Cap Gain Taxes at Year End

[Packman]

Since L/T capital gains and qualified dividends are taxed at zero if you are in the 15% (or lower) tax bracket, I use this strategy each year and pay little or no federal income tax. This is sometimes called 'tax gain harvesting'. At the end of the year, I take gains such that I try to fill the 15% tax bracket. There are many variables and late gains paid to me to "exactly" hit the top of the 15% bracket, so I am trying to figure out if it is better to stay below the top of the bracket or go over it. If I am below, I leave potential income that is not taxed on the table. If I go over, I pay tax at a 15% rate. I have many years of gains in taxable accounts so I can use this strategy for a while.

We have no earned income and very little other taxable income - almost all of our income is from investments. Any thoughts from others using this strategy?

[bingybear]

If just looking at the one item, it is a good thing to do.

For me, making Roth conversions before RMD time seems better over the long run. So I harvest capital losses and fund HSAs to reduce income. Then I convert (to Roths) up to the top of the 15% bracket.
Some will tell you that getting an ACA subsidy is better. I will not have that choice until next year.

Whether your approach is the best depends on many other factors in your situation. What you are doing makes sense, but is it best?

[Options]

Quote:

Originally Posted by bingybear If just looking at the one item, it is a good thing to do. For me, making Roth conversions before RMD time seems better over the long run. So I harvest capital losses and fund HSAs to reduce income. Then I convert (to Roths) up to the top of the 15% bracket. Some will tell you that getting an ACA subsidy is better. I will not have that choice until next year. Whether your approach is the best depends on many other factors in your situation. What you are doing makes sense, but is it best?

I'm doing a combination of both. Roth conversions and LTCG harvesting just up to the 15% tax bracket. I played around with tax software (Taxact, which I use to file taxes) to forecast taxes and optimize as much as possible at the same time. You might want to do the same to fit your exact situation.

Edited to add: ACA isn't an issue in my case as COBRA/CAL-COBRA is a financially superior health care choice for my situation.

[Willers]

Either strategy makes sense if ACA isn't an issue. In my case it is a $9K subsidy to stay under the limit so it doesn't work for me. I'll happily go down these paths once I turn 65 (or ACA implodes).

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[SecondCor521]

I think playing with tax software is the best way to approach it, since there are so many moving parts (in my case, ACA, child tax credit, retirement savings credit, state tax implications).

My rough rule of thumb is I'm happy to pay taxes today if the rate is below 15-20%.

Plugging my information so far into Turbotax online indicates that for my particular situation, doing a traditional IRA contribution of $5500, realizing capital gains of about $4000, and a Roth conversion of about $25,000 is the sweet spot.

To the OP's question of whether it is better to err on the lower or upper side of a bracket, I personally am erring on the low side by a few hundred bucks, but I suspect it is probably a small enough effect not to worry about it too much either way.

What I might do if I get really motivated is to compare my actual tax return that I complete early next year with the pro-forma tax-planning one I am doing in Turbotax now and see if I can learn anything from any discrepancies I can find. A few things that I know change from year to year that affect me are: the ACA income levels (and thus ACA subsidy amounts), personal exemption amounts, and tax bracket levels. But again, I think the effect is on the order of a few hundred dollars. After considering that my effective tax bracket in my particular sweet spot is maybe 10%, we're talking about $10 or $20 of taxes, which isn't enough to get me to work on it any more precisely.

[pb4uski]

Quote:

Originally Posted by Options I'm doing a combination of both. Roth conversions and LTCG harvesting just up to the 15% tax bracket. I played around with tax software (Taxact, which I use to file taxes) to forecast taxes and optimize as much as possible at the same time. You might want to do the same to fit your exact situation. Edited to add: ACA isn't an issue in my case as COBRA/CAL-COBRA is a financially superior health care choice for my situation.

Combination here too... capital gains occur naturally as we liquidate taxable funds to rebalance cash that we use for our living expenses... remainder is filled with Roth conversions to reduce RMDs later in life.

I usually overconvert and then recharacterize any excess when I finalize my tax return.... our taxable income has been exactly equal to the top of the 15% tax bracket the last two years.

[FreeBear]

Quote:

Originally Posted by Willers Either strategy makes sense if ACA isn't an issue. In my case it is a $9K subsidy to stay under the limit so it doesn't work for me. I'll happily go down these paths once I turn 65 (or ACA implodes).

Same here, we're chasing ACA subsidies heavily as long as they last politically or until we have to draw heavily on the IRA's. So we're harvesting gains over a couple of years that we've accumulated since 2009. This keeps us above the Medicaid line but still maximizes our subsidies. We only have a few years worth of gains to harvest, but after this time our income will rise as we'll start the IRA drawdown, so the ACA subsidy will be less relevant, if it even still exits.

[OverThinkMuch]

I suppose there's an additional tradeoff: go $100 under and you file taxes without worrying about paying the IRS. Go over $100, and you need to deal with electronic or check payment of $15-$25.

[mpeirce]

Quote:

Originally Posted by Packman We have no earned income and very little other taxable income - almost all of our income is from investments. Any thoughts from others using this strategy?

My dad uses this strategy (well, I put this strategy in play on his behalf). He lives of SS and his savings/investments. He has accumulated sizable capital gains in his investments and so each year I have him sell just enough to use up the 0% capital gains tax. He uses some of the proceeds to live on and the rest stays invested.

Two years ago he had a little more income from his job as a poll worker (there were extra elections that year) and I had overlooked that when I figured out how much capital gains to harvest. This left him with a couple of hundred in federal taxes.

He took that as a challenge. So rather than take the standard deduction he spent days digging through his receipts and records to come up with enough deductions to out do the standard deduction. He did it and didn't have to pay any income tax that year.

Now I'm slightly more conservative on how much capital gains I have him harvest so we don't have to go through that again.

[Fermion]

Sort of using the same strategy, except with a bit of active trading to generate more gains in the taxable accounts (a lot of our money is in 401K and IRA). I essentially am trying to squeeze $23,000 a year from $500K, spread out into cash like investments and stocks. This is the magic number for max ACA goodness.

Right now I am at $18,000 in realized gains but the year is not over yet.

[whatnot]

I have a question regarding the Roth Conversions. If you do a conversion as Bingybear discussed above, then the money is not available for 5 years. Is that correct?
We are not retired yet but I have done 2 back door conversions (correct term?) where I make a nondeductible IRA (due to income limits) and then convert to a Roth in the same year. But from what I understand, there is a 5 year wait to access those funds without penalty. Since we are working that is not an issue.
The majority of our investments are tax deferred, so I am trying to build up our after tax investments. But in retirement if we pull from our tax deferred, we would need those funds for our current year expenses. So my question for those that are doing conversions, do you have other non-taxable funds available to cover your current year expenses? Thanks for these threads - they do get me thinking or options!

expenses that allow you to use this

[Cobra9777]

Quote:

Originally Posted by bingybear ...For me, making Roth conversions before RMD time seems better over the long run. So I harvest capital losses and fund HSAs to reduce income. Then I convert (to Roths) up to the top of the 15% bracket...

Quote:

Originally Posted by Options I'm doing a combination of both. Roth conversions and LTCG harvesting just up to the 15% tax bracket. I played around with tax software (Taxact, which I use to file taxes) to forecast taxes and optimize as much as possible at the same time...

Quote:

Originally Posted by pb4uski Combination here too... capital gains occur naturally as we liquidate taxable funds to rebalance cash that we use for our living expenses... remainder is filled with Roth conversions to reduce RMDs later in life...

Similar approach here, although we don't routinely liquidate taxable funds for living expenses, just for occasional discretionary spending. So we have a choice of Roth conversions or gain harvesting to fill up a small gap in the 15% bracket. We usually just reduce conversions by the amount of any gains, to keep everything inside the 15% bracket. We don't routinely harvest gains as a standalone strategy, as I don't see any long-term comparative advantage over Roth conversions. But if I'm overlooking some aspect of this, I'd love to be enlightened.

[GTFan]

Quote:

Originally Posted by Willers Either strategy makes sense if ACA isn't an issue. In my case it is a $9K subsidy to stay under the limit so it doesn't work for me. I'll happily go down these paths once I turn 65 (or ACA implodes).

Same for me, I just can't ignore the $9k subsidy plus the excellent cost-shared Silver plan we get for staying below 200% FPL. And that subsidy is only going to get larger as insane ACA premium increases get approved in many states.

You're not only taking the savings now vs. maxing out the 15% bracket (and getting benefits later), you're also greatly reducing the impact of any health issues because the out of pocket expense is way lower than for Bronze or catastrophic plans. And some states tax everything above a low floor, that's another 6% in GA I won't pay now - when we hit 62 we get to exclude a decent chunk of retirement income but that's years away for us.

There's certainly an argument to be made either way to keep income low vs. reaping gains or doing Roth conversions. We also plan to use IRA charitable deduction rules to rollover IRA/401k RMDs after 70 1/2 and avoid the tax torpedo. This assumes you might not want to leave a large legacy to your children of course.

[ducky911]

I admit that I am an "addict to zero tax on qualified dividends"

Do I need a 12 step program?

This is an additional perk for stalling off SS.

[marko]

I know I should know this, but:

If you go over 15% do you pay 25% on the whole set of cap gains or do you pay 25% on only the amount that pushed you over 15%?

[bingybear]

Quote:

Originally Posted by marko I know I should know this, but: If you go over 15% do you pay 25% on the whole set of cap gains or do you pay 25% on only the amount that pushed you over 15%?

neither.
lets assume you have enough to be paying 15% on normal income or non-qualified dividends and enough LTCG to get you to the top of the 15 % bracket.

If we assume you get $1 more in normal income, this will be taxed at a marginal rate of 30%. This is because that last dollar will will be taxed at 15% and will push $1 of LTCG to be taxed at 15% at the same time because it gets pushed above the 15% normal income bracket.

Now if you just get $1 of LTCG starting from the same starting point, the one $1 LTCG over the 15% bracket will be taxed at 15% marginal rate. LTCG is taxed at a lower rate than normal income. This is really the answer to your question. Going over the 15% bracket with LTCG will be taxed at 15% unless you exceed the nest tax breakpoint. But be careful when calculating marginal rates... they can be much more involved. Thus neither of you answers are correct

[marko]

Quote:

Originally Posted by bingybear neither. lets assume you have enough to be paying 15% on normal income or non-qualified dividends and enough LTCG to get you to the top of the 15 % bracket. If we assume you get $1 more in normal income, this will be taxed at a marginal rate of 30%. This is because that last dollar will will be taxed at 15% and will push $1 of LTCG to be taxed at 15% at the same time because it gets pushed above the 15% normal income bracket. Now if you just get $1 of LTCG starting from the same starting point, the one $1 LTCG over the 15% bracket will be taxed at 15% marginal rate. LTCG is taxed at a lower rate than normal income. This is really the answer to your question. Going over the 15% bracket with LTCG will be taxed at 15% unless you exceed the nest tax breakpoint. But be careful when calculating marginal rates... they can be much more involved. Thus neither of you answers are correct

Thanks. This stuff makes my head hurt.

[kaneohe]

Quote:

Originally Posted by marko Thanks. This stuff makes my head hurt.

Here's your aspirin Perhaps a graphical explanation will make it easier.
https://www.kitces.com/blog/understa...p-up-in-basis/

[OverThinkMuch]

Quote:

Originally Posted by marko If you go over 15% do you pay 25% on the whole set of cap gains or do you pay 25% on only the amount that pushed you over 15%?

A tax bracket is a range of incomes that only applies to the money within that range. That's why the IRS description of the 15% tax bracket is "927.50 plus 15% of the amount over $9,275". Anyone filling up the 10% tax bracket is paying $927.50 on their first $9275 of income.
https://www.irs.com/articles/project...tax-rates-2016

In the 25% - 39.6% tax brackets you pay only 15% tax on long-term capital gains. So the extra dividends that push you into the 25% bracket, you're paying 15% of the money that falls in the 25% and higher tax bracket. But another part of the tax code kicks in, "net investment income tax" at 200k (single) / $250k (married). You add another 3.8% to the amount that went over.
https://www.irs.gov/uac/newsroom/net...ncome-tax-faqs

[bingybear]

Quote:

Originally Posted by OverThinkMuch A tax bracket is a range of incomes that only applies to the money within that range. That's why the IRS description of the 15% tax bracket is "927.50 plus 15% of the amount over $9,275". Anyone filling up the 10% tax bracket is paying $927.50 on their first $9275 of income. https://www.irs.com/articles/project...tax-rates-2016 In the 25% - 39.6% tax brackets you pay only 15% tax on long-term capital gains. So the extra dividends that push you into the 25% bracket, you're paying 15% of the money that falls in the 25% and higher tax bracket. But another part of the tax code kicks in, "net investment income tax" at 200k (single) / $250k (married). You add another 3.8% to the amount that went over. https://www.irs.gov/uac/newsroom/net...ncome-tax-faqs

This is a good explanation of how the IRS sets out the tax code. Some around here also look at localized marginal tax rates. Some of these occur due to sequence of income or effects like the PTC (I expect others). In the end taxing is as you note. However, if you are looking at doing a Roth conversion at the end of the year and you are modeling the added taxes will effect you and you are presently at the top of the 15% bracket.... then you will find for every $ in taxable conversion, you will push a $ of LTCG or Q divy over the 15% bracket. In this case the last $ of conversion is taxed at 15% and the LTCG/Qdivy pushed over the 15% bracket is taxed at 15% which creates as local 30% marginal rate.
Now depending upon circumstances one my be in the 25% local marginal bracket if the last Rollover $ is in the 10% marginal rate (add 15% for pushing LTCG over the 15% bracket).

Many of the local marginal rates can be confusing as several things can play with the results. It is not as clean cut as the IRS basic marginal tax rates. I sometime wonder if optimizing the local marginal rate may not optimize the long term tax situation... but just the near term taxes. However, I have not looked into this enough just for my case. It would take a fairly large effort to do this in general.