Tax cliff warning/reminder

[Fermion]

Hi all, just wanted to remind those who are on ACA plans about the tax cliff.

Since I do a lot of trading, especially in Robinhood where I am trying to simply turn $2500 into $250,000 in a reasonable 10 years, I tend to generate a lot of short term capital gains.

Since we are now in November, I took the time to load my 2018 tax software and put in the current taxable interest, dividend and capital gains across our various accounts.

I made two estimated tax payments this year totaling $8,000 because, well, this has been a decently good year.

Right now we will get a refund of about $1900 (really just a partial refund of the estimated tax payment).

If we make another $6000 in gains, we will get a refund of $1100.

If however we make $7000 more in gains this year, we will instead owe $6100!

Yes, that is right. If we make $1000 in profit we will owe $7200 in tax! The effective tax rate on that $1000 profit is 720%

Nobody wants to pay 720% in tax, so be careful out there!


edit: It would actually be of some benefit for a person to take $1000, invest it in a weekly option for anything, like Amazon $3000 calls and just take the capital loss when it expires worthless.

 

[EastWest Gal]

For those who use Schwab:

Schwab updated their website to include an estimated income for year end from the taxable brokerage account. based on past years, it looks like it's fairly accurate. Helpful for ACA planning, but the exact amount is important if you are close to the cliff.

Don't forget another place you can reduce your MAGI: HSA account.

Any hobby income? Put it in an IRA.

 

[Fermion]

Hobby income might not qualify as earned income, so be careful with that.

In general earned income would be income that you pay SS tax on, which you do not for hobby income.

It would kind of suck to be planning on deducting your $3000 in hobby income from selling crafts by opening an IRA with it and then find out instead that you now owe $7,000 in tax on that $3000 of crafts you sold because you went over the cliff.

 

[clobber]

If we make another $6000 in gains, we will get a refund of $1100.

If however we make $7000 more in gains this year, we will instead owe $6100!

.

Please explain why? just because your tax software says so?

 

[Fermion]

Please explain why? just because your tax software says so?

It has to do with the ACA subsidy and the cutoff for either receiving a tax credit when you file or having to pay back tax credits you received during the year that were applied to your insurance premium payment.

I knew it was steep but it still shocks me how steep the cliff is.

Essentially there is a income figure where making $1 more means you have to pay back about $7000 (in our case). It could be more or less for others depending on the size of their subsidy.

Something like the jury duty $10 pay my wife got could push you over the edge. Imagine jury duty costing you $7000!

 

[zinger1457]

Something like the jury duty $10 pay my wife got could push you over the edge. Imagine jury duty costing you $7000!

If you are getting a subsidy you definitely need to leave a buffer so that unexpected income like higher than expected dividends/capital gains won't bite you. It wasn't so bad when you could recharacterize a ROTH conversion if needed, that allowed you the ability to go back and adjust your income after the end of the year if needed, that options no longer available. I came within $50 of the cliff a couple years ago but had the recharacterization option if needed, definitely don't play it so tight anymore, it would cost me close to $10K.

 

[gauss]

Don't forget NII if Roth converting....

While on this topic, I will add my own PSA on this that may be relevant for Roth converters or anyone else who can have high discretionary income.

Another threshold to be aware of is when Net Investment Income (NII) tax kicks in. Although not a steep cliff like the ACA subsidy threshold, it can add up if you blow through the exemption amount. The amount can be an 3.8% additional tax above the threshold

I made some large Roth conversions last year and blew through the threshold unexpectedly, but not by too much fortunately.

FWIW the threshold is 200k/250k for single/married filing respectively.

-gauss

 

[Rianne]

Since DH has a consulting business at home, there is income which allows us to contribute to tIRA. Along with HSA contribution that helps avoid ACA cliff.

 

[aaronc879]

There should never be a $7000 cliff. If you think you will be close to the cliff then don't claim a low income to get a big subsidy. Claim an income slightly below the cliff so you get some subsidy. Then if you go over you don't owe much. If you go under on expected income then you get a refund. If you claim $25K income at the start of the year then realize later you will make close to the cliff then change it. Change in income is a "life event" so you can adjust your subsidy payment anytime during the year if you want to avoid a large payment at tax time. A $7000 payment is completely avoidable.

 

[RunningBum]

There should never be a $7000 cliff. If you think you will be close to the cliff then don't claim a low income to get a big subsidy. Claim an income slightly below the cliff so you get some subsidy. Then if you go over you don't owe much. If you go under on expected income then you get a refund. If you claim $25K income at the start of the year then realize later you will make close to the cliff then change it. Change in income is a "life event" so you can adjust your subsidy payment anytime during the year if you want to avoid a large payment at tax time. A $7000 payment is completely avoidable.

You don't understand the cliff some of us face. At the start of the year I estimate my income to be about $100 under 400% FPL. If I go $1 over 400% FPL I get no subsidy. If I stay $1 under 400% FPL, I get about an $8000 subsidy. There is no in-between, or what you seem to call "some" subsidy. It is not at all avoidable.

 

[aaronc879]

You don't understand the cliff some of us face. At the start of the year I estimate my income to be about $100 under 400% FPL. If I go $1 over 400% FPL I get no subsidy. If I stay $1 under 400% FPL, I get about an $8000 subsidy. There is no in-between, or what you seem to call "some" subsidy. It is not at all avoidable.

I wasn't aware people with that high of an income($1 under 400%FPL) got such a large subsidy. That doesn't seem right but I guess that's another discussion.

 

[FIREd_2015]

I wasn't aware people with that high of an income($1 under 400%FPL) got such a large subsidy. That doesn't seem right but I guess that's another discussion.

That's what the state of California said and so California extended the ACA subsidy to 600% FPL for 3 years starting in 2020. No more cliff at least in California for the next 3 years.

https://health-access.org/wp-conten...fordability-Assistance-Fact-Sheet_6.24.19.pdf

 

[cathy63]

I wasn't aware people with that high of an income($1 under 400%FPL) got such a large subsidy. That doesn't seem right but I guess that's another discussion.

It's called a cliff because it goes from a high number to zero in one tiny step. The closer you are to 65, the higher the cliff.

 

[aaronc879]

There should be a somewhat smaller cliff because people making 300-400% FPL should not be getting such a large subsidy IMO. However, the law is what it is so just do the best you can within the rules.

 

[scrabbler1]

I have been paying close attention to this since Fido's year-end distribution estimates came out about a week ago.


I went over the cliff in 2017 and 2018 when huge cap gain distributions ate up my entire cushion. The cliff was pretty small through 2016, less than $500 for the year. But in 2017, it rose to $800 and in 2018 it rose to $1,800. For 2019, if I go over it again, it will be $2,500.


But the 2019 estimates have me right near the cliff, barely over it. If I sell some high-cost shares of a mutual fund at a loss, it looks like I can barely escape the cliff. I have already set up specific-ID for selling shares although Fido has a bug in its system to prevent me from specifying them if I sell using their website. I would have to talk it through with a phone rep, something I have already tested with a phone rep, assuming they don't fix this glitch.


I can actually make the sale now although I won't know for sure until the last few days of the year if it will be enough, or will I have to make another sale. I will have to be mindful of any wash sale possibilities which could prevent me from taking some losses.

 

[Fermion]

Like I said, it is a $7000 cliff for us, $8000 to $10000 for people a little older than us.

It is crazy that it would be worthwhile to "lose" some money in the stock market just to pull your income down below 400% poverty level if you are just over 400%.

I think the best way to guarantee a loss would be to buy way out of the money stock options.

 

[RunningBum]

Like I said, it is a $7000 cliff for us, $8000 to $10000 for people a little older than us.

It is crazy that it would be worthwhile to "lose" some money in the stock market just to pull your income down below 400% poverty level if you are just over 400%.

I think the best way to guarantee a loss would be to buy way out of the money stock options.

How short of time frame can you have for those options? My make-or-break time is usually after the December mutual fund distributions. Vanguard gives estimates earlier, but they can be a little off. If I find out on Dec 22 that I'm a little bit over, can I buy an option and have it expired by the end of the year to take a loss?

 

[CRLLS]

While on this topic, I will add my own PSA on this that may be relevant for Roth converters or anyone else who can have high discretionary income.

Another threshold to be aware of is when Net Investment Income (NII) tax kicks in. Although not a steep cliff like the ACA subsidy threshold, it can add up if you blow through the exemption amount. The amount can be an 3.8% additional tax above the threshold

I made some large Roth conversions last year and blew through the threshold unexpectedly, but not by too much fortunately.

FWIW the threshold is 200k/250k for single/married filing respectively.

-gauss

Help me understand this a bit more. Correct me if I am wrong. The Roth conversion amount is not subject to the NIIT, as it is treated as ordinary income. Only any other interest and dividends are subject to the NIIT. For instance if you had 400k in Roth conversions and 10K in Interest and dividends, only the 10K is subject to the extra 3.8%, correct?

 

[Fermion]

How short of time frame can you have for those options? My make-or-break time is usually after the December mutual fund distributions. Vanguard gives estimates earlier, but they can be a little off. If I find out on Dec 22 that I'm a little bit over, can I buy an option and have it expired by the end of the year to take a loss?

Really short time frames on weekly options for SPY.

If you bought weekly call options on SPY $400 for the week of December 22 that expire before Dec 27, they should expire worthless (assuming the S&P500 does not go up another 33% lol.

Be careful about wash sales though if you have bought S&P500 index in your taxable or IRA. It might be safer to trade in a more obscure index or stock that you know you have not bought in the past 30 days.

 

[Which Roger]

Hearing others' stories about an unexpected capital gain pushing them over the cliff has made me appreciate index funds even more, in that they give you almost complete control over when you realize the gains. I'm starting on ACA next year, and not owning any active funds will make managing income much easier and avoid potential gotchas.


One thing I'd recommend to anybody who is going to start ACA and receive subsidies is to do a practice tax return to make sure you understand all the details regarding income, how subsidies are reconciled at tax time, etc. I did this in TurboTax and it really increased my comfort level before taking the ACA plunge.

 

[RunningBum]

Really short time frames on weekly options for SPY.

If you bought weekly call options on SPY $400 for the week of December 22 that expire before Dec 27, they should expire worthless (assuming the S&P500 does not go up another 33% lol.

Be careful about wash sales though if you have bought S&P500 index in your taxable or IRA. It might be safer to trade in a more obscure index or stock that you know you have not bought in the past 30 days.

Thanks. I have requested my VG brokerage account be enabled for options, in case I have to do this. I expect this year I'll just be find tuning my Roth conversion in that last week. Next year I may have more income and will have to decide if it's worth taking a loss to bring it back under, or if I should just punt the subsidy and do a larger conversion. But I like this strategy. You don't even have to be crazy out of the money on the option. You could buy a more reasonable call that would pay for the loss of the subsidy if it came through, or give you the subsidy if it doesn't.

 

[Fermion]

Thanks. I have requested my VG brokerage account be enabled for options, in case I have to do this. I expect this year I'll just be find tuning my Roth conversion in that last week. Next year I may have more income and will have to decide if it's worth taking a loss to bring it back under, or if I should just punt the subsidy and do a larger conversion. But I like this strategy. You don't even have to be crazy out of the money on the option. You could buy a more reasonable call that would pay for the loss of the subsidy if it came through, or give you the subsidy if it doesn't.

Yes, I thought about that too, but there is some risk if it only goes up a little bit and you make, say $100 profit instead of losing $1000.

If you can pick a option that is very binary, either it loses $1000 or goes up $10,000 then that would be best.

 

[SecondCor521]

Another strategy would be to do approach the cliff in stepwise fashion from the lower end of the income range:

1. Figure out where you think you'll be at the end of the year, making estimates (as best you can) for any distributions that happen near the end of December.

2. Figure out what your target income is, and then do a Roth conversion up to, say, $2K less than that number, thus giving yourself $2K of wiggle room. (Adjust the $2K number to whatever is "comfortably close" given your financial situation, inclination for risk, and ability to accurately estimate in step 1).

3. Wait until the distributions happen in late December, then re-do your tax calculations.

4. If you want, do another small Roth conversion of, say, $1.5K on December 26th or whatever to get you closer but still not over.

The above is what I do, and it's simpler to me than trying to lose money on options. But I've never traded options, so that is a factor for me. Also, with my approach you don't end up setting money on fire. (Yes, I get it, setting money on fire is better than losing a $12K tax deduction due to the ACA cliff. But not setting money on fire is better than setting money on fire, even if the burnt money is a small amount.)

...

Also, don't forget to do end of year tax stuff in general, like capital gain harvesting, capital loss harvesting, maxing out 401(k)s, spending down workplace medical savings accounts, etc. Probably preaching to the choir on this point.

 

[RunningBum]

The situation I'm interested in for the loss on options is where I've done everything I can with harvesting losses, HSA contribution, etc, and still will be a little bit over, even with no Roth conversions.

 

[SecondCor521]

The situation I'm interested in for the loss on options is where I've done everything I can with harvesting losses, HSA contribution, etc, and still will be a little bit over, even with no Roth conversions.

Ah, right. That is a different situation, and setting fire to a small pile of money would make sense in your case.

You could perhaps start a business and possibly generate a business loss through depreciation or other expenses...?