Another ROTH conversation question....

[Looking4Ward]

You could try this test. Run the same scenario without the 21K distribution. If you get the same $793 tax, I'd be pretty certain you are missing something.

Tried it, and I do not get the same $793 tax. Nor does the child tax credit even begin to appear (because there are no taxes due) until I start to enter an IRA distribution amount.

I'm running this little exercise in TaxCaster. The particulars:

Single, head of household
Standard deductions
Child under 18: 1
W-2 Income: $0
Qualified Dividends: $18K
Short term cap gains: $3.5K
Long term cap gains: $25K
IRA distributions: $21K

TaxCaster then returns:

Total Income $67,500
Total Deductions $9,100
Total Exemptions $7,900
Taxable Income $50,500
Regular Taxes $918
Alt. Minimum Tax $0
Additional Taxes $0
Tax Credits $918
Tax Payments $0
Your Refund $0
Marginal Tax Rate 25%

If I remove head of household and the child dependent but keep the same dollar amounts:

Single
Standard deductions
W-2 Income: $0
Qualified Dividends: $18K
Short term cap gains: $3.5K
Long term cap gains: $25K
IRA distributions: $21K

TaxCaster then returns:

Total Income $67,500
Total Deductions $6,200
Total Exemptions $3,950
Taxable Income $57,350
Regular Taxes $4,771
Alt. Minimum Tax $0
Additional Taxes $0
Tax Credits $0
Tax Payments $0
Your Refund $-4,771
Marginal Tax Rate 25%

If I then leave all dollar amounts the same but reduce the IRA distributions, I can only get to $550 in IRA distributions before a tax-owed condition begins to occur:

Single
Standard deductions
W-2 Income: $0
Qualified Dividends: $18K
Short term cap gains: $3.5K
Long term cap gains: $25K
IRA distributions: $550

TaxCaster then returns:

Total Income $47,050
Total Deductions $6,200
Total Exemptions $3,950
Taxable Income $36,900
Regular Taxes $0
Alt. Minimum Tax $0
Additional Taxes $0
Tax Credits $0
Tax Payments $0
Your Refund $0
Marginal Tax Rate 15%

Conclusion: Head-of-household status with one minor dependent has a huge impact.

 

[pb4uski]

....For instance, I was just toying around with TaxCaster using a filing status of single, head of household, with one minor dependent and standard deductions.

I entered the following estimates with no W-2 income:

Qualified Dividends: $18K
Short term cap gains: $3K
Long term cap gains: $25K
IRA distributions: $21K (if I converted $21K from tIRA to Roth, correct?)

The "Total Income" comes to $67K
The "Taxable Income" comes to $50K
"Regular Taxes" is $793, but there is a child tax credit of $793.

TaxCaster shows total federal tax due of $0. This is using the 2014 version so the 2015 version will probably allow for slightly higher income, standard and personal deductions.

What am I missing?

I think what happens is that your taxes are based on your taxable income but qualified dividends and LTCG are taxed at zero so your STCG and Roth conversion get the benefit of the 10% tax bracket.

To see this, put in HH with one dependent and your $3,000 of STCG and Roth conversion of $20,400. Once combined with your standard deduction and exemptions, your TI is $6,400 and the resulting tax is $643 (~10%).

Then, add you $18,000 of qualified dividends and your $25,000 of LTCG and you'll see that the $643 tax is unchanged so the tax on that $43,000 of income is 0%. Your TI is then $49,400, then top of the 15% bracket. So your tax of $643 is simply ~10% of your taxable income that is not subject to 0% tax.

Now, add $100 to your Roth conversion (increase from $20,400 to $20,500) any your taxes increase by $25 (from $643 to $668). Welcome to the 25% tax bracket!

The above ignores any EIC for minor child.

Including EIC your conversion amount could increase to $21,845 which would result in $1,000 in tax that would be offset by $1,000 EIC. YMMV.

 

[Options]

See this regarding conversion rules and penalties:

https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/

From the article:

For some, taking advantage of the Roth conversion 5-year rule is a way for those well under age 59 1/2 to tap their IRA funds "early" without an early withdrawal penalty. For others, the reality is that the Roth conversion 5-year rule is a moot point anyway, because they already meet another exception to the early withdrawal penalty (e.g., already being over age 59 1/2). However, in all cases, the 5-year rule for contributions must be met before any Roth earnings can actually be tapped tax-free; fortunately, though, because any first-time contribution or conversion can start the clock, clients who are concerned about the 5-year rule can make a contribution to a Roth (or to a traditional IRA and then convert it) to start the time window now, and ensure they'll never need to worry about it in the future!

 

[RunningBum]

...

Conclusion: Head-of-household status with one minor dependent has a huge impact.

It sure does! I missed that distinction the first time. The top of the 15% bracket is higher than normal single. I wonder if your tax credit would let you convert even more before you have to pay any taxes? I'd keep playing with TaxCaster until you hit it, especially since you probably don't have too many years in that status? Definitely convert as much of the IRA for free as you can.

 

[Looking4Ward]

It sure does! I missed that distinction the first time. The top of the 15% bracket is higher than normal single. I wonder if your tax credit would let you convert even more before you have to pay any taxes? I'd keep playing with TaxCaster until you hit it, especially since you probably don't have too many years in that status? Definitely convert as much of the IRA for free as you can.

The $21K was as high as I could go without triggering tax due. But then, the $25K for Cap Gains was based on last year's (2014) distributions which were unusually high. Should those fall this year to more reasonable levels, the difference could be added to the tIRA conversion.

DS is 9 so I've got this advantage for the next 9 years.