislation.

If you send me an e-mail I'll reply with an Excel SS that shows all this

BruceM

No. of Recommendations: 4

*Agree on politics vs. reasonable logic. But what political logic led to them being different?*

The Senate and House had different versions of tax reform. I forget many of the details, but one of them eliminated the 0% capital gains/qualified dividends rate, and they had different break points for ordinary income brackets. When the 0% rate was added back in the final compromise that became law, it carried its own bracket from a version that didn't have ordinary income brackets changing at the same point. That landed in a slightly different place than ordinary income bracket change, due to coming through a different legislative compromise process and Congress not caring much about making things simple, logical, or internally consistent.

TL/DR: It's because of the sausage-making process that creates tax law.

"He who loves sausage and the law should not watch either being made."

*I have $43050 of ordinary income.*

I can have 77200 + 24000 - 43050 = 58150 of LTCG and pay zero LTCG tax.

The 43050 will have 1905 of tax = (43050 - 24000) * 10%

Now ignoring the very slight difference in tax brackets (77400 for AGI and 77200 for cap gains).

An additional dollar of ordinary income will be taxed at 12%

An additional dollar of ltcg will be taxed at 15%

Is this correct?

A fine point for analytical purposes: Suppose you have $43050 of taxable ordinary income and $58150 of LTCG & qualified dividends, placing you right at the top of the 0% bracket for LTCG/QDIVs. Another $100 of LTCG/QDIV generates $15 in tax. Another $100 of ordinary income generates $27 in tax, $12 on the ordinary income and $15 for pushing $100 of the LTCG/QDIVs into the 12% bracket.

No. of Recommendations: 1

I think I’ve got it.

Looking at marginal tax rates:

Using 2019 brackets, if my total in ordinary income and ltcg is below $103150 (78750 for ltcg and 24400 for the std deduction), then my marginal tax rate will be no more than 12%, regardless of the mix of ordinary income and ltcg. It could be 0%, 10% or 12% depending on the mix.

If I go above 103150 with a dollar of ltcg it has a marginal rate of 15%.

If I go above 103350 (reflecting the stupid bracket difference) the marginal rate on a dollar of ltcg is again 15%. But the marginal rate of a dollar of ordinary income could be 15% (if in the 0% bracket and have ltcg), or 22% (if all ordinary income), or 25% (if in the 10% bracket and have ltcg), or 27% (if in the 12% bracket and have ltcg), or even a whopping 37% (if in the 22% bracket and have ltcg).

Is that correct?

No. of Recommendations: 0

*Using 2019 brackets, if my total in ordinary income and ltcg is below $103150 (78750 for ltcg and 24400 for the std deduction), then my marginal tax rate will be no more than 12%, regardless of the mix of ordinary income and ltcg. It could be 0%, 10% or 12% depending on the mix.*

If I go above 103150 with a dollar of ltcg it has a marginal rate of 15%.

If I go above 103350 (reflecting the stupid bracket difference) the marginal rate on a dollar of ltcg is again 15%. But the marginal rate of a dollar of ordinary income could be 15% (if in the 0% bracket and have ltcg), or 22% (if all ordinary income), or 25% (if in the 10% bracket and have ltcg), or 27% (if in the 12% bracket and have ltcg), or even a whopping 37% (if in the 22% bracket and have ltcg).

Is that correct?

There is a limit. Once you go above 103350 just with ordinary income, all the LTCG has been pushed into the 15% bracket already and the next dollar of ordinary income just generates the ordinary income marginal tax rate. So if your ordinary income is getting taxed at 22%, there's no 0% LTCG left to push into 15%.

Same sort of thing could happen where the LTCG rate goes from 15% to 20%, but I haven't looked at the numbers. In single brackets, a quick glance seems to say there could be a notch where it's 35% on incremental ordinary income + 5% incremental LTCG = 40%. I could be mistaken, my own numbers aren't close to that.

No. of Recommendations: 0

Scoopshot

You got it!

Those who use this method and determine they have 'headroom' in the 12% bracket should use this to do things like Roth Conversions or perhaps to realize some capital gains and 'step-up' their basis in stocks or funds they hold, tax free. It would be a shame to let it go to waste :-(

BruceM

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Thanks Bruce et al for your help. I'm glad I get it. What do I win?

I'm planning out optimizing taxes as best I can. We just started retirement, so we have choices between voluntary ira withdrawals and qualified dividends / capital gains. Another wrinkle in optimizing considers future social security and future ira rmds.

No. of Recommendations: 3

A suggestion since you've just started and I'll assume you haven't started Social Security yet (sorry if you've mentioned you have and I missed it) or a pension yet....meaning you've got lots of 12% headroom. If so, I suggest you use it all up in Roth Conversions, particularly if you've got a couple of large TIRAs. At 70.5, you'll be glad you did.

BruceM

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We have not started soc sec yet. I was planning on taking a mix of ira withdrawals and ltcg to get up to the top of the 12% bracket. I haven't studied roth conversions. We do have fairly large iras.

How should I get started learning about roth conversions? I've (gasp) skipped over those discussions on this board and on the retirement investing board.

No. of Recommendations: 3

*I haven't studied roth conversions.*

They're actually fairly simple - during the calendar year, you move money and/or securities from a pre-tax account to a Roth account. After the end of the year, you will get a 1099-R showing the amount that was withdrawn - it will count as income, and you will owe taxes on the income.

You will also have to document the conversion using a Form 8606. (If you have basis in your traditional IRA and are taking withdrawals, you have to fill out this form, too.)

After you have a Roth IRA opened for 5 or more years and are over 59 1/2, you can withdraw the money tax free. If you don't already have a Roth IRA opened, and will start the a new Roth IRA with your first conversion, you will still be allowed to take the converted amounts (but not the earnings) out of the account tax-free, if you are over 59 1/2, even if you haven't had the account opened for 5 years. (Note: the 5 year clock starts on Jan 1 of the year that you open the Roth account, even if you don't open it until December of that year.)

*We do have fairly large iras.*

I would suggest figuring out how big your IRA RMDs have the potential to be. With large IRAs and several more years to go before RMDs, you might be surprised at how high they might be. (I know I was.) Here's a calculator from Vanguard that projects RMDs and lets you assume different return rates. If you're planning on taking out 4%, but have 6% growth expectation, you could use a net 2% increase. https://personal.vanguard.com/us/insights/retirement/living/... Be sure to account for all pre-tax accounts you have where RMDs will be required - IRAs, 401(k)s, etc.

*I was planning on taking a mix of ira withdrawals and ltcg to get up to the top of the 12% bracket.*

Under current law, the tax brackets will return to the prior brackets (10%, 15%, 25%, 28%, etc.) beginning in 2026. If your RMDs will be large enough to put you into the 25% (current 22%) bracket then, it's probably worth considering doing Roth conversions even into the 22% or 24% bracket before then. If you think that Congress will extend the timeframe for the current brackets, it's still probably worth looking at doing conversions into the 22% bracket if your RMDs will put you into the 22% or 24% bracket.

AJ

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Thanks AJ.

One question I have is on ira contributions that were made without a tax break. I did a number of those in the 1990s. I think I read somewhere that there is no tax on them in a conversion. But documenting that could be a nightmare. Plus they are probably comingled with deductible ira contributions, as well as investment gains.

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*How should I get started learning about roth conversions? I've (gasp) skipped over those discussions on this board and on the retirement investing board.*

You've answered your own question. Some pretty detailed posts on how to figure out if you would benefit from Roth Conversions are available for you to follow. It's not rocket science.

IP

No. of Recommendations: 0

*One question I have is on ira contributions that were made without a tax break. I did a number of those in the 1990s. I think I read somewhere that there is no tax on them in a conversion. But documenting that could be a nightmare.*

If at all possible I believe you need to do this documentation anyway, or pay taxes on those already taxed funds on withdrawal. You are supposed to file form 8606 with your taxes when you put taxed money into a TIRA, and this filing is what allows you to keep track of how much of the distribution from the TIRA is taxable. A Roth converstion is essentially a withdrawal from a TIRA but a special distribution that you are allowed to transfer to a Roth which is then not taxed on withdrawal.

IP

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Thanks IP. I have work to do, both in searching this board and reviewing old tax returns.

Fun stuff. But not so bad given no desire to leave a warm house when it's almost zero outside.

No. of Recommendations: 2

*One question I have is on ira contributions that were made without a tax break. I did a number of those in the 1990s. I think I read somewhere that there is no tax on them in a conversion. But documenting that could be a nightmare. Plus they are probably comingled with deductible ira contributions, as well as investment gains.*

You cannot separate out those non-deductible contributions - they are only considered as a percentage of the account. That said - these contributions are considered the same way for both conversions and regular withdrawals, so you need to figure that out either way.

You should have filled out a Form 8606 each year you made the non-deductible contributions. They are forms that document multiple years, so you should only need the last one. If you don't have the old tax returns, you can ask the IRS - probably after the shutdown.

If you didn't document using a Form 8606, you may have trouble proving that you made non-deductible contributions. But, you would have that problem even if you are just making withdrawals, as already pointed out.

AJ

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I found the form 8606 in the last year I made a non-deductible contribution. The total basis for all years is included, and it's less than 2% of my current ira balance (all iras combined).

Does that mean 98% of my roth conversion is taxable?

Also, I still have some iras labeled as rollovers (from 401ks). Are their balances included when calculating the percentage?

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* *

I found the form 8606 in the last year I made a non-deductible contribution. The total basis for all years is included, and it's less than 2% of my current ira balance (all iras combined).

Does that mean 98% of my roth conversion is taxable?

Yes, the amount is prorated across the entire TIRA balances.

* Also, I still have some iras labeled as rollovers (from 401ks). Are their balances included when calculating the percentage? *

Yes, rollovers are now IRAs.

No. of Recommendations: 0

*I have work to do, both in searching this board and reviewing old tax returns. *

You are not alone. We just tracked down two taxed rollerovers to TIRAs. The funds are about 0.065% of our total TIRA so not too sure it's worth going back and doing the 8606s, if we can even do so for 1997 and 2011.

If anyone has a link to a good tutorial on this it would be appreciated.

IP