Seeking clarity about income and capital gains taxes

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bobsmith
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Joined: Thu Jan 24, 2013 3:02 pm

Seeking clarity about income and capital gains taxes

Post by bobsmith »

Hi,
I've got a guy doing my taxes each year because I find the whole process very intimidating and hard to understand. He's a good CPA, but I'm trying to understand some basic concepts on my own. I'm going to lay out a lot of information here, but at the end I will only have a couple basic questions, so hang in there to the end of you can! :D

Combine, my wife and I make about $100,000 gross, married filing jointly.
• We have two kids.
• We usually take the standard deduction.

We are able to take care of all our needs including college saving each year such that we essentially spend all our income each year. Let's assume nothing is left over for savings and nothing is ever taken out of savings. Years ago I received an unexpected inheritance which I have invested in a taxable account with Vanguard.

My intention is to supplement my income with my savings while directing our paychecks into retirement accounts available through work along with our personal IRAs. This will require me to cash in portions of my mutual funds creating taxable gains. Of course the unrealized gain varies on each fund, but for all intents and purposes it's fair to say that the value represented by each fund is about 50% unrealized gain. Using all my resources, I expect to be able to "move" $47,000 from my savings to my retirement accounts. Two IRAs-$11,000, one 403b7 plan-$18,000, and one 457plan-$18,000.

These are all after-tax roth investments. I realize this will be a red flag to many here. I'm open to criticism on this, but for now, I'm going to ask that we hold off on making a case for pre-tax contributions at least until I can get some answers on my tax situation as presented using all roths.


100,000 income
-12,400 standard deduction
----------
87,600

By the end of the year I'll have cashed in 47,000 worth of mutual funds. Of this amount, about 23,500 will be subjected to long term capital gains.

87,600
23,500
---------
111,000

Let me see if I've got this right:
Using 2015 tax brackets, married filing jointly...
I'll pay 10% income tax on the first 18,450 -- 1,845
then 15% income tax the next 56,450 -- 8,468
That should leave me with 12,700 income at 25% -- 3,175
(87,600 -18,450 -56,450 = $12,700)

The remainder is long term capital gains earnings, 23,500. Because my taxable total is 111,000 I'll still be in the 25% income bracket. Therefore, on the remaining 23,500 I would pay a long term capital gains rate of 15% as opposed to the 25% income tax rate.

I'll pay long term capital gains tax on 23,500 at 15% -- 3,535

In conclusion, I'll have 1,845 +8,468 +3,175 +3,535 = $17,023 in tax. Right?

Follow up question:
I mentioned I have two kids. I believe I get a $1,000 tax credit per child for a total of $2,000.

However, there's a qualification from the IRS regarding the tax credit:
"The credit is limited if your modified adjusted gross income is above a certain amount. The amount at which this phase-out begins varies depending on your filing status. For married taxpayers filing a joint return, the phase-out begins at $110,000."

Question: Is my modified gross income $87,600 or is it $111,000?

If, in the eyes of the IRS, my MGI is $111,000 then I'd be jeopardizing my tax CREDIT. In this case I would want to be careful to make sure that my realized gain did not push my MGI above $110,000 which is something I can easily control with a little planning.

http://www.irs.gov/uac/Ten-Facts-about- ... Tax-Credit
DSInvestor
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Re: Seeking clarity about income and capital gains taxes

Post by DSInvestor »

You forgot to subtract your personal exemptions. For 2015, each personal exemption is $4,000 and the standard deduction is $12,600. I believe you'd have 4 exemptions which would reduce your taxable income by $16,000.

Taxable Income = AGI - deductions - exemptions.

On 100K Salary without capital gains:
Taxable Income = 100,000 - 12,600 - 16,000 = $71,400

Your AGI includes your W2 income, interest income, dividend distributions, capital gains distributions, realized capital gains (losses), HSA contributions, Traditional IRA contributions (if deductible). If you make Traditional 401k contributions, that reduces your W-2 Income which in turn reduces your AGI, MAGI and Taxable Income. Roth 401k contributions are not tax deductible and do not reduce your W-2 income, AGI, MAGI or taxable income. The difference in tax cost between maxing out 2 Roth 401k and 2 Traditional IRA is the tax cost on an additional $36,000. Traditional 401k contributions will also reduce your state income tax.

Take some time and run some numbers with the Taxcaster online tax calculator. Taxcaster does not handle state income taxes.
https://turbotax.intuit.com/tax-tools/c ... taxcaster/

Before selling any shares of the taxable holdings, you should first check to see how much dividends the taxable holdings throw off. If the taxable holdings are large, the dividends alone may be sufficient to make up for the reduced paycheck. If you set the funds to distribute the dividends in cash rather than reinvest, you'd have less need to sell shares and realize capital gains. The dividends received from holdings in taxable accounts are taxed each year regardless of whether you reinvest or take in cash.

If your holdings have been reinvesting dividends for many years, your cost basis may be higher than you think because you've already paid taxes on the dividends which you used to acquire additional shares.

Realized capital gain = sales proceeds - cost basis.

Your taxable account will likely have a display of your cost basis and maybe even show you specific tax lots and allow you to select which tax lots to sell to minimize capital gains. Sell the tax lots with the highest cost basis will give you the smallest capital gain.
Last edited by DSInvestor on Mon Jan 05, 2015 10:25 am, edited 2 times in total.
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JW-Retired
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Re: Seeking clarity about income and capital gains taxes

Post by JW-Retired »

Question: Is my modified gross income $87,600 or is it $111,000?
Neither.
Your standard deduction (and exemptions) reduces taxable income but doesn't reduce your AGI (or MAGI). With $100k salary and the $23k of cap gains your AGI will be $123k. The best way to reduce your AGI is to make 401k or other work tax deferred contributions. They reduce AGI but your after-tax Roth plans savings do not. Traditional IRA contributions reduce AGI but not MAGI.
JW
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livesoft
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Re: Seeking clarity about income and capital gains taxes

Post by livesoft »

You asked us not to comment on the wisdom of your Roth contributions, but is that 457 plan even a Roth kind of thing?

You should probably try out Taxcaster which isn't so intimidating for just testing the big picture like you are trying to do: https://turbotax.intuit.com/tax-tools/c ... taxcaster/

Without going into details, the tax you figured is more than the income taxes that we pay and we have twice as much income as you outlined, so you are not doing something right.

A run of TaxCaster tells me that you can pay less than $4500 in Federal income taxes easily.

You have to also realize that if you can get your W2 income low enough by contributing deductible contributions to your 457 and 401(k)/403(b) plans that you will end up in the 15% marginal income tax bracket which means your Long-term capital gains tax rate will be 0%. If your tax person doesn't beat you over the head about this, then I would find another tax person.

PS: I also found a way to make your income taxes even lower, say around $2800.
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rkhusky
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Re: Seeking clarity about income and capital gains taxes

Post by rkhusky »

Also, you don't lose the entire Child Tax Credit for going over $110K. You lose $50 for each $1000 over $110K, which, on average, is an additional 5% to your marginal tax rate.
Topic Author
bobsmith
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Re: Seeking clarity about income and capital gains taxes

Post by bobsmith »

DSInvestor wrote:You forgot to subtract your personal exemptions. For 2015, each personal exemption is $4,000 and the standard deduction is $12,600. I believe you'd have 4 exemptions which would reduce your taxable income by $16,000.

Taxable Income = AGI - deductions - exemptions.

On 100K Salary without capital gains:
Taxable Income = 100,000 - 12,600 - 16,000 = $71,400
Your AGI includes your W2 income, interest income, dividend distributions, capital gains distributions, realized capital gains (losses), HSA contributions, Traditional IRA contributions (if deductible). If you make Traditional 401k contributions, that reduces your W-2 Income which in turn reduces your AGI, MAGI and Taxable Income.

Take some time and run some numbers with the Taxcaster online tax calculator.
https://turbotax.intuit.com/tax-tools/c ... taxcaster/"

Clearly, I'm confused by what is meant by personal exemption as well as the child tax credit. My tax guy is a family friend and we've been using him for years, but he's not the best communicator. I think he sometimes misses opportunities for me. I will play with that link. Thank you.

So to continue your formula...

Taxable Income = 100,000 - 12,600 - 16,000 = $71,400

Not considering other exempts you listed above, if I cashed in $47,000 in mutual funds which created a realized gain of $23,500, then...
$71,400 + $23,500 = $94,900 AGI. Therefore I could still use my child tax credit because this AGI is less than $110,000. (I'll do my homework on when/if personal exemptions are phased out).

Right?

Before selling any shares of the taxable holdings, you should first check to see how much dividends the taxable holdings throw off. If the taxable holdings are large, the dividends alone may be sufficient to make up for the reduced paycheck. If you set the funds to distribute the dividends in cash rather than reinvest, you'd have less need to sell shares and realize capital gains. The dividends received from holdings in taxable accounts are taxed each year regardless of whether you reinvest or take in cash.

If your holdings have been reinvesting dividends for many years, your cost basis may be higher than you think because you've already paid taxes on the dividends which you used to acquire additional shares.

Realized capital gain = sales proceeds - cost basis.

Your taxable account will likely have a display of your cost basis and maybe even show you specific tax lots and allow you to select which tax lots to sell to minimize capital gains. Sell the tax lots with the highest cost basis will give you the smallest capital gain.
In my case all the funds in my taxable account are all Vanguard stock index funds. I really do need to take a harder look at the tax impact of the dividends, but after considering the personal exemptions I don't think it will push me too close to that $110,000 I was worried about. Likewise, if I distributed these dividends, I don't think it would amount to much with regards to the $47,000 I'll need.

I've actually spoken to a Vanguard rep directly so I'm confident on my unrealized gain for each fund, both long and short. I use average cost basis which is good for me because it's simple to understand and also because these investments were made pretty much all at one time years ago with little being added since then. All these funds have very little unrealized short term gain relative to the unrealized long term gain. Using average cost basis, when I sell a share does uncle same leave the short term gains alone and just hit me for the long term gain or does he take a little from each proportionally?

Seeing how ignorant I've exposed myself to be, I might as well ask two more questions..

Regarding home mortgage tax deduction... First, if I'm taking the standard deduction, I can't claim this, right? Second, if I do want to itemize my return in order to claim this, the only part I am claiming is the interest on the payment, not the property taxes, correct? My home is mostly paid for. I'm wondering if it might be to my advantage to have a higher mortgage.

You mentioned HSA. I don't tend to have a lot of medical expenses. I understand why having an account setup for this has some investment advantages, but for simplicity, I find it easier to just save my medical receipts and file them during tax time. Either way, these can be filed in addition to the standard deduction, correct?

Thank you for your time and advice. I'll start doing some more homework and maybe get a dummies book or something.
rkhusky
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Re: Seeking clarity about income and capital gains taxes

Post by rkhusky »

bobsmith wrote: Therefore I could still use my child tax credit because this AGI is less than $110,000. (I'll do my homework on when/if personal exemptions are phased out).
Yes, you would get the full $2000 credit. If your AGI is $111K, the credit would be $1950.
bobsmith wrote: Regarding home mortgage tax deduction... First, if I'm taking the standard deduction, I can't claim this, right? Second, if I do want to itemize my return in order to claim this, the only part I am claiming is the interest on the payment, not the property taxes, correct? My home is mostly paid for. I'm wondering if it might be to my advantage to have a higher mortgage.
If you take the standard deduction, you cannot claim itemized deductions.

You can claim property taxes and mortgage interest (and charitable contributions. and medical expenses if they are large enough. (you don't file your medical receipts)) Take a look at Schedule A.

I would not get a higher mortgage in order to itemize deductions.
DSInvestor
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Re: Seeking clarity about income and capital gains taxes

Post by DSInvestor »

Here's a link to IRS Form 1040 Schedule A itemized deductions which will show you what's included in itemized deductions:
http://www.irs.gov/pub/irs-pdf/f1040sa.pdf
You should itemize deductions if the sum of your itemized deductions exceeds the standard deduction. Common itemized deductions are:
1. Mortgage Interest
2. Real estate taxes
3. State Income tax or Sales taxes.
4. Charitable donations
5. Medical expenses (amount that exceeds 10% of AGI)

I would not suggest getting a larger mortgage just to itemize taxes. If the sum of your deductions is close to the amount of standard deductions, you may be able to alternate between itemizing and taking the standard deduction by bunching your deductions. For example, in 2015 double up on charitable donations for 2015 and 2016 and pay 2015 and 2016 real estate taxes. This increases the amount of deductions for 2015 which may allow you to itemize. Your 2016 deductions will be lower so you should take the standard deduction. For 2017, you'd itemize again by again doubling up on charitable donations and real estate taxes.

When you play around with taxcaster, enter your base tax situation (filing status, dependents, income, dividend income, interest income, mortgage interest, real estate taxes etc) without the capital gain. Once you have the base tax, add the long term capital gains into taxcaster and see how much the fed tax increases. The increase in fed tax is the tax cost for realizing the capital gains. There may be scenarios where there may be zero fed tax cost for realizing 25K of long term capital gains (e.g. if you both max out Traditional 401k/403b/457b plans).

You should several scenarios:
1. No 401k contributions which is the same as maxing out Roth 401k.
On 100K Gross income with Roth 401k or no 401k contributions, your AGI would be 100K.
What is the base tax? What is the additional tax for 25K of LT capital gain?

2. Max out Traditional 401k. If you both max out Traditional 401k for 18K each, your AGI would 64K. Your taxable income after deductions and exemptions would be 34,500 giving you lots of room in 15% bracket for QDI and LTCG.
Taxcaster doesn't have a field for traditional 401k contributions but you can reduce you and your spouse's income by the amount of the Trad401k contribution.
What is the base tax? What is the additional tax for 25K of LT capital gain?

You will find big differences in your tax liability in these two scenarios.

I would suggest that you not make any contributions to college savings accounts until you're maxing out all tax advantaged retirement plans. Assuming you and your spouse are under age 50, that's 18K for your 401k, 18K for her 401k and 5.5 each for your IRAs. It's too late to make workplace contributions for 2014 but 2014 IRA contributions are allowed up until tax filing deadline April 15, 2015.
Last edited by DSInvestor on Mon Jan 05, 2015 12:24 pm, edited 1 time in total.
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DSInvestor
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Re: Seeking clarity about income and capital gains taxes

Post by DSInvestor »

Nolo page - Bunching Tax deductions to meet the threshold for itemizing:
http://www.nolo.com/legal-encyclopedia/ ... tions.html
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bobsmith
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Re: Seeking clarity about income and capital gains taxes

Post by bobsmith »

JW Nearly Retired wrote:
Question: Is my modified gross income $87,600 or is it $111,000?
Neither.
Your standard deduction (and exemptions) reduces taxable income but doesn't reduce your AGI (or MAGI). With $100k salary and the $23k of cap gains your AGI will be $123k. The best way to reduce your AGI is to make 401k or other work tax deferred contributions. They reduce AGI but your after-tax Roth plans savings do not. Traditional IRA contributions reduce AGI but not MAGI.
JW
First, to be clear, when I said my AGI I meant my "modified adjusted gross income". As I linked earlier, the MAGI is what is considered to determine at which point the child tax credit is phased out. This was a careless source of confusion. Sorry.
http://www.irs.gov/uac/Ten-Facts-about- ... Tax-Credit

Therefore, it doesn't matter what my deductions are. The number uncle sam will see is 100,000 + 23,500 = 123,500. Therefore losing $50/each $1,000 over $110,00 (as rkhusky pointed out)...

123,500
-110,000
------------
13,500

13.5 thousand over the limit losing $50 each thousand = $675

$1,000 credit - $675 = $325

Two kids, so I'd have a credit of $650. Right?

note: To be clear, when rkhusky said I could get my full child tax credit, he was basing this on the incorrect information I gave him when I stated that my AGI (rather MAGI) was $110,000.
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bobsmith
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Re: Seeking clarity about income and capital gains taxes

Post by bobsmith »

livesoft wrote:You asked us not to comment on the wisdom of your Roth contributions, but is that 457 plan even a Roth kind of thing?
In my case, yes, a roth 457 is available.

You should probably try out Taxcaster which isn't so intimidating for just testing the big picture like you are trying to do: https://turbotax.intuit.com/tax-tools/c ... taxcaster/
Thank you. I can't do this right now, but I certainly will check it out.

Without going into details, the tax you figured is more than the income taxes that we pay and we have twice as much income as you outlined, so you are not doing something right.

A run of TaxCaster tells me that you can pay less than $4500 in Federal income taxes easily.
I'm assuming this is achieved primarily by making traditional pre-income-tax contributions instead of roths?

You have to also realize that if you can get your W2 income low enough by contributing deductible contributions to your 457 and 401(k)/403(b) plans that you will end up in the 15% marginal income tax bracket which means your Long-term capital gains tax rate will be 0%. If your tax person doesn't beat you over the head about this, then I would find another tax person.

Hmmm.... I have a pension which is why I'm primarily interested in Roths. However, you make a good point I haven't run the numbers on. If I could get my income down enough to pay 0% on capital gains in part or in whole, that might alter how I do things.
PS: I also found a way to make your income taxes even lower, say around $2800.
I'm still struggling with basic tax ignorance, but give me the nutshell!
DSInvestor
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Re: Seeking clarity about income and capital gains taxes

Post by DSInvestor »

Just take 15-30 minutes to play with taxcaster and I think you will find it illuminating. It really helped me understand our tax system, at least the parts of it that pertain to my situation.

Here are two simple scenarios comparing Traditional vs Roth contributions to workplace plans.

Roth 401k/403b/457b contributions:
W2 Income: 100K (Roth workplace contributions do not reduce W-2 income)
AGI: 100K
Std deduction 12,600
4 Exemptions: 16,000
Taxable Income = 100,000 - 12,600 - 16,000 = 71,400 (near the top of the 15% bracket)
What is the base tax without any LTCG?
Once you have this, add some LTCG maybe $1000 at a time and watch what happens to your tax liability.

Traditional 401k/403b/457b contributions of 18K each:
W2 Income: 64K (reduced by Traditional contributions to work place plans)
AGI: 64K
Std deduction: 12,600
4 Exemptions: 16,000
Taxable Income = 64000 - 12,600 - 16,000 = $35,400 (near the bottom of the 15% bracket)
What is the base tax?
Once you have this, add some LTCG and watch what happens to your tax liability.

With Traditional contributions to workplace plans, you'd have ample space in 15% tax bracket to fill up with LTCG and QDI to be taxed at 0% Fed. State income tax may apply depending on your state of residence.
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bobsmith
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Re: Seeking clarity about income and capital gains taxes

Post by bobsmith »

DSInvestor wrote:Here's a link to IRS Form 1040 Schedule A itemized deductions which will show you what's included in itemized deductions:
http://www.irs.gov/pub/irs-pdf/f1040sa.pdf
You should itemize deductions if the sum of your itemized deductions exceeds the standard deduction. Common itemized deductions are:
1. Mortgage Interest
2. Real estate taxes
3. State Income tax or Sales taxes.
4. Charitable donations
5. Medical expenses (amount that exceeds 10% of AGI)

I would not suggest getting a larger mortgage just to itemize taxes. If the sum of your deductions is close to the amount of standard deductions, you may be able to alternate between itemizing and taking the standard deduction by bunching your deductions. For example, in 2015 double up on charitable donations for 2015 and 2016 and pay 2015 and 2016 real estate taxes. This increases the amount of deductions for 2015 which may allow you to itemize. Your 2016 deductions will be lower so you should take the standard deduction. For 2017, you'd itemize again by again doubling up on charitable donations and real estate taxes.

When you play around with taxcaster, enter your base tax situation (filing status, dependents, income, dividend income, interest income, mortgage interest, real estate taxes etc) without the capital gain. Once you have the base tax, add the long term capital gains into taxcaster and see how much the fed tax increases. The increase in fed tax is the tax cost for realizing the capital gains. There may be scenarios where there may be zero fed tax cost for realizing 25K of long term capital gains.

You should several scenarios:
1. No 401k contributions which is the same as maxing out Roth 401k.
On 100K Gross income with Roth 401k or no 401k contributions, your AGI would be 100K.
What is the base tax? What is the additional tax for 25K of LT capital gain?

2. Max out Traditional 401k. If you both max out Traditional 401k for 18K each, your AGI would 64K.
Taxcaster doesn't have a field for traditional 401k contributions but you can reduce you and your spouse's income by the amount of the Trad401k contribution.
What is the base tax? What is the additional tax for 25K of LT capital gain?

You will find big differences in your tax liability in these two scenarios.

I would suggest that you not make any contributions to college savings accounts until you're maxing out all tax advantaged retirement plans. Assuming you and your spouse are under age 50, that's 18K for your 401k, 18K for her 401k and 5.5 each for your IRAs. It's too late to make workplace contributions for 2014 but 2014 IRA contributions are allowed up until tax filing deadline April 15, 2015.
Clearly, I need to educate myself on the basics before giving itemize deductions full and proper considerations. That said, despite re-reading this thread, I'm confused about a couple things:

If I take the standard deduction, can I still write off my mortgage interest in addition to that?

I wouldn't get a larger mortgage for the sole purpose of itemizing my deductions. However, my home is mostly paid off and there's a kitchen renovation on the horizon. Home equity interest rates seem pretty reasonable and I'd already be generating a lot of capital gain in trying to fund the roths.

I get your point about the college saving contributions. I misstated this. My kids already have 529s which I no longer contribute to because I feel they are large enough at this point.

I struggle with the question of whether to invest in roths or traditional pre-tax plans. Among other reasons, I will have a pension when I retire which makes roth much more attractive. I think I'll table the roth vs. traditional questions for now as it truly is a big can of worms and my plate is currently full. Maybe I'll open up a new thread when I have time. At the moment, I'm still generally of the assumption that roths are the best path for me.
DSInvestor
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Re: Seeking clarity about income and capital gains taxes

Post by DSInvestor »

bobsmith wrote: If I take the standard deduction, can I still write off my mortgage interest in addition to that?
No. The standard deduction is what you can deduct even if you have no deductions. If you have more deductions than the standard deduction, you can itemize your deductions. You either take the standard deduction or itemize. Mortgage interest is an itemized deduction and can only be claimed by itemizing. However if the sum of your itemized deductions do not exceed your standard deduction, you should just take the standard deduction. For example if you paid no state income tax, had $2000 in real estate tax and $3000 in mortgage interest, your itemized deductions are $5000. You can itemize deductions for $5000 or take the $12,600 standard deduction. You'd pay less tax if you took the standard deduction.

Note that Roth workplace contributions are irrevocable. Once made, there is no mechanism to change them to Traditional and get the tax deduction. Traditional work place contributions may offer the option to change to Roth at a later date via an in-plan conversion. If your plans offer in-plan conversion, you can contribute Traditional now and later in the year convert to Roth once you've had a chance to better understand your tax situation to make an informed decision about Roth vs Traditional workplace contributions.
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rkhusky
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Re: Seeking clarity about income and capital gains taxes

Post by rkhusky »

bobsmith wrote: Therefore, it doesn't matter what my deductions are. The number uncle sam will see is 100,000 + 23,500 = 123,500. Therefore losing $50/each $1,000 over $110,00 (as rkhusky pointed out)...

123,500
-110,000
------------
13,500

13.5 thousand over the limit losing $50 each thousand = $675

$1,000 credit - $675 = $325

Two kids, so I'd have a credit of $650. Right?

note: To be clear, when rkhusky said I could get my full child tax credit, he was basing this on the incorrect information I gave him when I stated that my AGI (rather MAGI) was $110,000.
You round up to the nearest $1000, so you would lose $700 of your credit, leaving a $1300 credit (for 2 children: $2000-$700).
livesoft
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Re: Seeking clarity about income and capital gains taxes

Post by livesoft »

bobsmith wrote:I'm still struggling with basic tax ignorance, but give me the nutshell!
The nutshell: You are killing yourself by insisting on Roth 403(b) and Roth 457. Really, really killing yourself. If you use traditional 403(b) and traditional 457, then you would be eligible for deductible traditional IRAs, too. Your 403(b) and 457 contributions are NOT included in MAGI, but deductible IRA contributions (Form 1040 line 32) are.

This is probably too much to understand right now, but here is the IRS publication on all this for completeness and future reading: http://www.irs.gov/pub/irs-pdf/p590.pdf

Stop killing yourself.

And here is link with a link about a family making $150,000 and paying only $150 in income taxes. You ARE that family:
http://www.bogleheads.org/forum/viewtop ... 9#p2274479
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DSInvestor
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Re: Seeking clarity about income and capital gains taxes

Post by DSInvestor »

When you have time to think about the Roth vs Traditional 403b/457b contributions, take a look at thefinancebuff's "The Case Against Roth 401k":
http://thefinancebuff.com/case-against-roth-401k.html
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bobsmith
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Re: Seeking clarity about income and capital gains taxes

Post by bobsmith »

First, thanks to everyone for all your help, suggestions, and corrections. I really appreciate it.

I've ordered a tax book online and plan to get a better core understanding. In the meantime, I've played with the Taxcaster software.

To be clear, I never once meant to suggest that investing in Roths would, in the short run, be beneficial to my current tax return. It's a no brainer that pre-tax contributions would lower my income level and along with it my taxes for the current year. I won't go into it here right now, but one of the main reasons I've opted for roth is that I'll have a pension. My income tax ignorance may be a bit embarrassing, but I've got a pretty good idea of core investment strategies using a passive approach, and I have explored the TIRA/Roth question before. As these new retirement plans have become available to me, I've had to rethink things.

For now, I was able to use TaxCaster to run a couple scenarios.

I gave all the input above, but I threw in another $4,000/year in dividends. This is a total guess as I haven't had time to check my returns.
2 kids, under 16. 100,000 income. Just as I described above.

I ran it under three scenarios paying long term capital gains (15%) on 23,500 then 14,500, then 6,000.

From the start I expected to pay 15% capital gains on the shares I would have to sell to have enough money to fund the roths. Turns out the only thing I end up losing beyond this is my child tax credit as it's phased out. In other words, when I run my scenario without any Roth contributions and then compare it to those with contributions, my taxes go up by exactly 15% on the capital gain, plus the amount that it hurts my child tax credit. My income just isn't high enough to harm other credits or deductibles.

For 23,500 in gains over my income, $900 of the child tax credit would be forfeited.
Likewise, for $14,500, $450 forfeited.
6,000 and less, I'd get the full child tax credit.

I'm still playing with the numbers and will revisit the idea of a traditional IRA contribution. I'll get back to you on that once I get my ducks in a row.
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PaddyMac
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Re: Seeking clarity about income and capital gains taxes

Post by PaddyMac »

You mentioned HSA. I don't tend to have a lot of medical expenses. I understand why having an account setup for this has some investment advantages, but for simplicity, I find it easier to just save my medical receipts and file them during tax time. Either way, these can be filed in addition to the standard deduction, correct?
Except that medical receipts for out of pocket expenses are not tax deductible unless they consist of 10% of your AGI.
http://www.irs.gov/taxtopics/tc502.html

If you are eligible for an HSA, it's a great way to sock away tax-deferred savings and withdraw it tax free in retirement (or whenever you need it).

For some reason, the ACA plans on the exchange have very few HSA-eligible plans to choose from, so we've had to give up our HSA this year. But we have a few years worth socked away for the future - thanks to a tip I found in the bogleheads book!
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BL
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Re: Seeking clarity about income and capital gains taxes

Post by BL »

If you are eligible for a Flex medical plan, this will not be considered taxable income.

HSA would be the same with different benefits-could be considered an IRA you never pay taxes on if you save your receipts or use it to pay for Medicare part B.

If you use traditional 401k, you will have 15-25% + state% more money to help you to fill those tax-advantaged accounts so you won't need to cash in as much taxable and thus have less capital gains.

I would do everything possible to keep within the 15% tax bracket (75,900 max) and also below the MAGI limits for child credits.

I would only consider Roth 401ks if I had enough money to fill all of the space in tax-advantaged accounts and wanted to put in more. It takes something like 30% more income to fill Roth than deductible 401k. Doing Roth IRAs and regular work accounts might be a good balance. Be sure to put in what you would have put into college savings. There is something wrong if you can't come up with a good percent of the funds to fill tax advantaged accounts. It would be great if you can pull most of this money out of current spending and save the taxable fund for retirement. Can you cut cable, eating out, some cell phones, etc? Look very carefully at your budget and see what your whole family can do.

I also encourage using something like Taxcaster to learn what happens as you change things in income and capital gains. Even better is to sit down and actually work out a complete IRS 1040 and all the schedules you need. There is no one that can watch your taxes better than you, and you will be able to plan instead of just paying what it ends up being. I don't think a regular tax-preparer owes you the advice you may need to save money on taxes. Paying a good CPA might give you that, except it might cost a good part of what it saves.
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bobsmith
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Re: Seeking clarity about income and capital gains taxes

Post by bobsmith »

There's a lot of good information here and a lot of thought provoking questions and considerations. I really appreciate that and it's one of the reasons this is such a valuable forum. I'm still running some scenarios and re-debating within myself the roth or non-roth question. I'm not a typical case and there are a lot of factors to consider including a pension, possible early retirement, not knowing what state I'll retire to, and the impact of a future inheritance, to name a few. Once I get these things in perspective I'll be able to ask some more informed questions with regards to the long term implications of investing in roths or non-roths.

I started playing around with taxcaster just as DSInvestor suggested. One thing I find a bit baffling is that at some point if I could live entirely off taxable gains that I could report a realized gain of just over 100,000 and pay no tax, income or capital gains. I'm not talking about IRA contributions or anything to dodge taxes. Just the standard deduction and personal exemptions for my family of 4 would put me at the top of the 15% income bracket. Yet if I work hard enough to put myself into the middle class that's the pie uncle same decides to cut from. This was a rather profound realization for me and the nature of our society and it directly effects how I will plan for retirement.

I have good healthcare through work so I don't need and wouldn't qualify for other plans at this time. Perhaps in the time period after retirement but before medicare I will need to look into this more carefully. While I did understand what HSA was and how it worked, I had the misconception that turning in medical receipts while filing taxes pretty much got you the same thing. I will still save my medical receipts as I believe it helps with state income taxes. I always thought of HSA as something you would use in the short term... why tie up money in a way you could only use it for a limited purpose? But upon further reflection I see how it would be beneficial to save now for medical needs I'll likely have when I'm older and greyer.

If I understood DSInvestor correctly, contributing to a traditional retirement plan (pre-tax) DOES effect MAGI with regards to what is looked at when determining the child tax credit. Correct? I'm quite certain about this, but as DSInvestor said, there is no way to input this into Taxcaster other than subtracting it from your known income before actually entering the amount.

As a few of you have advised, I do plan to work though my taxes on my own to see if I can understand the forms. I find them grossly non-intuitive. Once I have a long term plan from here to retirement I also plan to pay a CPA to review it and give me some feedback under some kind of flat fee arrangement. I won't be using my regular guy.

Thanks again everyone. My plate is full of food for thought.
kaneohe
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Re: Seeking clarity about income and capital gains taxes

Post by kaneohe »

bobsmith wrote: If I understood DSInvestor correctly, contributing to a traditional retirement plan (pre-tax) DOES effect MAGI with regards to what is looked at when determining the child tax credit. Correct? I'm quite certain about this, but as DSInvestor said, there is no way to input this into Taxcaster other than subtracting it from your known income before actually entering the amount.

.
Correct......but be aware that there are many MAGIs so be sure when googling be sure to get the right MAGI by putting it in the right context.
e.g. " MAGI child tax credit". If you are inputting info from your W2, http://www.irs.gov/pub/irs-pdf/fw2.pdf, the wages in box 1 have
already been adjusted for your retirement contributions. If you are inputting info from your pay stub , you will have to input the corresponding info......
it is not what you would consider your gross income, but it might be called Federal gross.......ask your HR folks if you can't figure it out.
JW-Retired
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Re: Seeking clarity about income and capital gains taxes

Post by JW-Retired »

bobsmith wrote:
I started playing around with taxcaster just as DSInvestor suggested. One thing I find a bit baffling is that at some point if I could live entirely off taxable gains that I could report a realized gain of just over 100,000 and pay no tax, income or capital gains. I'm not talking about IRA contributions or anything to dodge taxes. Just the standard deduction and personal exemptions for my family of 4 would put me at the top of the 15% income bracket. Yet if I work hard enough to put myself into the middle class that's the pie uncle same decides to cut from. This was a rather profound realization for me and the nature of our society and it directly effects how I will plan for retirement.
A little more playing with TaxCaster would show you that, for example, if you are living off the same $100,000 but with it consisting of $50k cap gains and $50k pre-tax IRA or 403b withdrawals, then with the family of 4 (2 kids under 16) you would still pay almost zero taxes ($366). It would be $2366 tax if the dependent kids were over 16. Either of these represents an extremely low tax rate on the 403b withdrawals compared to the 25% rate you would save in taxes in making pre-tax contributions.

More food for thought.
JW
Retired at Last
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