Tax on your final dollar

[BreathFree]

It seems that with the current tax laws we have diminished the intensive to make more money. The limits for tax payer to get assistance from ACA are way to high.
.

I was hoping to make a little income on a side hustel during retirement, but I don't know if it is worth it now. Taxes would be 25% fed, 6% state, 15% payroll, and now, no subsidy. If you are only making an extra ten to twenty thousand a year, and it causes you to loose your subsidy, then there may be nothing left. Although, it is my understanding, you can purchase the insurance under your business and then the premiums are fully deductible.

 

[kcowan]

Top marginal 38%. Average tax paid 7.3%
with DW, average tax rate drops to 5.2%

 

[RetireAge50]

Huh?

Tax Brackets (Federal Income Tax Rates) 2000 through 2016

I know there is a 15% tax bracket but while you are paying tax in this bracket you are also losing tax credits of 15% so total is about 30% right?

I need to dig in to this some more when I get time. Here is an article which also illustrates what I am trying to say.

Obamacare Subsidies Act Like an Effective Marginal Tax of About 15 Percent as Your Income Goes Up | Mother Jones

 

[bingybear]

I know there is a 15% tax bracket but while you are paying tax in this bracket you are also losing tax credits of 15% so total is about 30% right?

I need to dig in to this some more when I get time. Here is an article which also illustrates what I am trying to say.

Obamacare Subsidies Act Like an Effective Marginal Tax of About 15 Percent as Your Income Goes Up | Mother Jones

Short answer is likely yes. For me there is a point where I add $1 of income or more technically 1 cent and it costs about $6000 in PTC. In reality many people will not be effected by it. Many are not buying on exchange insurance, so they can not get PTC. Others just have too high of income. They can think of it as marginal tax, but likely better thinking of it as the price of insurance.

But you can see similar effects by how you add the "last dollar" without considering the ACA PTC. Take having income up to or a little over the 15% marginal bracket with a good mix of ordinary income and qualified dividends. The ordinary income is assumed to be up to somewhere in the 15% bracket. This is our starting case.

so now we add 1 $ in qualified dividends. This is taxed at 15% for the starting case defined.

now back to the same starting case and let's add 1 $ in ordinary income. This is taxed at 30%. The 1 dollar of ordinary income is taxed at 15%, but it pushes 1 $ of qualified dividends above the 15% marginal rate and so it gets taxed at 15%. Combining these taxes caused by the 1 $ of addition income turns out to be taxed at 30%.

Be careful how you order your analysis.

I'm sure there are some people that will cripple their portfolios and reduce their portfolio performance by many 10's of thousands to capture a $6k PTC cliff.

 

[Clone]

Let me try again, I had it slightly wrong and I'll use rough numbers:

Standard deduction + 2 personal exemptions about $20,000 tax free and free health insurance.

Next $8,000 or so is taxed at 10% and free health insurance.

Next $10,000 or so is taxed at 10% plus 15% health insurance.

Finally remaining income is taxed at 15% plus 15% health insurance.

I think it is much more convoluted than this. First off, you are trying to describe the landscape of incremental tax rates, but throwing health care into it is really a complicating factor. I have been trying to help a friend navigate the healthcare marketplace, and it is much more than just taxes.

$0 to approx $23000 is medicaid. Creates a lien against any assets.
The 138% FPL threshold is a big change to where you become eligible for policies on the exchange, with significant subsidies.
This diminishes to (I believe) 400% FPL, where all subsidies stop. I believe the role of medicaid is a state-by-state thing, so perhaps the rules are different in other areas.

If you retire with a plan to live on the money in after tax accounts (and obtain health care insurance through ACA), you need to generate enough MAGI to get you above the medicaid bracket and into the ACA marketplace with incentives. This means you need to pull money from tax advantaged accounts, such as IRAs, 401Ks, etc. Or get a job. Or generate enough interest or dividends. Or pay through the nose for non-ACA insurance. Or accept the liens associated with medicaid.

I have retirement healthcare through my previous employer, so my incremental tax rate has nothing to do with the ACA numbers. My healthcare costs are independent of what I generate for MAGI.

 

[bingybear]

I think it is much more convoluted than this. First off, you are trying to describe the landscape of incremental tax rates, but throwing health care into it is really a complicating factor. I have been trying to help a friend navigate the healthcare marketplace, and it is much more than just taxes.

$0 to approx $23000 is medicaid. Creates a lien against any assets.
The 138% FPL threshold is a big change to where you become eligible for policies on the exchange, with significant subsidies.
This diminishes to (I believe) 400% FPL, where all subsidies stop. I believe the role of medicaid is a state-by-state thing, so perhaps the rules are different in other areas.

If you retire with a plan to live on the money in after tax accounts (and obtain health care insurance through ACA), you need to generate enough MAGI to get you above the medicaid bracket and into the ACA marketplace with incentives. This means you need to pull money from tax advantaged accounts, such as IRAs, 401Ks, etc. Or get a job. Or generate enough interest or dividends. Or pay through the nose for non-ACA insurance. Or accept the liens associated with medicaid.

I have retirement healthcare through my previous employer, so my incremental tax rate has nothing to do with the ACA numbers. My healthcare costs are independent of what I generate for MAGI.

+1

at 400% it often has a large $ step function to go to 0. For me it does not go smoothly to 0. Some areas of the PTC can be modeled by constant percentages, but not all areas.

 

[jebmke]

The 30% shown is the normal 15% bracket plus an additional 15% for ACA. No state taxes married filing jointly.

Not sure this is correct. There is a hidden 30% marginal rate as dividend income + other income increases. It isn't a bracket rate. Eventually the marginal rate actually decreases back to 25%. I ROTH-convert through this hidden "30% bracket" and through the 25% and 28% rates and then stop.

Suffice it to say that using the IRS tax brackets as marginal tax rates is a risky proposition.

 

[RetireAge50]

Not sure this is correct. There is a hidden 30% marginal rate as dividend income + other income increases. It isn't a bracket rate. Eventually the marginal rate actually decreases back to 25%. I ROTH-convert through this hidden "30% bracket" and through the 25% and 28% rates and then stop.

Suffice it to say that using the IRS tax brackets as marginal tax rates is a risky proposition.

This is what I was trying to say. Thanks!

 

[Alan]

This thread got me thinking and for us it very much depends on where the next $ come from and which of us receives it. No ACA subsidies or Medicare income limits to think about.

Although we now live in England, as US citizens we still get taxed on our worldwide income as well as being taxed by the UK on our worldwide income. There is a Double Taxation Agreement (DTA) in place between the US and UK which means we pay tax to the country that taxes the most on each type of income.

The UK taxes individuals only (no MFJ, MFS, Head of Household etc) and the social programs (child allowance, student loans, charitable donations, dependents, etc) are handled outside the tax system so it is very simple compared to the US.

All our after tax money comes from investments in my wife's name, and I have no savings other than an IRA and Roth, but I do have pensions.

The big drop in the £ has now increased my US pensions by ~33% and moved me up a tax band from 20% to 40% so when I start a new pension in 2017 it will all be taxed at 40%. However the DTA states that SS is only taxed in the UK so when my wife starts her SS in 2017 it will be totally tax free as it will be below her tax free allowance of ~$12k.

The dividends and cap gains my wife receives will be mostly tax free in the UK because of the way those items are taxed (£11k tax free then 15% for cap gains, £5k tax free then 5% for Q'divs). However, we will be paying 15% on this in the US since that is the higher tax rate.

We both have the UK equivalent of Roths in the UK (ISAs) but the US does not recognize this so we pay 25% of each $ earned. Fortunately the UK recognizes Roths so all the earnings and withdrawals are tax free in both countries.

 

[kramer]

I am a retired expat so no State tax and no health care subsidy issues and no earned income. I do not get Social Security and am under Medicare age.

My federal marginal tax rate is 8%.

The last few years I ROTH convert my IRA up to the top of the 10% tax bracket. And then I fill any space left in the 15% bracket with capital gains (0% capital gains tax).

The reason my marginal rate is 8% and not 10% is due to foreign taxes paid by my Vanguard mutual funds. Since my overall federal tax rate is so low, and because foreign taxes paid by these funds exceeds $300, I must file form 1116. Once you pass the $300 foreign taxes paid (single), you can only deduct foreign taxes up to the same percentage tax you paid on your US income. So, for instance, if I didn't do an IRA to ROTH conversion, my income taxes would be $0 and would I lose the entire foreign tax credit (over $1000 for me). As my tax bill increases from 0 by converting some IRA to ROTH, I can take advantage of more and more of the foreign tax credit.

If I decided to IRA to ROTH convert into the 15% tax bracket, my marginal tax rate goes to just under 12%. So far I have not done that, because I like getting 0% on as much cap gains as possible. It's a close call for me.

 

[RunningBum]

...

The last few years I ROTH convert my IRA up to the top of the 10% tax bracket. And then I fill any space left in the 15% bracket with capital gains (0% capital gains tax).

...

If I decided to IRA to ROTH convert into the 15% tax bracket, my marginal tax rate goes to just under 12%. So far I have not done that, because I like getting 0% on as much cap gains as possible. It's a close call for me.

Agree, you really want to keep all the cap gains at 0% if you can. Otherwise, as others have mentioned, every $1 you convert gets taxed at 15%, but also you push $1 of cap gains or qualified dividends into a 15% tax, for an effective 30% tax rate on that $1.

The decision could be whether to take as much cap gains at 0% as possible, or convert as much at 15% as you can without pushing any CGs or divs that you can't easily avoid into being taxable. This is probably a close call. If MRDs are later going to push you above 15%, you might want to do more converting. Also to consider is that your heirs get a stepped up basis on your taxable holdings so if you are looking to pass on money to your heirs, having appreciated equities in a taxable fund is better than money in an IRA.

 

[Cobra9777]

Our last dollar of income is taxed at 15%. Effective tax rate on gross income is usually 8-9%. We do Roth conversions to the top of the 15% bracket. If we overshoot, it's quite easy to recharacterize back down to the top, avoiding the so-called 30% incremental rate. No ACA subsidies to consider. We both have pensions and employer-subsidized retiree health insurance. No state income tax in Texas. We have small foreign tax credits associated with international equity investments, but I don't consider those as part of any incremental rate.

 

[Mulligan]

My last dollar is 25% Fed and 6% state, no subsidies for healthcare obviously. Getting close to 28%.

 

[urn2bfree]

I'm confused.
Suppose I make enough in qualified dividends to be sitting at the very top of the 15% bracket ($75,300 or whatever it is in that year). I am paying Zero federal taxes and state tax rate will vary.
So my question is just considering federal taxes.
Now what happens if I make $1 more as ordinary income or non qualified dividend?
I pay $0.25? Right? Because now I am in the 25% bracket. But it pushes $1 of the dividends over the edge and so it falls into 15% tax. So I pay another $0.15 in taxes? Total FEDERAL tax bill is now $0.40? So the last dollar having created a tax bill of $0.40 was taxed at 40%? (And is that the case of every dollar thereafter up to the next bracket?). So while I am taxed at the very low overall rate of essentially zero (0.4/75301). Every dollar I try to make above my dividends or cap gains has to be thought of as $0.60?
Do I have that right?


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[bingybear]

I'm confused.
Suppose I make enough in qualified dividends to be sitting at the very top of the 15% bracket ($75,300 or whatever it is in that year). I am paying Zero federal taxes and state tax rate will vary.
So my question is just considering federal taxes.
Now what happens if I make $1 more as ordinary income or non qualified dividend?
I pay $0.25? Right? Because now I am in the 25% bracket. But it pushes $1 of the dividends over the edge and so it falls into 15% tax. So I pay another $0.15 in taxes? Total FEDERAL tax bill is now $0.40? So the last dollar having created a tax bill of $0.40 was taxed at 40%? (And is that the case of every dollar thereafter up to the next bracket?). So while I am taxed at the very low overall rate of essentially zero (0.4/75301). Every dollar I try to make above my dividends or cap gains has to be thought of as $0.60?
Do I have that right?

no.
your $1 would be at the 0% marginal bracket in your case but it would push your q-divy 1 $ into the 25% bracket which is taxed at Q-divy special rate of 15%.

note bold - this is $ after standard or itemized deductions which is what I think you implied.

 

[meierlde]

I'm confused.
Suppose I make enough in qualified dividends to be sitting at the very top of the 15% bracket ($75,300 or whatever it is in that year). I am paying Zero federal taxes and state tax rate will vary.
So my question is just considering federal taxes.
Now what happens if I make $1 more as ordinary income or non qualified dividend?
I pay $0.25? Right? Because now I am in the 25% bracket. But it pushes $1 of the dividends over the edge and so it falls into 15% tax. So I pay another $0.15 in taxes? Total FEDERAL tax bill is now $0.40? So the last dollar having created a tax bill of $0.40 was taxed at 40%? (And is that the case of every dollar thereafter up to the next bracket?). So while I am taxed at the very low overall rate of essentially zero (0.4/75301). Every dollar I try to make above my dividends or cap gains has to be thought of as $0.60?
Do I have that right?


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Actually note that if the last dollar was dividends it does not affect the tax bracket. (look at the qualified dividends and capital gains worksheet). You find that you take your gross income and subtract the amount of qualifed dividends and capital gains from it before figuring your tax. So in the case cited the amount used in the tax table would not include the last qualified dividend amount.

In essence
Total income-qualifed dividends-capital gains= income used in tax table or bracket. The qualified dividends are taxed at their 15 (or 20% if very high income) rate. At the bottom of the form you add the tax table amount and the 15% rate on the qualified dividends and capital gains to get your tax due.
So the answer is 15% because the qualified dividends don't affect the tax bracket.

 

[RunningBum]

I never truly understood this until I tried different numbers in that Qualified Dividends and Capital Gains Worksheet in a simple TurboTax run.

Start with your income (less deductions and exemptions) plus divs & CGs below the 15% limit. Divs & CGs are not taxed, and the last part of income is taxed at 15%. So every new $1 of income under the bar for that sum is taxed at 15%. A new $1 of CGs/divs is not taxed as long as you stay under the bar.

Now push that sum just above. The last part of income is still taxed at 15%, but now any part you push above 15% makes that much in CGs & divs taxed at 15% too. Now every new $1 of income is effectively taxed at 30%. A new $1 of CGs/divs is taxed at 15%.

Then push just income over the 15% top. You've now pushed every bit of divs & CGs into being taxed at 15%. Every new $1 of income is now taxed at 25%, but there's no additional impact to divs & CGs because they are all already taxed. A new $1 of CGs/divs is taxed at 15%.

This holds true until you get into the very high income level where CGs are taxed more. I don't worry about that one so you can figure it out for yourself if it applies.

 

[bingybear]

Actually note that if the last dollar was dividends it does not affect the tax bracket. (look at the qualified dividends and capital gains worksheet). You find that you take your gross income and subtract the amount of qualifed dividends and capital gains from it before figuring your tax. So in the case cited the amount used in the tax table would not include the last qualified dividend amount.

In essence
Total income-qualifed dividends-capital gains= income used in tax table or bracket. The qualified dividends are taxed at their 15 (or 20% if very high income) rate. At the bottom of the form you add the tax amount and the 15% rate on the qualified dividends and capital gains to get your tax due.
So the answer is 15% because the qualified dividends don't affect the tax bracket.

If you look at this thread and many others like it, people are looking for effective marginal rates, not IRS defined tax rates. For instance if one had ordinary income to the middle of the 15% IRS marginal bracket and the rest of the 15% bracket filled with Q-divys. If one adds 1 $ of ordinary income, the tax increases by 30 cents (or 30%). 15% is attributed to the added ordinary income in the 15% bracket and 15% by 1 $ of Q-divy being pushed above the 15% IRS marginal rate (resulting from the addition of 1 $ ordinary income). So the effective marginal rate is 30%, the ordinary income was taxed as 15% and caused a Q-divy to be taxed differently.
people are including PTC into the effective marginal rate.

The effective rate is likely more of a consideration when looking at roth conversions and other other adjustments or tax planning than just the IRS marginal rate.

 

[pb4uski]

^^^^^ this.

30% if your ordinary income is already in the 15% tax bracket and qualified income (divs or LTCG) fill up the rest of the 15% tax bracket. Add $1 and you get 15c of more ordinary tax and $1 over the 15% tax bracket that gets taxed at 15% CG/Qdiv rate for a total of 30c. That is why I do my tax return, determine how much over the 15% tax bracket I am and then recharacterize any excess... I'm not paying 30% when I can so easily avoid it!

This is a pretty good explanation... especially the graphs.

So if you add $100 of ordinary income it increases 15% rate ordinary income from $11,550 to $11,650 and the tax increases from $1,732.50 to $1,747.50. That $100 of additional ordinary income increases capital gains subject to 15% tax from $5,900 to $6,000... increasing the capital gains tax from $885 to $900. So the total tax bill increases from $4,432.50 to $4,462.50... an increase in tax of $30 on a $100 increase in ordinary income (like Roth conversions).

If the $100 increase is $100 of more capital gains or qualified dividends then the tax increase is only $15.

 

[Clone]

I tried to identify all of the factors that go into this, and quickly ran into a number of circular references. The last one I thought of was this:

If you are drawing SS and your age is less than XX, then you also lose $Y.YY for each additional $ of earned income.

So, as soon as we can agree on the proper time to begin drawing Social Security, then I believe we can optimize the answer to the OP's question!

 

[meierlde]

Note that another example is Medicare Part B (and D) premiums. For part B if your magi goes from 85000 to 85001 then your part B premiums go up by $ 586.80 for the year (the same applies for the higher break points, all be it with different amounts).
This is a point that is often discussed with welfare benefits where there are points where above 100% taxation applies (as it does in this case).
The tax code is full of things with dollar amount limits that cause such behavior.

 

[SecondCor521]

My tax situation is so complicated this year that I did not trust myself to figure out all of the marginal additions and subtractions and adjustments and cliffs and stuff. I have salary income, traditional IRA contribution, Roth conversion, 1099 income, dividends, interest, capital gains subject to section 1202 exclusions, ACA subsidies and a partridge in a pear tree.

The only thing I could figure to do was to fire up 2015 Turbotax and put all of my real numbers into it, then start adding in another $1000 of IRA contribution and/or capital gains and/or Roth conversions and see what the effective marginal rate was on those deltas.

I also figure personally I am OK paying tax at 15% but not at 20%, so I fiddled with it until the numbers settled down.

In my case, what made sense was a full traditional IRA contribution, realizing all of the CGs I had, and then a reasonable sized Roth conversion. I overconverted so as my last dividends and interest and stuff comes in next month and as things settle down, I can recharacterize to get exactly where I want to be.

This is my first year that I can pick my AGI and I'm excited about the options but a little bewildered and disappointed by the complexity of the tax code. I look forward to seeing my actual tax return so I can figure out what actually happened - like, did I actually get any benefit from the saver's credit, or did I get the full child tax credit, etc.

 

[GravitySucks]

15 cents Federal income
4 cents State income
8 1/2 cents County/ State sales tax.