The tax man cometh

[Cooked]

Another contrived example. Mr and Mrs Contrived have 90k-95k of income(AGI). A (not insignificant) portion of it is LTCG. The Contriveds have a theoretical portfolio that includes some stock that is 99.99% capital gains and they have some tax deferred IRAs. For the sake of this example, the stock and the IRA are of roughly equal value. Their family is not contrived at all. It has its share of dysfunction like all families do. After one particulate stressful Thanksgiving, the Contriveds decide that they need a vacation. They need to hit their portfolio to get 10k for a week in Las Vegas.


Surely the first thing they would do would (in this utterly contrived example) be to consult their tax man. He would recommend a stock sale over and IRA. The stock sale would require a sale of (10k/.85) ~11.8k of stock. A IRA distribution might require (10k/.7) ~14.3k to fund the same vacation.


If they then asked their FA the same question, the answer may be different. The FA may, for example, recommend using IRA funds for liquidity reasons or for future RMD considerations.


But the point is that ,all else being equal, if they sold 10k of stock and blew it all they you owe the tax man 1.5k more when the returned and in the IRA case they would owe 3k.


This is a contrived example. The Contriveds do not exist and this whole example was made up. Were they silly for planning the Vegas trip? Possibly. Were they equally silly for consulting their tax man first? Another possibility. Would we question the Contriveds judgment for trying to minimize their taxes while funding a total money pit? Definitely. We appreciate them letting us look into some of the details of their fictional lives in order to demonstrate a point about our overly complicated tax code.

 

[adrift]

When I said total tax I was referring to taxes in a general sense rather and thinking of ordinary and capital gains taxes (which get included together on line 47) and not referring to captions for specific lines of Form 1040.

I concede that you are correct, but that is a bit of a nit-pick.

It's not a nit-pick to me. The amount on line 63 is what I have to pay. I do my tax planning around that.

In my state, at my age, I can do ROTH conversions up to 40K (20K each for myself and spouse) with no state taxes. When I do, a portion of that 40K pushes beyond the top of the 15% bracket. But, I get a larger Foreign Tax Credit. Because of the the tax credit, the total tax on the portion past the top of 15% bracket is effectively close to 25% Federal and 0% State.

Paying 25% now is better for us that the eventual RMD alternative.

I guess my point (if there is one), is that it can be more complicated than the simple assertions one often sees.

 

[pb4uski]

....I guess my point (if there is one), is that it can be more complicated than the simple assertions one often sees.

True, but I suspect that very few of the people on this forum are running into limitations on the amount of foreign tax credit that they can use as you are.

We'll have to agree to disagree on whether or not it was a nit.

While you brought up a useful point, the entirety of the prior discussion on the issue was focused on tax. Using the term total tax rather than tax was my bad.

 

[pixelville]

I worked on a tax return recently for a couple of new retirees. It is volunteer work so it does not count against my retiree status. They retired in 2014 and they are the perfect retirement tax storm. I was hurt just looking at their numbers.


The most significant mistake that they made was not understanding SS tax-ability. It caused a triple taxation event. They cashed in some IRAs ( taxable) which pushed some SS into the taxable range (taxable) which put them over the top for ACA premium (taxable). It broke my heart.

If these are new retirees and have earned income (W2, Sch-C) and just went over one of the cliffs, you can potentially have them contribute to an IRA. That would reduce their AGI (& also MAGI for ACA) to reduce the impact.

 

[MBSC]

We are talking in the OP, item#2 about the marginal tax rate on Roth conversions if you breach the top of the 15% tax bracket. Take TaxCaster and create a hypothetical return for a MFJ couple under 65 with $20,000 of LTCG and $74,100 of pension income for this Roth conversion that we are hypothesizing about. The TI is $73,800 and the tax is $7,166. Now add $100 of pension income and the tax increases by $30 to $7,196. So the marginal tax rate on that incremental $100 of Roth conversion is 30%.

Thank you!!

I initially read the OP, item #2 as starting with $94,100 in LTCG and then adding the IRA/pension distribution but I see the light now.

Wake up call number 2. For a married couple with AGI income below [-](roughly) 93k[/-]$94,100, the portion consisting of capital gains (CG) and qualified dividends (QD) are untaxed. Be careful, there is a trap here. If your income is [-]~93k[/-]$94,100 and you have some CG/QD included in that amount then they are taxed at 0. Cash in a 10k IRA that is taxable and watch what happens. The IRA gets taxed at 15% and the CG/QD gets taxed at 15%. An effective marginal tax rate of 30%.

 

[pb4uski]

I'm a little fuzzy on where the 30% is coming from as well, but I wonder if this is it?

Firstly, in that example, let's say you pay zero taxes on capital gains/dividends, up to an AGI of $93,000. But, anything above that, you pay 15%. If you cash in a $10,000 IRA, that would be taxed at 15%. It would also push $10,000 worth of your capital gains/dividends above the threshold, and they would then get taxed at 15%.

Yeah, it's actually 15% on the IRA and 15% on the capital gains, but effectively, you're paying $3,000 more in federal taxes by cashing in that $10,000 worth of IRA.

It's not putting you into any kind of 30% marginal tax bracket...in fact, there is no 30% bracket, as they go from 28 to 33%. But in the case above, cashing in a $10,000 IRA triggers a $3,000 tax, overall, or 30%, on that money.

At least, I think that's what the logic is.

That is exactly what it is, you're paying 15% on the additional $10,000 of ordinary income since the ordinary income is taxed first and it is still within the 15% tax bracket, and because the $10,000 IRA pushes total taxable income over the 15% tax bracket the capital gains in excess of the 15% tax bracket is subject to 15% tax rather than 0% tax, so the net effect of the $10,000 incremental income is $3,000 more in tax.

 

[bingybear]

I'm a little fuzzy on where the 30% is coming from as well, but I wonder if this is it?

Firstly, in that example, let's say you pay zero taxes on capital gains/dividends, up to an AGI of $93,000. But, anything above that, you pay 15%. If you cash in a $10,000 IRA, that would be taxed at 15%. It would also push $10,000 worth of your capital gains/dividends above the threshold, and they would then get taxed at 15%.

Yeah, it's actually 15% on the IRA and 15% on the capital gains, but effectively, you're paying $3,000 more in federal taxes by cashing in that $10,000 worth of IRA.

It's not putting you into any kind of 30% marginal tax bracket...in fact, there is no 30% bracket, as they go from 28 to 33%. But in the case above, cashing in a $10,000 IRA triggers a $3,000 tax, overall, or 30%, on that money.

At least, I think that's what the logic is.

Andre..in bold above, you have it $10k more income and 3k more tax... 30% marginal tax rate. No the IRS does not show this as a defined marginal rate, but it is an effective marginal rate that can occur due to the tax laws.
audreyh1... I think you understand what is going on... but have been focusing on the details of the tax mechanisms while others are just looking at the macro picture (last dollar causes how much tax).

I think in the ER domain and later have potential for hitting this tax state. People may invest in Q-dividend paying stocks or ETFs and trade some of these investments. Up to a point this investment scheme can work very well. Then this retiree then either takes a distribution from an IRA (or converts part of an IRA to a Roth). Done right on can pay 0% tax on all the Q-div and LTCG. Done wrong you get a 30% marginal tax rate (15% on IRA withdraw + 15% on Q-div). I think you'll find this more common when people are non-employed and living off investments.

I'm too far off to look at the SS issue too. I know it gets partially taxed at some point... maybe when it is closer. Not expecting to take SS for 16 more years.

 

[adrift]

The entirety of the prior discussion on the issue was focused on tax. Using the term total tax rather than tax was my bad.

Apparently, I misread the thread. I thought it had to do with marginal tax rates. That was why my reply was about the marginal tax rate. I didn't understand that it was about line 47 before the full tax code was applied.

True, but I suspect that very few of the people on this forum are running into limitations on the amount of foreign tax credit that they can use as you are.

I really don't know what the tax situation of the people on this forum is. I only check in here infrequently. So, you're certainly more of an expert than I.