Tax rate stacking - help me think straight

joesxm3

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I was playing with Turbo Tax tonight an started to wonder if I found another tax rate bubble like the one with social security.

Single filer.
$15,700 interest income (equal to the standard deduction)
$44,625 LTCG (equal to the 0% LTCG limit)
If I am recounting this correctly TT show $0 tax owed.

If I increase interest income by $1000, TT shows $250 tax owed.

So it seems that I now pay 10% on the $1000 of interest income, but it also pushes $1000 of LTCG into the 15% tax zone.

Am I correct in thinking that the extra $1000 of interest (or maybe ROTH conversion) is actually being taxed at an effective rate of 25%?

We talk of ROTH converting up to the top of the 12% range. It seems that saying this assumes there are no LTCG.

It seems to me that if there are LTCG then some portion of the ROTH conversion will be taxed at 12% but also trigger 15% on some LTCG, effectively being taxed at 27% on the margin.

Would it be more correct to suggest ROTH converting to (the top of the 12% range minus any LTCG amount) ?

Am I analyzing this properly?
 
Yeah, you got it.

I think of it as Roth converting so after the Roth conversion taxable income is at the top of the 12% tax bracket, so the taxable income before any Roth conversions already includes all income including qualified dividends and LTCG.

If you do that and then add another $1,000 of ordinary income, it would push $1,000 of LTCG into 15% and the added $1,000 of ordinary income would be taxed at ordinary rates.

The ordinary income would be taxed at 0%, 10% or 12% depending on how much preferences income you have.
 
OP, yes, you are. Here's a Kitces article that discusses the issue:


If you do that and then add another $1,000 of ordinary income, it would push $1,000 of LTCG into 15% and the added $1,000 of ordinary income would be taxed at ordinary rates.
The above is accurate.

The ordinary income would be taxed at 0%, 10% or 12% depending on how much preferences income you have.

The above is inaccurate. Preferenced income stacks on top of ordinary income. Therefore, ordinary income can affect the taxation of preferenced income; however, the reverse is not true. Ordinary income is taxed at 0% then 10% then 12% and so on but only depends on the amount of ordinary income; the amount of preferenced income is irrelevant to the taxation of the ordinary income.

I'm pretty sure pb4uski knows that. It's easy to misstate tax stuff; I do so regularly.
 
No, what I wrote is accurate. You misread it. An additional $1,000 of ordinary income would be taxed at 0%, 10% or 12% and the the additional $1,000 of ordinary income pushes $1,000 of preferences income from 0% to 15%. So the total tax would be 15%, 25% or 27% depending on the circumstances.
 
No, what I wrote is accurate. You misread it. An additional $1,000 of ordinary income would be taxed at 0%, 10% or 12% and the the additional $1,000 of ordinary income pushes $1,000 of preferences income from 0% to 15%. So the total tax would be 15%, 25% or 27% depending on the circumstances.

I agree with the above 100%.

If you do that and then add another $1,000 of ordinary income, it would push $1,000 of LTCG into 15% and the added $1,000 of ordinary income would be taxed at ordinary rates.

I also agree with the above 100%.

The ordinary income would be taxed at 0%, 10% or 12% depending on how much preferences income you have.

[Emphasis added.]

I still disagree 100% with this statement. To be precise, I 100% agree with the unbolded first half; the second bolded half makes the sentence, as written, inaccurate the way I read and understand it.

I'm not sure why we're having a miscommunication. As mentioned before, I know pb4uski knows his tax stuff.

Let's try this as a way to clarify:

Suppose a taxpayer has taxable ordinary income up to the top of the 10% bracket and $0 of preferenced income. For a single person in 2024, that's $11,600 of ordinary income. The income tax on that ordinary income will be 10% of the taxable amount, pretty much by definition, or $1,160. (*) Now suppose they have $1M of preferenced income. The income tax on their ordinary income would still be 10% of the taxable ordinary income or $1,160 right? Which doesn't seem to square with the bolded part of the statement. [Yes, they'd owe a boatload of capital gains and probably NIIT and AMT and ACA subsidy repayment and who knows what else, but their $11,600 of ordinary income would still only be taxed at 10% AFAICT.]

ETA: Now that I reread your posts, I think what you *might* be meaning to say - and I'm not trying to put words in your mouth, just trying for understanding - is that the apparent tax effect of adding $1000 of ordinary income can result in a tax bill that is higher than just the ordinary income tax part of the bill because of the ordinary income pushes some of the preferenced income into higher CG brackets, so the practical effect of this is a 25% or 27% or whatever bracket - in my example in the previous paragraph it would be $1000 at 12% plus $1000 at 23.8% or a 35.8% phantom bracket. I think we all agree on this. If that is what you were trying to say, then I think that the way you phrased it was something that I could see being misinterpreted. And if that's what you meant, I would think it would be clearer to say "15%, 25%, or 27%" instead of "0%, 10% or 12%".

(*) Yes, one can make the minor nitpick that the tax will actually be $1,163 or something like that because of the $50 income ranges in the tax tables that the taxpayer is required to use.
 
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Let me try it differently. Say that your taxable income is at the top of the 12% tax bracket and all preferenced income. And let's ignore the pesky minor difference between the top of the 0% preferences tax bracket and the top of the 12% tax bracket.

Your tax is $0. If you then add $1,000 of ordinary income, the ordinary income is taxed $0 because the ordinary income is less than the standard deduction. However, the added $1,000 of ordinary income pushes $1,000 of preferenced income from 0% to 15%, resulting in $150 in tax.

ETA: Proof: $123,250 of preferenced income for MFJ both under 65 results in $0 tax. Add $1,000 of ordinary income and tax is $150.
 
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Let me try it differently. Say that your taxable income is at the top of the 12% tax bracket and all preferenced income. And let's ignore the pesky minor difference between the top of the 0% preferences tax bracket and the top of the 12% tax bracket.

Your tax is $0. If you then add $1,000 of ordinary income, the ordinary income is taxed $0 because the ordinary income is less than the standard deduction. However, the added $1,000 of ordinary income pushes $1,000 of preferenced income from 0% to 15%, resulting in $150 in tax.

I agree with that example as well.

It's pretty clear that I'm just reacting on a technicality of language. I got good grades in college by doing that, and two Fortune 500 tech companies paid me a lot of money to do that for 20+ years. Hard habit to break, as Chicago would say.

🍻
 
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