Marginal Tax Rate Estimate -It depends?

[ERD50]

Related to this thread:

http://www.early-retirement.org/forums/f28/fed-tax-rate-doesnt-add-up-97324.html#post2222100

At the end of doing my income taxes, I enter some summary numbers in a spreadsheet, to have a kind of history of trends of my Fed & State income taxes. I make a note of my marginal tax bracket, which seems useful.

Well this year, I realized there doesn't seem to be a marginal tax bracket. It depends on if it was W2 income, LTGC, Q divs, or for us, retirement income (not taxed at the IL level).

I guess that's been the case for a long time, I just never really considered it. I'm not sure it's even worth tracking, it's probably more important to look forward. For example, for 2019, I should use one of the simple tax estimator forms, and enter my estimates for each category to see where I have opportunities to harvest 0% LTGC, and/or maximize ROTH conversions, and forget about any marginal bracket, except for the ROTH conversion decision (but that's apples-apples Retirement income comparison).

Related to this, to summarize a thread I started earlier, and got great feedback - "optimize" can be tricky. I realized I will likely leave money to heirs, so even though I could harvest more LTCG at 0%, I seem to better off doing ROTH conversions, because if I can hold those equities for my heirs, the cost basis gets stepped up anyhow. So I plan to harvest only enough for my cash flow needs, until RMDs kick in.

-ERD50

 

[RobbieB]

I just play with last years Turbo Tax for a plan. It's easy to add ordinary income using "gambling winnings" as no forms need filling and the impact of Roth conversions is seen for any amount you would like to enter.

 

[jebmke]

This isn't new. There has always been a hidden marginal rate for mixed dividend and ordinary income. Prior to the tax bill, the hidden marginal rate was 30%; now it is 27%

 

[Sunset]

OP - We also are in IL which does not tax retirement income.

So my new focus is to leave my regular stock accounts as stagnant as I can, and withdraw money from IRA's since IL does not tax it.

We paid IL about $2,500 less in taxes this year by paying attention to the source of our spending money.

 

[pb4uski]

This isn't new. There has always been a hidden marginal rate for mixed dividend and ordinary income. Prior to the tax bill, the hidden marginal rate was 30%; now it is 27%

The way I view it many here probably have two marginal tax rates.... one for marginal ordinary income and another for marginal preferenced income (qualified dividends and LTCG).

Before tax-deferred withdrawals and Roth conversions, ours marginal rates are 0% for both. Since we do tax-deferred withdrawals or Roth conversions to the top of the 0% preferenced bracket, our marginal tax rate for ordinary income is 22% and for preferenced income is 15% (ignoring a small $200 band that is actually 27%).

 

[RunningBum]

Many moving pieces, at least for me, which make it hard to just classify your types of incomes into brackets upon which to make decisions.

1) Ordinary Income

2) LTCGs and QDivs, taxed at 0% if your income is low enough, 15% otherwise, but also a 20% rate.

3) NIIT, a 3.8% tax at high enough investment income, which includes IRA distributions, counting conversions.

4) SS income ranges from 0 to 50 to 85% taxable, which can cause pockets of very high marginal rates.

5) AMT, though that may affect fewer people with the new tax laws, I believe.

6) ACA subsidies, a tax benefit for lower income. What's the subsidy worth, and the consequence of going over the cliff?

7) Various other credits and deductions that fade with high income.

For short term planning it's not too hard to plug all the numbers into a tax program and see what happens if you add capital gains, do a Roth conversion, etc.

For long term planning over the years, it becomes harder to know for sure, for example, to what level you should do Roth conversions.

Point is, there's a lot more to simply stating you're in a certain tax bracket bracket and CG rate.

 

[audreyh1]

We had the interesting situation in 2018 of having ordinary income between $74,200 and $74,400. So we fell within the 12% ordinary tax bracket but had no 0% capital gains bracket.

We were subject to NIIT so our marginal capital gains rate was 18.8%. Our marginal ordinary income rate was 12%+15%+3.8% = 30.8% just before we hit $74,200 as any additional ordinary income pushed the same amount of capital gains income from 0 to 18.8% and got taxed at 12% itself.

No longer subject to AMT.

 

[kaneohe]

...............................

3) NIIT, a 3.8% tax at high enough investment income, which includes IRA distributions, counting conversions.

.................................................

.

from 8960 Pt I: Investment Income

1 Taxable interest (see instructions) . . . . . . . . . . . . . . . . . . . . . 1
2 Ordinary dividends (see instructions) . . . . . . . . . . . . . . . . . . . . 2
3 Annuities (see instructions) . . . . . . . . . . . . . . . . . . . . . . . 3
4a Rental real estate, royalties, partnerships, S corporations, trusts,
etc. (see instructions) . . . . . . . . . . . . . . . 4a
...................................
5a Net gain or loss from disposition of property (see instructions) .

Investment income includes interest,dividends, annuities, rental RE,etc, CGs.
I don't see IRA distributions there as investment income.
However IRA distributions can push AGI up so that the investment income
exceeds the 200K/250K thresholds similar to how ordinary income can push
QDIV/CGs can up so they are taxed at 15% rather than 0% (and of course the
ordinary income is also taxed).

 

[RunningBum]

OK, thanks kaneohe. I misread a source on this. I also remember in 2017 when I made a large conversion and it was going to push some dividends into NIIT so that falsely confirmed what I thought I read. I didn't look at it closely enough to see that once I had pushed all of my divs and CGs into being taxed at 3.8%, that would've been the end of the tax. I didn't want to do that anyway but now I understand better.

 

[scrabbler1]

My marginal rate for QD and LTCG is 15%. But my marginal rate for ordinary income is 27% (12% bracket plus it pushes some of my 0% QD/LTCG income into the 15% bracket). Throw in another 6% for state income taxes and I am in an overall 33% bracket. Yuck.

 

[SecondCor521]

Many moving pieces, at least for me, which make it hard to just classify your types of incomes into brackets upon which to make decisions.

1) Ordinary Income

2) LTCGs and QDivs, taxed at 0% if your income is low enough, 15% otherwise, but also a 20% rate.

3) NIIT, a 3.8% tax at high enough investment income, which includes IRA distributions, counting conversions.

4) SS income ranges from 0 to 50 to 85% taxable, which can cause pockets of very high marginal rates.

5) AMT, though that may affect fewer people with the new tax laws, I believe.

6) ACA subsidies, a tax benefit for lower income. What's the subsidy worth, and the consequence of going over the cliff?

7) Various other credits and deductions that fade with high income.

For short term planning it's not too hard to plug all the numbers into a tax program and see what happens if you add capital gains, do a Roth conversion, etc.

For long term planning over the years, it becomes harder to know for sure, for example, to what level you should do Roth conversions.

Point is, there's a lot more to simply stating you're in a certain tax bracket bracket and CG rate.

8) Financial aid which is mostly based on FAFSA which is partly based on AGI.

9) State income tax

10) Local income tax

11) Number of dependents - my kids are all over 17, but will vary over the next several years as to whether they qualify as my dependents. The $500 "other dependent" tax credit comes into play because I can use it to offset Roth conversions.

For me the big items are 2, 6, 8, 9, and 10.