Deductions when AGI is mainly capgains & qualified divs.

[walkinwood]

We are ER'd. Our "income" from interest and non-qualified dividends is very low - way below the standard deduction. Our AGI this year, which is mainly long-term capital gains, will put us squarely into the 25% bracket.

I can't figure out how deductions (standard or itemized deduction + personal exemptions + HSA contrib) work. I know that they reduce taxable "income", but do they reduce taxable cap gains?

Can someone explain this to me or point me to a good tutorial? Thanks.

I know I can model this in Turbotax, but I'd like to understand the mechanisms at work.

Thanks.

 

[walkinwood]

Of course, they offset cap gains. (I'm sometimes very dense!)

In my case, the first $75,900 of taxable income (line 43 of 1040) will be tax free and everything above that will be taxed at 15%.

Well, hope this monologue helps someone since I can't delete this thread any more.

 

[kaneohe]

My impression on how it works.......(pls verify w/ a tax calculator/software).
Imagine your income as a stack of LTCG/QDIV sitting on TOP of a stack of ordinary income. Subtract your deductions/exemptions from the BOTTOM of the stack........which means it reduces the ordinary income first. If your ordinary income is smaller than deductions/exemptions, then the LTCG/QDIV stacks starts getting reduced too so your tax will be reduced further (if LTCG/QDIV taxed at 15% (25% bracket or higherJ).

 

[audreyh1]

Yes. Your AGI is made up of wages, interest, dividends, capital gains, IRA withdrawals, and a several other possible sources of income. These all add together to become your gross income.

Then a few things are taken off of that - IRA/401K contributions, HSA contributions, quite a list of things.

Now you have your adjusted gross income AGI.

Next you deduct your standard deduction or Schedule A deductions and your personal exemptions.

Now you have your taxable income.

From there (the taxable income), the tax owed depends on the source of income, whether ordinary or long-term cap gains or qualified dividends. So it's broken back up and the tax computation performed on the various components.

If all your income was from cap gains and qualified dividends, you would not owe anything on the first $74.9K, and the amount above that you would owe 15% tax.

In general income from long term cap gains or qualified dividends is subtracted from the total taxable income before calculating the taxes owed on the remaining taxable income which is treated as ordinary income and sent to the ordinary income tax tables. It's a bit more complicated than that, but you get the general idea.

 

[LOL!]

I just look at my Form 1040 to see how things work. Perhaps tax software is so good that folks don't print out their filled out forms anymore and look at them.

 

[LOL!]

If all your income was from cap gains and qualified dividends, you would not owe anything on the first $74.9K [of taxable income, not income and not adjusted gross income that could be substantially larger], and the amount above that you would owe 15% tax.

See edit. If you had written "If all your taxable income ...", then ....

 

[audreyh1]

See edit. If you had written "If all your taxable income ...", then ....

I was doing things stepwise in order and the taxable income was the part the taxes were calculated on.

 

[RunningBum]

I just look at my Form 1040 to see how things work. Perhaps tax software is so good that folks don't print out their filled out forms anymore and look at them.

What's not obvious to a lot of people is that when you have QDivs and LTCGs, the tax is calculated from the Qualified Dividend and Capital Gains Worksheet. Good luck finding that if you use H&R Block. They bury it in a Schedule D worksheet that doesn't even print with your forms or saved pdf file. It seems to equate to the same thing, but is not the same worksheet. In Turbo Tax they do show that worksheet (at least as of 2015) and it shows up in the saved version of forms/pdf.

 

[mamadogmamacat]

What's not obvious to a lot of people is that when you have QDivs and LTCGs, the tax is calculated from the Qualified Dividend and Capital Gains Worksheet. Good luck finding that if you use H&R Block. They bury it in a Schedule D worksheet that doesn't even print with your forms or saved pdf file. It seems to equate to the same thing, but is not the same worksheet. In Turbo Tax they do show that worksheet (at least as of 2015) and it shows up in the saved version of forms/pdf.

Right. It is quite obvious to us dinosaurs who still do paper (and use my own spreadsheet also) returns and get the paper forms and instructions at the library/PO, and either file a paper return or sometimes use federal free file if I'm getting a modest refund . If I owe a bit as usually do, i send it snail mail

 

[audreyh1]

What's not obvious to a lot of people is that when you have QDivs and LTCGs, the tax is calculated from the Qualified Dividend and Capital Gains Worksheet. Good luck finding that if you use H&R Block. They bury it in a Schedule D worksheet that doesn't even print with your forms or saved pdf file. It seems to equate to the same thing, but is not the same worksheet. In Turbo Tax they do show that worksheet (at least as of 2015) and it shows up in the saved version of forms/pdf.

Yeah it's pretty complicated.

Yeah, we see and review the Turbotax Schedule D tax computation all the time.

We print out and do a thorough review of all the forms generated by Turbotax. I occasionally find something we missed.

 

[jebmke]

What's not obvious to a lot of people is that when you have QDivs and LTCGs, the tax is calculated from the Qualified Dividend and Capital Gains Worksheet. Good luck finding that if you use H&R Block. They bury it in a Schedule D worksheet that doesn't even print with your forms or saved pdf file. It seems to equate to the same thing, but is not the same worksheet. In Turbo Tax they do show that worksheet (at least as of 2015) and it shows up in the saved version of forms/pdf.

You should be able to find a blank one on the IRS dot gov web site.

 

[RunningBum]

You should be able to find a blank one on the IRS dot gov web site.

I was kind of hoping that a tax program that I paid for, and that I bothered to type all of my info into, would show me the filled in form with my numbers.

 

[scrabbler1]

You should be able to find a blank one on the IRS dot gov web site.

Actually, the QDCGT Worksheet is in the Form 1040 instruction booklet. For 2016, it is on page 44, which, coincidentally, happens to refer to Line 44 of Form 1040. Unlike the tax forms in individual pdf files, this page has no fill-in quality. You can print the page by itself without printing the entire instruction booklet, but you have to write in any figures by hand.

As part of my homemade skeleton tax return spreadsheet, I created a version of this worksheet which mimics its data and calculations. To save some valuable space in my printed pages, I skip most lines between lines 15 and 23. I do have to update figures which change every year, and as a check I still complete the worksheet by hand.

Even doing all of this, that worksheet is pretty complicated.

 

[pb4uski]

I guess that mine is pretty easy. I calculate taxable income then split it into two pieces... preferenced (qualified dividends and LTCG) and ordinary. Then I calculate the tax on ordinary income using the tax tables and 0% for the preferenced income. Since I manage to the top of the 15% tax bracket (and don't exceed it) it is that easy.

If you broach the 25% tax bracket then it gets more complicated... but probably not much... calculate ordinary tax on ordinary income and take preferenced income in the 25% tax bracket at 15%.

At really high income it gets much more complicated.

 

[tinlizzy]

You can play around with the TaxCaster app to get a better feel for income tax.

 

[RunningBum]

I guess that mine is pretty easy. I calculate taxable income then split it into two pieces... preferenced (qualified dividends and LTCG) and ordinary. Then I calculate the tax on ordinary income using the tax tables and 0% for the preferenced income. Since I manage to the top of the 15% tax bracket (and don't exceed it) it is that easy.

Sure, but just to take full advantage of the 0% preferenced rate you have to understand which worksheet is being used and how it is used. And it helps to understand what happens if you go over (the 30% bump). Once you know that, it is pretty easy.

The OP asked to understand the mechanics, though in post 2 said they understood so I wasn't going to bother saying anything. But then post #5 said to just look at the 1040. It's not as simple as looking at the top form, you have to dig into the right worksheet or at least understand what it does.

 

[pb4uski]

Sure, but just to take full advantage of the 0% preferenced rate you have to understand which worksheet is being used and how it is used. ...

Not sure about that... isn't it as easy as just adding preferenced income (LTCG since you can control that) on top of your ordinary taxable income (ordinary income less deductions less exemptions) until you get to the top of the 15% tax bracket? That takes full advantage of the 0% preferenced rate.

And if you accidentally overshoot and have Roth conversion income you can recharacterize any excess.

 

[RunningBum]

Not sure about that... isn't it as easy as just adding preferenced income (LTCG since you can control that) on top of your ordinary taxable income (ordinary income less deductions less exemptions) until you get to the top of the 15% tax bracket? That takes full advantage of the 0% preferenced rate.

And if you accidentally overshoot and have Roth conversion income you can recharacterize any excess.

I guess it's the difference between:

Add up your income, subtract your deductions/exemptions, and trust me, that total tax number you get included 0% for preferred income.

vs.

Here's the mechanics of where you prove that 0% rate and see exactly how that total tax number was calculated.

Once you've done it once, you can skip the form, but if you want to understand the mechanics (as the OP first said), I think it's worth going through the form at least once. If you fully understand the principle, it's not needed either. I just like seeing the proof for myself. Maybe nobody else cares.

 

[kaneohe]

I guess it's the difference between:

Add up your income, subtract your deductions/exemptions, and trust me, that total tax number you get included 0% for preferred income.

vs.

Here's the mechanics of where you prove that 0% rate and see exactly how that total tax number was calculated.

Once you've done it once, you can skip the form, but if you want to understand the mechanics (as the OP first said), I think it's worth going through the form at least once. If you fully understand the principle, it's not needed either. I just like seeing the proof for myself. Maybe nobody else cares.

Maybe it's just me but I find that QDIV/CG wksht "hard" to use. There are so many of those "compare this to that, if greater, input this , otherwise input that" steps. Just one error and the whole thing is wrong. Granted that each step is simple and the instructions are good ........if you are not slow and careful, watch out.

I find it simpler to understand the stacked bar chart concept to determine how much preference income is in which bracket to get the answer. Then I do the worksheet until I get the same answer. I customize the spreadsheet so it follows the stacked bar chart model rather than mimic the worksheet line by line.

 

[pb4uski]

I think it is easy to prove if the total taxable income is in the 15% tax bracket.

Example: $15,000 qualified dividends, $20,000 pension income, $25,000 LTCG and $35,000 Roth conversions

Total income...................$95,000
Standard deduction...........12,600
Exemptions........................8,100
Taxable income...............$74.300

Preferenced income..........$40,000
Ordinary income................34,300
Taxable income................$75,300

Tax on ordinary income:
First $18,550 * 10%.............$1,855
Next $15,750 * 15%..............2,363
Total ordinary tax...................4,218
Preferenced tax............................0
Total tax..............................$4,218

From Taxcaster:

Total Income ? $95,000
Total Deductions ? $12,600
Total Exemptions ? $8,100
Taxable Income ? $74,300
Regular Taxes ? $4,221
Alt. Minimum Tax ? 0
Additional Taxes ? 0
Tax Credits ? 0
Tax Payments ? 0
You Owe ? $4,221
Marginal Tax Rate ? 15%

Not sure where the $3 difference is but close enough for the purpose.