Effect of Standard Deduction on AGI and 0% LTCG

[joesxm3]

I am filing as a single and get ACA, so my ACA income limit is $40,000. The 12% bracket seems to be about $40,050 or so. This affects me since under that limit my LTCG tax rate is 0%.

I got myself into sort of a pickle when I sold some old "non-covered" mutual funds and discovered that they separate the basis between "non-covered" and "covered", so I created an unexpectedly large LTCG.

I have some short term investments that I might want to sell at a gain because they are speculative and might have a sudden price drop, but I am trying to assess the impact of going over my limits.

I just ran a "play" Turbo Tax scenario and it seems to confirm the following assumptions, but I wanted to double check by asking here.

1. The standard deduction does not get subtracted from the AGI calculation, so any income over my $40,000 ACA limit is going to reduce my subsidy. I am guessing that this will add 8% to my tax amount for the over the limit gains.

2. The standard deduction does get subtracted from the taxable income, so my actual limit for the 0% LTCG rate is not just $40,050 of income, but $40,050 plus the standard deduction amount.

3. Interest and short term gains are counted first and will push the LTCG up over the limit if the STCG are too much.

I ran the quick and dirty Turbo Tax scenario as follows and it gave me $0 taxes owed:

Interest $10,000
Short term capital gain $10,300
Short term capital loss ($7950)
Long term capital gain $37950

So it seems to let me have roughly $50,300 of income, which seems close to the $40,050 12% limit plus the standard deduction. I probably had some other carry over stuff that might have effected it a little bit, since it copied from my actual return for 2019 but I don't think it would materially affect the result.

So, do my assumptions make sense and seem correct?

If so, it would seem I have another $10,000 or so of wiggle room to take some STCG.

Thanks.

Joe

 

[pb4uski]

Looks about right to me.... but only $2,650 of wiggle room... $40,400 - $37,750.

 

[turbo89]

Looks about right to me.... but only $2,300 of wiggle room... $40,050 - $37,750.

What software is that!? Seems like it could be useful!

 

[RunningBum]

I'm not sure what you mean when you say "my ACA income limit is $40,000". Where did you get that number from? The ACA subsidy is on a sliding scale. You (probably) want at least 135% FPL to stay out of Medicaid. Staying under 250% is desirable to get cost sharing reductions. Up until this year, staying under 400% FPL was the difference between getting any subsidy or not. But that cliff has gone away.

In any case, every $ of income costs you a little bit of subsidy. $30K of income gives you a larger subsidy of income than $40K, and $50K further reduces the subsidy. It's an 8.5% increase, a little less at lower levels of income. So I don't see where $40,000 is a meaningful number or limit.

Otherwise what you wrote looks mostly right. If you take another $10K of STCG you will be paying tax on most of that as your regular income would exceed the standard deduction. I'm not sure why you want to take more STCGs unless it's an investment you really want out of. You could take another $10K of LTCGs with no tax. I generally use this wiggle room to do Roth conversions at 10 or 12%.

Also, don't forget that an HSA contribution, if you have an eligible plan, reduces your AGI.

 

[pb4uski]

What software is that!? Seems like it could be useful!

https://www.irscalculators.com/tax-calculator

Yes, very useful.

 

[zinger1457]

1. The standard deduction does not get subtracted from the AGI calculation, so any income over my $40,000 ACA limit is going to reduce my subsidy. I am guessing that this will add 8% to my tax amount for the over the limit gains.

Not quite sure what you mean by adding 8% to your tax amount but if your current ACA subsidy is based on $40K income and you end up with $50K income then yes you will have to pay some back, close to $1600 when I ran the numbers. You can use the KFF subsidy calculator to get an accurate estimate on how much.

 

[bobandsherry]

That's same thought I had as well RB. With the revised ACA scale for the next two years, cliff gone and 8.5% cost, I view the next two years as an opportunity for taking gains now so future years, if they fall back under the old cliff approach, I'll not have to be concerned as I'll have plenty of room to stay under the cap. Could be the next two years is the new norm, but not looking a gift horse in the mouth.

 

[SevenUp]

I ran the quick and dirty Turbo Tax scenario as follows and it gave me $0 taxes owed....

Depends on your ACA specifics, e.g., your APTC and SLCSP. See Roth Conversion and Capital Gains On ACA Health Insurance for another quick but much less dirty evaluation tool.

Even that one doesn't address potential Cost Sharing Reduction effects, but it should provide a much better picture that TurboTax can.

 

[SecondCor521]

@joesxm3:

The key understanding is that AGI - deduction = taxable income.

1. Your ACA subsidy is based on AGI (well, ACA MAGI, which is derived from AGI and may be equal in your case).

2. Your ACA limit - by which I assume you mean 400% of FPL, is actually 400% * $12,760 for this year, or $51,040. ($12,760 comes from https://thefinancebuff.com/federal-poverty-levels-for-obamacare.html and assumes you do *not* live in Alaska or Hawaii.)

3. Despite what I wrote in item #2 above, for 2021 and 2022, the subsidy cliff has been eliminated, so if your AGI happened to exceed 400% of FPL, you'd still get a subsidy.

4. The 15% tax bracket on LTCG for singles starts at $40,400 of taxable income for 2021.

5. Covered vs. non-covered just has to do with whether the brokerage firm where you held / hold the stock is required by law to keep track of your basis. Even if you sold non-covered shares, they still would have a basis. It would just be that you would have to provide it yourself when completing your Schedule D and Forms 8949 on your taxes rather than rely on your brokerage firm to provide it to you. It does not mean that the basis is zero, even if that is what the brokerage firm might report to the IRS. You may need to dig up your old records to figure out your basis for the non-covered shares. If you cannot find old records, you may be able to estimate your basis if you remember when you bought the shares and can look up the price per share at that time.

6. RunningBum is correct that your ACA subsidies are on a sliding scale, but underestimates the amount of increase. The applicable figure RB refers to is indeed a maximum of 8.5%. However, because of the way the ACA subsidy is calculated, the actual marginal increase is more like 15% in the range you're talking about. See https://seattlecyclone.com/aca-premium-tax-credits-2021-edition/ and especially the second graph there, which shows the actual marginal tax effect of the loss of ACA subsidies, taking into account the American Rescue Plan Act passed in March of this year.

7. As a minor nit, the top of the 12% ordinary income tax bracket and the end of the 0% capital gains bracket are no longer the same, but they're within a few hundred dollars of each other. They also go up a bit for inflation every year. These factors probably explain where the difference between your $40,050 number and my $40,400 number.

8. The best way to check your assumption and question at the end of your OP is to add $10K in STCG in your "play" TurboTax return and see if you still get the $0 tax that you are expecting. Of course, it's best to do this with a 2021 version of TT, but that won't be available publicly until around Thanksgiving.

9. I'm not sure if RunningBum is correct in his assertion that an additional $10K of realized STCG would mean you would be paying taxes on it. Although STCG is taxed at ordinary income tax rates, it isn't taxed as ordinary income - it can be offset by capital losses, for example. Again, the best bet is to run your numbers through an actual tax prep program.

10. All of the above is only the federal level. In my state, realized capital gains are taxed as ordinary income, and this is also true in other states as well. So if you live in a state with state income taxes, you might owe state income taxes on your capital gains. And as mentioned above, it will reduce your ACA subsidy, so the net cost of your capital gains might be around 20% (~15% ACA subsidy loss + ~5% state tax).

 

[SevenUp]

The best way to check your assumption and question at the end of your OP is to add $10K in STCG in your "play" TurboTax return and see if you still get the $0 tax that you are expecting.

Definitely won't be $0 tax on an additional $10K in STCG.

At least, the tool referenced in Roth Conversion and Capital Gains On ACA Health Insurance shows ordinary income tax starting with only an additional $200 of ordinary income. The ACA effects depend on facts not yet shared, but at least that tool is available now, apparently with 2021 tax laws incorporated.

 

[VanWinkle]

I use this tax tool to calculate taxes/cap gains.

https://www.mortgagecalculator.org/calcs/1040-calculator.php


See if you like it.

VW

 

[qwerty3656]

Definitely won't be $0 tax on an additional $10K in STCG.

At least, the tool referenced in Roth Conversion and Capital Gains On ACA Health Insurance shows ordinary income tax starting with only an additional $200 of ordinary income. The ACA effects depend on facts not yet shared, but at least that tool is available now, apparently with 2021 tax laws incorporated.

Wow - based on that spreadsheet, not only should I I not do Roth conversions, I should withdraw money from my Roth to maximize my ACA subsidy. (I'm planning on going on ACA next year for the 1st time)

 

[RunningBum]

6. RunningBum is correct that your ACA subsidies are on a sliding scale, but underestimates the amount of increase. The applicable figure RB refers to is indeed a maximum of 8.5%. However, because of the way the ACA subsidy is calculated, the actual marginal increase is more like 15% in the range you're talking about. See https://seattlecyclone.com/aca-premium-tax-credits-2021-edition/ and especially the second graph there, which shows the actual marginal tax effect of the loss of ACA subsidies, taking into account the American Rescue Plan Act passed in March of this year.

You're right, I didn't appreciate the effect of the rate increase under 400% FPL, where increased income applies the higher rate to every dollar.

 

[joesxm3]

My scenario was just quick and dirty, but here are some explanations for some things questioned in the replies.

The ACA $40,000 limit was based on what I told ACA my income would be and was used to calculate my premiums. I picked this number because I planned to book LTCG up to the top edge of the 12% bracket for 0% LTCG tax and I thought that limit was $40,050 because I overlooked the standard deduction.

The 8% number on additional ACA income was based on a post I read that said if you go over the cliff, this year the maximum you pay for ACA premiums would be 8% of your income. I figured that must be the rate they used to make the sliding scale.

The numbers I entered for STCG and LTCG were not my actual numbers. Instead of entering the actual sale price and actual basis, I just entered the gain as sale price and basis as zero to avoid typing.

I would prefer to not bail out of the risky investments and incur STCG. The reason I was doing this simulation is to clarify whether the combined ACA hit and increased capital gain taxes was large enough to justify riding through the volatility on the risky investments.

I will double check the ACA affect as mentioned by SecondCor521 and RunningBum. If it is indeed a marginal 15% that would cancel out the 0% LTCG tax rate savings.

I will be going on Medicare in two months, so this is the last year of dealing with the ACA issues.

I will have to see if my ACA info was carried into the "play" Turbo Tax return.

Thanks to all who replied with such detailed information.

 

[Sue J]

https://www.irscalculators.com/tax-calculator

Yes, very useful.

Oh, I like this one. Thanks for posting.

 

[PaunchyPirate]

OP, just be careful relying too much on the TurboTax numbers. TurboTax for tax year 2020, which is all that's out there as of right now, really doesn't accurately use numbers that apply to all the financial changes for 2021 as a result of the Covid recovery legislation that was passed.

And a critical number that must be entered is the cost of the Second Lowest Cost Silver Insurance Plan for you in your zip code, which also won't be the same as you entered from 2020 forms sent to you. That impacts subsidy amounts too.

If you fully understand the new math of the new legislation (and I think you do), then you'll have to adjust the TurboTax numbers in your head (or a spreadsheet) to get the actual impact.

 

[SecondCor521]

Definitely won't be $0 tax on an additional $10K in STCG.

At least, the tool referenced in Roth Conversion and Capital Gains On ACA Health Insurance shows ordinary income tax starting with only an additional $200 of ordinary income. The ACA effects depend on facts not yet shared, but at least that tool is available now, apparently with 2021 tax laws incorporated.

Oh, yeah, MDM's case study spreadsheet. That's one of the best tools out there, and the fact that it is available for 2021 and includes all the ACA stuff including the American Rescue Plan Act is wonderful. The only drawback I know of is that it's a little bit obscure in terms of how to enter the relevant data, so you have to sort of hunt around to figure out where and how to properly enter data.

@joesxm3, if you use this spreadsheet, I'd recommend putting in your 2020 tax return info and make sure that it is close to matching, then add the modifications you want (extra STCG or whatever). It won't be exact, because the 2021 version of the spreadsheet will have a slightly higher standard deduction, slightly different brackets, etc. But at least you can figure out how to use it correctly first.

My scenario was just quick and dirty, but here are some explanations for some things questioned in the replies.

[1] The ACA $40,000 limit was based on what I told ACA my income would be and was used to calculate my premiums. I picked this number because I planned to book LTCG up to the top edge of the 12% bracket for 0% LTCG tax and I thought that limit was $40,050 because I overlooked the standard deduction.

[2] The 8% number on additional ACA income was based on a post I read that said if you go over the cliff, this year the maximum you pay for ACA premiums would be 8% of your income. I figured that must be the rate they used to make the sliding scale.

[3] The numbers I entered for STCG and LTCG were not my actual numbers. Instead of entering the actual sale price and actual basis, I just entered the gain as sale price and basis as zero to avoid typing.

I would prefer to not bail out of the risky investments and incur STCG. The reason I was doing this simulation is to clarify whether the combined ACA hit and increased capital gain taxes was large enough to justify riding through the volatility on the risky investments.

[4] I will double check the ACA affect as mentioned by SecondCor521 and RunningBum. If it is indeed a marginal 15% that would cancel out the 0% LTCG tax rate savings.

I will be going on Medicare in two months, so this is the last year of dealing with the ACA issues.

[5] I will have to see if my ACA info was carried into the "play" Turbo Tax return.

Thanks to all who replied with such detailed information.

[Numbers added for reference.]

1. Ah, OK. The ACA subsidies are adjusted at tax time by comparing your estimated AGI ($40K) with your actual AGI (maybe ~$52K). If your actual is higher than your estimated, you'll pay back the extra unwarranted subsidy with your 1040, essentially as an additional tax. If it's the other way around, you'll get the extra deserved subsidy with your 1040, essentially as a tax credit. In either case, the math is done on Form 8962; you can see the two cases at the very bottom of the form.

It's sort of like "health care subsidy withholding" - just like income tax withholding, you withhold a certain amount and then true up at tax time.

2. The 8% number is actually 8.5%, and that is something called the "applicable figure", which is essentially the percentage of your income that the government has decided is reasonable to spend on health insurance. The applicable figure changes at various AGI levels - it's a progressive system just like income tax brackets. It starts lower (IIRC it's even 0% currently at lower AGI levels).

But again, the applicable figure understates the marginal tax effect. The true rate varies and is higher. If you want to understand this effect, read here: https://seattlecyclone.com/marginal-tax-rates-under-the-aca/

3. Yeah, that'll work just fine.

4. I'm right, but you should always double check me and anyone else here.

5. Look for Form 8962 in the play tax return. If you find it, you can look at the bottom of the first page to see if you're getting additional credit or additional tax. Although with the changes to the ACA in the spring, any 2019 or 2020 tax calculator is going to be very misleading with respect to the ACA portions - the cliff is gone, the applicable figures have changed, the income ranges have been adjusted for inflation, your SLCSP has likely changed a little bit or even a lot, and maybe others I can't think of at the moment. I'd again recommend MDM's case study spreadsheet. If you want to, you can call your exchange folks or look at your subsidy information to find out your 2021 SLCSP number.

The other resource I think is very good, and also appears to be available for 2021, is at https://sites.google.com/view/incometaxspreadsheet/home/download. It's got a better user interface I think, but is much slower to open and has a lot more functionality in it.

 

[SevenUp]

At least, the tool referenced in Roth Conversion and Capital Gains On ACA Health Insurance shows ordinary income tax starting with only an additional $200 of ordinary income. The ACA effects depend on facts not yet shared, but at least that tool is available now, apparently with 2021 tax laws incorporated.

Wow - based on that spreadsheet, not only should I I not do Roth conversions, I should withdraw money from my Roth to maximize my ACA subsidy. (I'm planning on going on ACA next year for the 1st time)

It can indeed be useful to use a tool that accurately incorporates all the pertinent effects.

 

[RunningBum]

6. RunningBum is correct that your ACA subsidies are on a sliding scale, but underestimates the amount of increase. The applicable figure RB refers to is indeed a maximum of 8.5%. However, because of the way the ACA subsidy is calculated, the actual marginal increase is more like 15% in the range you're talking about. See https://seattlecyclone.com/aca-premium-tax-credits-2021-edition/ and especially the second graph there, which shows the actual marginal tax effect of the loss of ACA subsidies, taking into account the American Rescue Plan Act passed in March of this year.

I took a closer look at this tonight. That chart is a real eye-opener. I verified it with my own MAGI numbers from $30K (235% MAGI) to $54K (423% MAGI) in $1K increments. The marginal rate of subsidy loss is 13.2 to 16.8 up to 300% FPL, then 13.2 to 18% up to 400% FPL. Above 400% FPL is drops to 8.4%--not sure why it's not 8.5%, maybe some kind of rounding. That really changed from 2020 and before. It puts into question whether I should be converting at all since this income addition costs me whatever my marginal fed+state tax rate is, plus as high as 18% subsidy loss.

Thanks for pointing this out. I wish I had realized this before I made a $15K conversion early in the year. Perhaps someone said this and I missed it. Not a huge deal in the grand scheme, and if I hadn't done it all I would have some unused subsidy with the plan I chose costing less than the subsidy amount until I converted about $6K.

A bit humbling to find out my calculations were wrong, but it's better to learn and adapt than to repeat mistakes.

 

[scrabbler1]

5. Look for Form 8962 in the play tax return. If you find it, you can look at the bottom of the first page to see if you're getting additional credit or additional tax. Although with the changes to the ACA in the spring, any 2019 or 2020 tax calculator is going to be very misleading with respect to the ACA portions - the cliff is gone, the applicable figures have changed, the income ranges have been adjusted for inflation, your SLCSP has likely changed a little bit or even a lot, and maybe others I can't think of at the moment. I'd again recommend MDM's case study spreadsheet. If you want to, you can call your exchange folks or look at your subsidy information to find out your 2021 SLCSP number.

A 2021 draft version of Form 8962 has appeared in the IRS website.

https://www.irs.gov/pub/irs-dft/f8962--dft.pdf

The instructions have not yet been updated in Draft form, but the form is out there.

In a discussion we had back in March in this thread, I predicted how the form would change. As you can see in the Draft form, Line 6 has disappeared.

https://www.early-retirement.org/fo...lation-re-aca-cliff-108318-3.html#post2576759

Without the instructions, the Draft form is tough to work with because it refers to the instructions.

As to the SLCSP, it is not always easy to get this number before Form 1095-A comes out. I have tried asking my state's exchange for this data prior to that form being produced, but they don't know it, either. Over the years, I have tried to figure it out beforehand based on sorting the rates for comparable policies, but I was always off, often by a lot, so I gave up.

 

[SecondCor521]

As to the SLCSP, it is not always easy to get this number before Form 1095-A comes out. I have tried asking my state's exchange for this data prior to that form being produced, but they don't know it, either. Over the years, I have tried to figure it out beforehand based on sorting the rates for comparable policies, but I was always off, often by a lot, so I gave up.

Yeah, this has always puzzled me too. I always thought that the second-lowest cost silver plan would be, I dunno, the second lowest priced silver plan? I go to my exchange sometime during the year, put in my particulars, filter to silver plans only, then sort by price, and take a screen shot. Sometimes it matches exactly, sometimes it's off by a bit. Shrug.

Thankfully, the focus of my tax planning in my particular situation focuses on a part of the Form 1040 before the ACA reconciliation stuff. So I optimize for that aspect, and Form 8962 is whatever it is.

 

[cathy63]

Regarding SLCSP -- I think you should be able to look it up any time. The trick is to make sure you enter the ages of your plan participants on January 1 of the coverage year, not their current ages.

In California we use the SLCSP and lowest cost bronze plan premium to calculate the state's shared responsibility penalty, so during tax season I have to look these numbers up several times a day. When we started this last year, I looked back about 3 years and verified our own numbers to make sure they were right, and they were accurate to the penny.