ER, unearned income, and (no) taxes

[Symbiotic]

Until recently, I've been focused on tax planning (well, minimization) during recent years of high income. Last week, though, I sat down and started looking at what taxes will look like in ER for someone whose portfolio is primarily made up after-tax holdings like mine will be. I was pleasantly surprised, and maybe even a bit shocked.

Consider a married couple filing jointly with one child. This couple can accumulate as much as $90,000 in long-term capital gains and qualified dividends and, because of the standard deduction and exemptions, pay $0 federal income tax under the 2013 rules. All that remains is whatever state tax might apply.

Does that sound right to you all? It almost seems "unfair" that a family living a moderate lifestyle on investment income can essentially dial in exactly the right amount of earning each year to convert maximum gains into basis and pay no federal tax.

Moreover, if said family chooses to keep income below $78,000, the ACA credits kick in as well. (Not to get off topic, but they're really going to have to fix that sharp edge at the 400% FPL...)

I'd be curious to hear from others who have REd and are holding most of their net worth in post-tax buckets. Are you all just laughing all the way to the bank, or am I dreaming here? What other tricks do you experts have up your sleeves?

 

[BigNick]

I'm in France, but I've also been pleasantly surprised by the tax position I'm in (although not as happy as I was when paying no income tax on my salary, working for an intergovernmental organisation).

DW continues to work for that organisation, so her salary is not taxed. My pension is taxable, but it works out to be just enough to push me into the first marginal tax bracket (5%). Capital gains tax used to be 19%, but is now "your marginal tax rate", which is therefore 5% for us (although we may hit the 14% bracket next year when DD is off the payroll). Any extra income from my semi-ER job goes through a "sole trader" company setup in which I pay 20% for payroll deductions (but that gets me medical insurance, regardless of how much or little I earn) and allows me to pay just 2% on top of that to cover the tax (i.e., I don't have to add my company income to my pension at the marginal rates).

When DW retires, her pension and mine will be mixed, so our tax on that will go up a lot. At that point, the shortfall between her salary and her pension will be made up by drawing on after-tax funds. The growth on these is still taxable, but /a/ at a very favourable rate (7.5%) and /b/ in our case, two of the three funds have some nice capital losses from drops in share values over the 2000-2008 period, so that the current growth - all in money market funds - is tax-free. We're making about 3.5% net, risk-free, in Euros on those funds right now.

All of this results from the complexity of the tax code (I don't know which is worse, France or the US, but I know that both are ferociously complicated), which we are thus gaming to some extent.

 

[NanoSour]

You're not dreaming. I'm at about 55-45 on post-tax/tax-deferred ratio and with family of 5 will pay 0 tax on 110K spending. Much of that spending comes from post-tax dollars, but a good portion is from pension, cap gains and dividends. This is according to ESPlanner's tax projections for my ER which starts 1 Jul. This is one of the reasons I decided it was time.

I also plan to move the tax-deferred accounts over to tax-free Roth accounts over the next 5-6 years to further reduce tax liability in the years post ER.

 

[Z3Dreamer]

A few more tricks. 1) Coordinate your tax planning with SS. When to take distributions, etc. 2) Qualifying for ACA is large. Don't forget that ACA is based on MAGI. 3) Many would say that they have adjusted the ACA cliff as you get more subsidy if is MAGI is 200% or 300%. Much discussion on not just the subsidy, but the lower deductibles and out of pocket if you are at 200% vs. 400%. 4) State taxes may be $4,500 in the range you suggest.

 

[Apex1]

I am 38, own a business, have not RE'd, but I would consider myself "marginally" FI. Tax minimization is HUGE part of FIRE planning for me.

Owning a small business corporation here in Canada, the business can keep the first 500k of profits and only pay 15.5% tax (as opposed to paying 46% of tax if you are in the highest personal tax bracket). In my business nest egg, i plan to buy and hold "forever" (i have done this for 12 years now), therefore I have never had to pay capital gains either. I plan to continue this indefintely.

Lastly, when I do trigger RE...... the corporate nest egg can then pay almost 50k per shareholder as a dividend with very minimal taxes (approx 2k). Professional corps only allow family members to be shareholders. When my kids turn 18 and become eligible shareholders, we will then have 4 shareholders (and almost 200k with very minimal taxes) and then we will really open the taps

 

[Andre1969]

Yeah, it does almost seem too good to be true. I just looked up the tax tables, and for 2013 the 25% bracket kicks in at $36,250. But, there's the $6100 standard deduction (single taxpayer) and personal exemption of $3900.

So, in my case, it looks like I could get up to $46,250 per year in qualified dividends and LT capital gains, and not pay a dime in federal taxes? I don't even live off of that much right now, so this is definitely giving me something to look forward to!

However, I do have REITs, which are taxed at regular income tax rates, so I guess I'd still end up paying something.

 

[travelover]

Welcome to the 47%

 

[HFWR]

Welcome to the 47%

You mean that some who pay no FIT aren't welfare queens or illegal aliens?

 

[truenorth418]

No reason to feel guilty about the current federal tax system or the amount you owe. This is the tax system that our Congress and President agreed on as a result of the fiscal cliff discussions of last Nov-Dec. I know they all put a lot of thought and consideration into it as it was all over the news during the Christmas and New Years holidays.

 

[HFWR]

No reason to feel guilty about the current federal tax system or the amount you owe. This is the tax system that our Congress and President agreed on as a result of the fiscal cliff discussions of last Nov-Dec. I know they all put a lot of thought and consideration into it as it was all over the news during the Christmas and New Years holidays.

 

[Dreamer]

You mean that some who pay no FIT aren't welfare queens or illegal aliens?

 

[PatrickA5]

Personally, I wouldn't make any long-term plans based on the tax advantages of capital gains and dividends. From what I've been reading on possible future tax reform, those two tax breaks will be in the front of the line in cuts. But, with our current Congress, real tax reform could be decades away.

 

[MooreBonds]

However, I do have REITs, which are taxed at regular income tax rates, so I guess I'd still end up paying something.

Don't forget - many REITs have distributions which are composed of a variety of categories - some regular dividends, some capital gains, some qualified dividends, and some return of capital.

It's always a good idea to check your REITs to see what they're distributing - it could make sense to sell it in one account (tax-deferred/taxable) and then buy it in your other account, if you get tax benefits in doing so.

 

[pb4uski]

....I'd be curious to hear from others who have REd and are holding most of their net worth in post-tax buckets. Are you all just laughing all the way to the bank, or am I dreaming here? What other tricks do you experts have up your sleeves?

Your're not dreaming. if you're living of of savings you have very little income so pay no income tax and can take advantage of the 0% rate for qualified dividends and cap gains.

I'm not laughing all the way to the bank because I paid a whole bunch in taxes while I was working - in some years more than many people make. No guilt at all.

ACA just adds another dimension to the game.

 

[FUEGO]

We are planning on doing pretty much this exactly. Pay zero tax, get free or almost free health insurance under ACA. Convert Trad IRAs to Roths and/or "tax gain harvest" highly appreciated shares in our taxable accounts. All the while paying zero or very near zero fed income tax and paltry (maybe $500-1000) state tax.

We will probably aim at having a MAGI around 138-140% of fed poverty level to maximize the benefits. And yes, with our various pots of money we can dial it in about to the dollar of where we want to be. And we will have 3 young dependents for many years of ER until they age out of our household (or at least age out of dependent status on our tax forms...).

 

[ERhoosier]

Tax systems have always been a bit of a 'game' to max one's net (after-tax) income. With apologies to Ben Franklin, the only THREE things certain in life are death, taxes, and changes in tax law

 

[kramer]

Yes, I tax gain harvest each year up to the limit. I don't feel guilty about it though. I am part-owner of these companies and 100% of my original investment was post-tax money from me -- money I already paid taxes on.

Each year, corporate taxes are paid on all company profits according to my shares held, at the corporate level. Personal capital gains and dividends taxes are a second level of taxes on already-taxed money.

 

[ERhoosier]

Yes, I tax gain harvest each year up to the limit. I don't feel guilty about it though. I am part-owner of these companies and 100% of my original investment was post-tax money from me -- money I already paid taxes on.

Each year, corporate taxes are paid on all company profits according to my shares held, at the corporate level. Personal capital gains and dividends taxes are a second level of taxes on already-taxed money.

Great point.

 

[David1961]

Is there a link someone can send (preferably an IRS link) that describes this zero taxes on dividends and capital gains if your income is low enough?

 

[LOL!]

The easiest thing to do is probably to run Intuit's Taxcaster online tax forecaster. Google it.

Otherwise, Form 1040 instructions with particular attention to Schedule D. Look on page 41: http://www.irs.gov/pub/irs-pdf/i1040.pdf