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LTCG - Do I have this right?
Old 01-24-2013, 03:12 PM   #1
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LTCG - Do I have this right?

In order to figure out what the tax will be on LTCG - I have to be below the income cutoff by the same amount so as not to push taxable income into the next higher bracket?

I read a thread on here and on Bogleheads with a bar chart explaining this. I had envisioned that LTCG's were like rocks sinking to the bottom of a bucket of water and they displace your taxable income upward.

I want to make sure I have this straight in my head going forward.

Thanks!
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Old 01-24-2013, 03:47 PM   #2
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best to give numerical examples if you really want to know if you know.
LTCG are more like foam floating on top than rocks sinking to the bottom.
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Old 01-24-2013, 04:01 PM   #3
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2012 Marginal Tax Brackets: Tax Information
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Old 01-24-2013, 04:01 PM   #4
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Quote:
Originally Posted by tinlizzy View Post
In order to figure out what the tax will be on LTCG - I have to be below the income cutoff by the same amount so as not to push taxable income into the next higher bracket?

I read a thread on here and on Bogleheads with a bar chart explaining this. I had envisioned that LTCG's were like rocks sinking to the bottom of a bucket of water and they displace your taxable income upward.

I want to make sure I have this straight in my head going forward.

Thanks!
I think it's the other way around - your taxable (ordinary) income pushes your long term capital gains/qualified dividend income to the next tax rate level - 0%, then 15%, then 18.8%, then 23.8%.
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Old 01-24-2013, 04:07 PM   #5
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I think it's the other way around - your taxable (ordinary) income pushes your long term capital gains/qualified dividend income to the next tax rate level - 0%, then 15%, then 18.8%, then 23.8%.
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Old 01-24-2013, 04:29 PM   #6
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best to give numerical examples if you really want to know if you know.
LTCG are more like foam floating on top than rocks sinking to the bottom.
Yes, that's much more accurate.

If you are single and looking at staying under the 15% cap ($36250) and have $30K of income, adding $10K of capital gains isn't going to sink to the bottom of that bucket and spill $3750 of income into the 25% bracket. Instead, your $30K of income remains in the 15% bracket, and the first 6250 of LTCGs are free, and the next $3750 of LTCG foam oozes out and is taxed at 15%.

Don't forget to subtract deductions and exemptions from your income.
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Old 01-24-2013, 04:34 PM   #7
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Money is fungible, but because the dividend+cap gain tax rate is lower than that of ordinary income, it is more appropriate to think of the former as being on top.

The analogy to the foam like, say, on top of a mug of beer is apt, because if the foam gets too high, it gets blown off. If it is under the rim of the glass, it survives intact.

Or another analogy is like crouching in a fox hole in a battle. If you stick your head up, you may get a haircut by a bullet. Stick it up even higher, well, I happen to recall a sword fight scene in the movie Kill Bill where the character O-Ren got a deeper-than-normal haircut.

I found the scene on youtube too, but it's too gruesome to post here.
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Old 01-24-2013, 04:34 PM   #8
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Also, keep in mind if you have a full bucket of part income liquid and part LTCG foam, and you pour more liquid in the form of Roth conversion income into the bucket, not only is that liquid taxed at 10 or 15%, but the foam that oozes over gets taxed at 15% too, for an effective 25 or 30% tax on that conversion.
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Old 01-24-2013, 04:37 PM   #9
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We need a taller glass! Or a deeper fox hole.

The above said, I think I will be quite OK. Being retired and having no earned income, no pension, nor SS yet is like having short legs. Nothing sticks out from my foxhole, if I do not get carried away with Roth conversion. Or it's like having my glass full of foam, with no liquid there at all.
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Old 01-24-2013, 06:16 PM   #10
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Here is an example (it is fictional): say my wife and I need to come up with $90,000 a year to fund our lifestyle.
$2,700,000 in assets to withdraw from.
$900,000 in a tIRA;
$100,000 in cash reserves,
the rest in taxable investments generating $22,000 in dividends and $8000 in interest
accumulated Capital Gains of $400,000. That means starting withdrawls from a principle basis of $1,270,000.
How much to take out of each place and how much if any RothIRA conversion to attempt?
Am I right in concluding that only the $8000 would be subject to 15%tax if you took the dividends and also $60000 from the taxable investments? Of that $60000, only about $20000 is cap gains and still 0 tax rate?
Also the top of the 15% marginal tax rate is $70,700. so how much of that would be left for Roth conversion without pushing up the rates? Is it $70,700 - $8000? or $70,700 - $30,000? or $70,700 -$50,000? I have left out standard deduction of $11,600, but feel free to consider that too.
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Old 01-24-2013, 06:41 PM   #11
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72,500 is the new top of the 15% bracket for marrieds for 2013. It's 72500+exemptions+deductions - 50,000 that you have room for Roth conversion to keep income at 15% and LTCGs and qualified dividends at 0%.
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Old 01-24-2013, 09:29 PM   #12
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I really appreciate the answers and I thought I got it (I like the foam analogy) but urn2bfree's fictional scenario lost me (plus I am tired which is not helping).

I am planning on retiring in 7 yrs (at 52) and will take a reduced pension = $24000/yr. Single filer. I have about $515,000 saved now but only $11k in a Roth ira. I have approx $110,000 in capital gains. I will need to learn this.

I'll have to try again tomorrow. I work outside and the cold really zaps me.
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Old 01-24-2013, 11:16 PM   #13
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I but urn2bfree's fictional scenario lost me (plus I am tired which is not helping).
urn2bfree's example, because you get the wheat along w/ the (related) chaff, tends (prob. unintentionally)to disguise the problem.
I agree w/ RB's analysis.
$22,000 in dividends and $8000 in interest
$20000 is cap gains................is the stated income = $50K = AGI
The 15% bracket upper limit is for MFJ in 2012 70.7K TAXABLE income

TAXABLE income = AGI - exemptions - deductions (assuming no adjustments)

AGI (corresponding to 15% bracket upper limit in 2012) =
70.7K + exemptions + deductions
see here for exemptions, deductions Reference Room
for MFJ , exemptions 2x 3.8 = 7.6K; std deduction= 11.9K

so AGI (at 15% upper limit) = 70.7K + 7.6K + 11.9K = 90.2K
With stated income of 50K, you have room for 40.2K of additional income and will stay within the 15% bracket where the tax rate for LTCG and QDIV is 0%. Once you exceed that amount, the foam on top gets pushed into the
25% bracket where LTCG/QDIV is taxed at 15%. If the pushing is done by more LTCG/QDIV, the foam within the 15% bracket is taxed at 0% but the foam pushed above the limit is taxed at 15%.

As RB points out, if the foam on top gets pushed into the 25% bracket by more ordinary income, the LTCG/QDIV pushed over the limit gets taxed at 15% but in addition the pushing ordinary income under the foam is taxed at 15% (perhaps some at 10% if starting low) for a total marginal rate of 30%
(or perhaps 25% for part). Best to use tax software or a calculator like
Taxcaster (google for it) to check your assumptions to prevent surprises.
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Old 01-25-2013, 12:09 AM   #14
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Another thing to be aware of that may not fall into the otherwise cute beer-foam analogy is that having a lot of LTCG taxes at 15% (or slightly more with new tax changes for high-income earners) will trigger the AMT and other phaseouts such as for itemized deductions and personal exemptions.

I learned this for myself back in 2008 when I cashed out my company stock worth nearly $300k at mostly LTCG rates (using NUA, Net Unrealized Appreciation). My other income, mostly wages, was around $30k, so I was in the 15% bracket for ordinary income.

But adding to that measly wage income this huge income bomb caused me to have to pay attention to all of those little exceptions I had always been able to ignore. Those included the limitation of my itemized deduction and personal exemption. Then came the AMT which added about $8,500 to my tax bill because all of that wage income got taxed at a much higher rate through the AMT's relatively high rates (and the AMT has its own personal exemption limitation).

Still, being able to pay only 15% on a nearly $300k blob of iLTCG ncome (even with the AMT) overshadowed anything the AMT did to the rest of my income.
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Old 01-25-2013, 12:23 AM   #15
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Another thing to be aware of that may not fall into the otherwise cute beer-foam analogy is that having a lot of LTCG taxes at 15% (or slightly more with new tax changes for high-income earners) will trigger the AMT and other phaseouts such as for itemized deductions and personal exemptions.
Oh man! AMT is extremely painful. As my consulting part-time work was so erratic, one year I had so little income. Then, the next year I got a such a severe hair cut I thought I looked like a skinhead, when a friend I did some work for came across some money that enabled him to pay what he deferred, and boosted up my income to level I did not anticipate.

It is no longer the foam analogy, but the haircut that would cause a severe headache.

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Or another analogy is like crouching in a fox hole in a battle. If you stick your head up, you may get a haircut by a bullet. Stick it up even higher, well, I happen to recall a sword fight scene in the movie Kill Bill where the character O-Ren got a deeper-than-normal haircut.

I found the scene on youtube too, but it's too gruesome to post here.
OK, you asked for it. See the following.


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Old 01-26-2013, 03:52 AM   #16
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Thank you everyone for the breakdown.

Urn2bfree - thank you for that scenario. It really forced me to think it through. It was that $60,000 from taxable that was tripping me up. When I was tired I kept thinking of the $90,000 as income vs $90,000 to spend, $30,000 of which is income. Anyway, it's completely understood now!

OT - I work outdoors and although it's cold, I at least have a shelter to hide from the wind. I think mail carriers have the most brutal job in the US (at least in most states) and don't know how they manage to function when the work day is over.
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Old 01-26-2013, 07:12 AM   #17
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Sorry I did not make things clearer. The hardest part of it is trying to anticipate what percent of your spending (withdrawn) money will still be taxable. During our accumulation years we are so used to owing taxes on the money we have to spend' that the difference is mind blowing to me. Then to add to the confusion is the notion that some of the money growing in our portfolios is made up of those growing "tax-free"which is an illusion. The growth is free, till you want to harvest. They grow tax deferred, not free. And when those are withdrawn now we suddenly have to tax every penny . Meanwhile our "taxable" account is the one mostly (for most of us) made up of money that has been taxed as it grew, so we are used to worrying about taxes on it. But on withdrawal only some is partly taxed (the amount will depend on your success. If your taxable account was all Apple stock that you bought at 1/10th of the sell price then 90% of what you take out will be subject to cap gains taxes at whatever rate your tax bracket puts you in) Only Roth IRA grows tax free. (taxed before "planted")
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Old 01-26-2013, 10:44 AM   #18
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No, it was perfect because it was vague! I really do have it clear in my head now because it forced me to think of all the ways that money is pulled out of various accts. (excl. cost basis) and how it is taxed.

All the explanations helped tremendously! I am very relieved because it has been nagging at me since I read those other threads.
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