Taxes: Going over the 15% bracket due to LT Cap Gains

[walkinwood]

I want to verify that I've understood this correctly.

Our ordinary income is less than our deductions, HSA contribution & personal exemptions.

If our taxable income goes over the 15% bracket (ie. greater than $75,300) because we have realized capital gains by selling shares, then the marginal tax on those gains is 15%.

That is, the marginal rate will not be 30% (or 25%) because our ordinary income from non-qualified dividends, ST cap gains and interest is low - less than our deductions, HSA contribution & personal exemptions. We are ER'd so no earned income.



This is the best explanation of the tax implications of harvesting cap gains that I've seen, but he does not address our particular situation:
https://www.kitces.com/blog/underst...st-capital-gains-for-a-free-step-up-in-basis/

 

[gauss]

One way to verify this is to use tax software and create a sample return. I have not done this recently, however.

That being said, I believe that any portion of the long-term capital gain, after combining with other income, that is less than the 15% threshold is taxed at 0%.

The remainder would be taxed at 15% assuming that total income does not exceed the 35% bracket.

In order to determine how much of the long-term capital gain exceeds the threshold (75,300) the ordinary income is considered first and then the LTCG (and qualified dividends) is added on top of it. This can be visualized if you think of a stacked bar graph.

Again, this is from memory, so hopefully someone else will confirm or correct this shortly.

-gauss

 

[walkinwood]

One way to verify this is to use tax software and create a sample return. I have not done this recently.

That being said, I believe that any portion of the long-term capital gain, after combining with other income, that is less than the 15% threshold is taxed at 0%.

The remainder would be taxed at 15% assuming that total income does not exceed the 35% bracket.

In order to determine how much of the long-term capital gain exceeds the threshold (75,300) the ordinary income is considered first and then the LTCG is added on top of it.

Again, this is from memory, so hopefully someone else will confirm or correct this shortly.

-gauss

Thanks.

I want to understand the mechanics behind the calculations.

I just realized... that since my marginal income is LT Cap gains (and not ordinary income), it really doesn't matter that my ordinary income is so low. That ordinary income is not increased by the sale of stock with LT cap gains.

My intention is to stay in the 0% LT Cap gains bracket, but I wanted to understand the implication of going over by a bit because mutual fund will not give me the exact qualified dividend breakup till sometime in 2017.

 

[RunningBum]

Your understanding looks correct to me. That 30% marginal tax rate comes when people have 15% on ordinary income, plus 15% on cap gains, when they've passed that $75,300 limit. But since your ordinary income tax rate is 0%, your marginal tax rate would be 0%+15%, or just 15%, for the cap gains and dividends over 75,300.

 

[kaneohe]

Thanks.

................................................................

I just realized... that since my marginal income is LT Cap gains (and not ordinary income), it really doesn't matter that my ordinary income is so low. That ordinary income is not increased by the sale of stock with LT cap gains.

...................................................

I think you nailed it ! Marginal tax rate means the change when (usually) a small change is made to the taxable income. If your taxable income is sitting
at the top of the 15% bracket and is a combination of ordinary and CG income
in any proportion, the marginal tax rate depends on which income you are increasing. If you increase the ordinary income, you increase your tax by 15% of your increase in ordinary income. In addition , that additional income pushed the same amount of CG into the 25% bracket where it is taxed at 15%.
Hence the so-called 30% bracket (for ordinary income). (and I suppose if your ordinary income is very low, your increase
in tax on the ordinary income could also be 10% or even 0% so you might get an overall marginal rate of 15-30%).

On the other hand, if the income increases because the CG increases, the only change is in taxation of the CG displaced into the upper bracket so the marginal rate is 15%.

A useful article for thinking about this graphically https://www.kitces.com/blog/underst...st-capital-gains-for-a-free-step-up-in-basis/
oops.......this is the same as your link.

 

[nwsteve]

I think you nailed it ! Marginal tax rate means the change when (usually) a small change is made to the taxable income. If your taxable income is sitting
at the top of the 15% bracket and is a combination of ordinary and CG income
in any proportion, the marginal tax rate depends on which income you are increasing. If you increase the ordinary income, you increase your tax by 15% of your increase in ordinary income. In addition , that additional income pushed the same amount of CG into the 25% bracket where it is taxed at 15%.
Hence the so-called 30% bracket (for ordinary income).

On the other hand, if the income increases because the CG increases, the only change is in taxation of the CG displaced into the upper bracket so the marginal rate is 15%.

A useful article for thinking about this graphically https://www.kitces.com/blog/underst...st-capital-gains-for-a-free-step-up-in-basis/
oops.......this is the same as your link.

Thx Kaneohe! Kites does a super job explaining the 0% cap gains strategy

 

[gcgang]

Great. I finally understand how the LTCG "stacks" on top of ordinary income, and now the tax laws will probably change.

 

[stlguy57]

You might also try https://turbotax.intuit.com/tax-tools/calculators/taxcaster to run your scenarios. It allows you to plug in the various estimated type of income to show how much federal tax you could potentially owe.

I've used it and it's very interesting to see the projections and how changing the estimate will effect the total amount due.

 

[pb4uski]

I want to verify that I've understood this correctly.

Our ordinary income is less than our deductions, HSA contribution & personal exemptions.

If our taxable income goes over the 15% bracket (ie. greater than $75,300) because we have realized capital gains by selling shares, then the marginal tax on those gains is 15%.

That is, the marginal rate will not be 30% (or 25%) because our ordinary income from non-qualified dividends, ST cap gains and interest is low - less than our deductions, HSA contribution & personal exemptions. We are ER'd so no earned income. ...

Yes... you got it. If you add more capital gains above $75,300 then the excess is taxed at 15%, capital gains within the $75,300 are taxed at 0%.

But OTOH, if you are at $75,300 and add ordinary income (like a Roth conversion) then the ordinary income will be taxed at your marginal ordinary income tax rate (in your case 0% until your ordinary income exceeds your deductions and exemptions) and the capital gains that are bumped above $75.300 as a result will be taxed at 15%.

If your marginal ordinary income tax rate was 15% then any incremental ordinary income will be taxed at 30% (15% ordinary and 15% bumped-up capital gains)

Verify with your favorite tax forecasting tool.

 

[walkinwood]

Great. I finally understand how the LTCG "stacks" on top of ordinary income, and now the tax laws will probably change.

Haha! That was my thought exactly!

Thank you all for your confirming my understanding and adding more information.

 

[rayvt]

I want to understand the mechanics behind the calculations.

Add up all your income (& deductions) *except* qualified dividends and LTCG.
The difference between that and the top of your 15% bracket is the amount of divs + LTCG that is taxed at 0%. The remainder is at 15%.