Capital Gain Tax Help

[Jerry1]

I'm looking for some help understanding capital gain treatment. I understand that if I keep my income below $78,750 (MFJ), I pay zero tax on the gain. The problem is that I'm right on the edge. If I go over that amount, do I pay 15% on the entire amount of the gain? I put my data in TT (roughly so can't really rely on the output yet) and it taxed my entire gain at 15%.

I converted $20,000 to ROTH this year. If I enter only $10K, then the tax goes almost to zero, but not exactly zero. So, is the tax like a bracket where you pay zero on some of the gain and 15% on the amount over $78,750 or is it like a cliff where if you go over $78,750, you pay 15% on the entire gain (seems to be this way)?

So, this isn't a big deal, but there's about $1,000 on the line. I'm sure I could pull back the ROTH conversion (all or partial), but I'd like to be able to do this after I receive all my documents. Can I pull back the conversion now and do more by April 15th? Or, does it have to be done before 12/31. In the year end case, I guess I'd have to get pretty precise on my estimates. The main thing I'd have to firm up is interest and dividends from my taxable accounts.

This seems a pain, unless I'm missing something, but it's worth it rather than making a $1K mistake.

Help is appreciated.

 

[RunningBum]

It's not a cliff, though it is a higher rate then you might expect. See if the 3 posts starting here help: http://www.early-retirement.org/for...-conversion-this-year-100754.html#post2324695

 

[Jerry1]

It's not a cliff, though it is a higher rate then you might expect. See if the 3 posts starting here help: http://www.early-retirement.org/for...-conversion-this-year-100754.html#post2324695

Thank you. I searched, but did not see that thread. Very helpful.

 

[Jerry1]

So, now what to do. I need to pull some of that ROTH money back.

 

[RunningBum]

Recharacterizations are no longer allowed so I don't think you have the option to pull back any Roth conversions. I assume you've done things like HSA contributions that would reduce income already. Any regular income that would allow a tIRA contribution? How about any losses you can harvest? If you itemize deductions, are there any you can stack up this year? Open a DAF and fund it for a few years?

Or you can just live with a little of your LTCGs being taxed, making an effective 27% marginal rate. Or, especially if you've pushed most of those into being taxed, convert more to the top of the 22% bracket. Once all LTCGs/QDivs are taxed you go back to a 22% marginal rate. It depends on your long term picture whether that's worth it once in awhile. I'm likely to be there next year, and might use it as a year to heavily convert my Roth.

 

[Jerry1]

Maybe not. I didn't realize that I didn't select Qualified for my dividend estimate. If my dividends are qualified, then my entire situation changes. I think I'll be fine assuming most dividends are qualified, which I believe they are.

This stuff is like going back to school. I'm a CPA, but worked in industry and only did a few years of taxes some 20 years ago. Easy enough to DO my taxes, but the estimate process combined with the new (retired) situation is a bit more difficult.

Thankful to the members here who have traveled this road before me.

 

[Jerry1]

Recharacterizations are no longer allowed so I don't think you have the option to pull back any Roth conversions.

So you can't change your mind even if you're still in the tax year in question?

Guess I won't be doing those conversions until much later in the year and with a better tax estimate in the future.

 

[RunningBum]

So you can't change your mind even if you're still in the tax year in question?

Guess I won't be doing those conversions until much later in the year and with a better tax estimate in the future.

I don't think so. I don't believe they were targeting people who would recharacterize to keep from going over the ACA cliff or stay away from other limits like yours. Instead they were probably trying to eliminate the horse race, where you would convert to two different Roths--one that you made risky investments, the other more stable ones. Perhaps just stocks in one, bonds in the other. At tax time, you keep the winner, and recharacterize the loser. You could end the race in December rather than early in the following year, so they took away Roth conversion recharacterizations completely.

I believe you can Roth and tIRA recharacterize contributions, since you may go over some income limit so they are no longer allowed, but not conversions.

 

[RunningBum]

Maybe not. I didn't realize that I didn't select Qualified for my dividend estimate. If my dividends are qualified, then my entire situation changes. I think I'll be fine assuming most dividends are qualified, which I believe they are.

Dividends still fill that bucket, whether they are qualified or not. They are taxed differently, so you'll likely be paying less if they are qualified, but you are trying to not overflow that bucket to avoid any LTCGs/QDivs from being taxed.

 

[SecondCor521]

I don't think so. I don't believe they were targeting people who would recharacterize to keep from going over the ACA cliff or stay away from other limits like yours. Instead they were probably trying to eliminate the horse race, where you would convert to two different Roths--one that you made risky investments, the other more stable ones. Perhaps just stocks in one, bonds in the other. At tax time, you keep the winner, and recharacterize the loser. You could end the race in December rather than early in the following year, so they took away Roth conversion recharacterizations completely.

I believe you can Roth and tIRA recharacterize contributions, since you may go over some income limit so they are no longer allowed, but not conversions.

RunningBum's understanding above matches mine. The changes were part of the TCJA in 2017.

Now the only real useful strategy I know of is to approach it carefully and perhaps in parts in December once you know all of your income. And leave some room in case you're near a cliff you don't want to go over (such as 400% of FPL for ACA).

 

[Jerry1]

So I refined my numbers and I'm right on the edge. If I delete my withdrawal for the ROTH conversion, I would get the capital gains at zero tax. When I add the ROTH conversion back, I don't get the capital gain benefit, but some of the ROTH conversion is at 12%. Mathematically, it works out to almost exactly 22% on the ROTH conversion. Not terrible, but not as planned. If I had the information I have today when I decided on the ROTH, I probably would not have made it. On the other hand, it's hard for me to argue that 22% is not a good rate given that my plan figures that when RMD's kick in I'll be at 22% or maybe (probably) back to the 28% bracket. Oh well. Live a learn. In the end, I'm mainly frustrated because I did not do a good job in my estimate when I made the ROTH conversion. I might have still done the conversion, but I would have done it with full knowledge. Now I've done it out of a level of ignorance that I'm not comfortable accepting. Note to self, these decisions can cost you a lot. Spend more time on them. It's worth it.

Thanks for the help.

 

[pb4uski]

^^^^^ If you are just barely in the 12% bracket, your marginal rate should be 27%... 12% on the incremental conversion income and 15% on capital gains pushed into the 15% capital gains tax bracket... then at some point you may be back in the 12% bracket once all capital gains are in the 15% capital gains bracket (or once ordinary taxable income exceeds the top of the 10% bracket).

You might look at the incremental tax and incremental tax rate on conversions of $10k increments to the top of the 12% bracket.