qualified divds taxation question

[towdie]

In 2010 my QDI's took me a few hundred dollars over the 34.000 15% bracket. I did not pay taxes on the majority of the QDI amount, but it looks as if the amount of QDI that took me over the 15% bracket were taxed at the 15% rate.

Is that the way it works?

Don

[TheGuru1]

Yes. You can be in the 35% bracket and have qualified dividends and the QD's would be taxed at 15%.

[dbr]

Yes. You can be in the 35% bracket and have qualified dividends and the QD's would be taxed at 15%.

Exactly, there is a different computational structure for different kinds of income. That means that any particular tax bracket rate is not the same as the marginal rate for a mixture of income sources, even before allowing for phase-outs and other contingencies.

[towdie]

Interesting - I knew that QD's were not taxed if you were in the 15% bracket but assumed that ALL of your QD's were exempt if you otherwise fell into the 15% bracket. I use Turbo Tax for my taxes and was looking over the QD worksheet for 2010 when i noticed that was not the case.

So QD's do not count to determine your base bracket, but once your taxable income exceeds the 15% bracket threshold including the QD amount, the excess QD amount is taxed at 15% - at least for now?

Don

[tfb]

So QD's do not count to determine your base bracket, but once your taxable income exceeds the 15% bracket threshold including the QD amount, the excess QD amount is taxed at 15% - at least for now?

That's correct. Otherwise the rich would draw very little ordinary income and enjoy $10 million in QD tax free.

[retiredjg]

This might be semantics, but I would say almost the opposite.

QDs do count in determining your marginal tax bracket. You were in the 25% tax bracket in 2010, if only by a few hundred dollars. The amount of money that was in the 25% bracket was taxed at 25% bracket rates.

QDs that were in the 15% bracket and below carried a capital gains/qualified dividends tax of 0%. The amount of QDs that fell into the 25% tax bracket were taxed at the proper rate of 15% for capital gains and qualified dividends.

Hope that didn't confuse things.

[sscritic]

I am with jg on this. Consider if you had only qualified dividends and nothing else. What determines your bracket? My answer is the qualified dividends. Now add $10 of interest income from Prime Money Market. How is it taxed? It depends on your bracket that is determined by your qualified dividends (+ $10).

I could be wrong. I forget who it is, but one of us has a good explanation of how the various rates apply with stacked bars of income, one on top of the other.

[tfb]

I am with jg on this. Consider if you had only qualified dividends and nothing else. What determines your bracket? My answer is the qualified dividends. Now add $10 of interest income from Prime Money Market. How is it taxed? It depends on your bracket that is determined by your qualified dividends (+ $10).

The order is still important. If a single person has $50k of QD and nothing else, you say he/she is in 25% bracket. If you add $100 interest income from Prime Money Market, tax goes up by $15, not $25. The $100 goes into the 0% bracket but pushes up $100 of QD into the 25%/15% bracket.

[retiredjg]

The order is still important.

Somebody has a blog page that shows the order. Is it you perhaps? I know I've seen it somewhere.

We know that ordinary income sinks to the bottom and that capital gains/qualified dividends rise to the top. I think interest is now just part of ordinary income. I' guessing non-qualified dividends sink, but not sure if they are part of ordinary income or sit on top of ordinary income. I'd guess they are just part of ordinary income.

What other types of income are there? SS is handled separately. Hmmm, just musing about how it works. Interesting stuff. And just about the time you get a handle on it, it changes. Impermanence is all around us! Om.

[tfb]

Somebody has a blog page that shows the order. Is it you perhaps? I know I've seen it somewhere.

I have this for 401k contributions but not for qualified dividends or long term capital gains. Maybe I should do one.

What other types of income are there? SS is handled separately.

With the 1/2 thing and 50% and 85% calculations, it's difficult to even describe with just sink/float or represent it with a graph.

[retiredjg]

That looks familiar and maybe that is what I was thinking of.

Yes, I don't know how you would put SS in since it floats up and down depending on the other stuff. Two graphs with one changing in response to the other? Way outside my abilities!

I guess the AMT messes up things for people who deal with that too? I could be off in the weeds as I have little idea about how AMT works. Well, guess I'm straying way off from the original post....

[kaneohe]

I'm with tfb on this one. I too find stacked bars of income a very useful way to think about this stuff.
For just ordinary income and QDIV/LTCG, I picture the QDIV/LTCG on top of the ordinary income. Deductions
and exemptions get taken from the bottom of the stack leaving the QDIV/LTCG intact assuming the ordinary
income is large enough. The part of the QDIV/LTCG above the 15/25% bracket dividing line gets tax at 15%;
the part below at 0%. No income is taxed at 25% unless the ordinary income bar is above that dividing line.

[sscritic]

I am in full retreat at this point. I knew there was something about the stacked bars, but I must have had the wrong bars on top. The key is to put the ordinary income on the bottom. Thanks tfb and kaneohe for trying to straighten me out.

[towdie]

Well, at least now I understand why I didn't understand!

[kaneohe]

ssc.......I know you like to work things out for yourself so here's your homework

The stacked bars concept comes from here: the qualified dividends & CG worksheet
http://homepage.mac.com/daviddee/Review/files/2009_WS_QDCGT.pdf

If you go thru the worksheet you will recognize from the 1040 line #s the various components of the
calculation : e.g. line 43 taxable income; line 9b (QDIV) and then line 15/16 of Sch D (CG) which are added
up to form the top bar. You will also recognize the 15/25% bracket dividing line (67900 for MFJ last yr).
Then there are various subtractions, etc. The part where you multiply by 15% on line 14 of the worksheet is where you
are multiplying the part of QDIV/CG above the 15/25% bracket dividing line. On line 15, you are calculating
the tax on the ordinary income less adjustments/deductions/exemptions which is the bottom bar. On line 16, you
are adding the 2 components of the tax (ordinary bar and QDIV/CG bar).

I find the worksheet completely non-intuitive when just following the form . The picture of the stacked bars
helps me a lot more.

[scrabbler1]

Well put, Kaneohe. The use of the stacked bar chart with your description makes the issue most easily understood. While I kinda knew how it worked, it wasn't until I filed my 2008 tax return when I saw just how meaningful this was. That year, I had a $300k company stock payout using the NUA option (most of the payout was NUA). I had a relatively small amount of ordinary earned income and saw that the deductions and credits were applied only to that smaller portion while the larger NUA blob (along with some other QD and LTCG) was taxed at 15%. Furthermore, only the other income was subject to AMT, further shielding the NUA and similar income from being taxed any higher than 15%.

[retiredjg]

Well, at least now I understand why I didn't understand!

Does this mean you still don't understand? If so, just let us know what the question is.

[retiredjg]

Well put, Kaneohe. The use of the stacked bar chart with your description makes the issue most easily understood.

Did I miss something? Is there a link to a stacked bar chart somewhere?

[abuss368]

Correct.

That is until the current qualified dividend tax rate of 15% goes away 12 months from now. That might be a good possibility.

[Alan S.]

If you have both LTgains/QDI AND SS income, and then want to determine what the tax cost will be for an incremental conversion to fill the 15% bracket, the actual rates for various conversion amounts looks like a roller coaster profile.

The first conversion dollars may end up with a marginal rate of 27.75% because you are incorporating 85% of SS income (1.85X 15%)
Once all the SS is included at 85%, then there may be a few thousand that gets the desired rate of 15%
But that does not last long until you start pushing your QDI out of the -0- bracket and into the 15%. The marginal conversion rate then becomes 30% (15% on the conversion plus 15% on the QDI pushed up to 25% bracket as a result of the conversion).
Once you push all the QDI up to 15%, the conversion cost drops back to 25%.
(AMT not considered here)

The somewhat surprising result is that conversions you intended to do at 15% may actually turn out as costly or even higher than those done in the 25% bracket. The result depends on your mix of SS, QDI and converted amount selected. And if so, you might actually save tax dollars by converting through the 25% bracket in alternate years only and do nothing every other year. Of course, 2013 may again alter the landscape.

Using taxcaster, you can figure the cost of different taxable conversion amounts before completing the conversion before year end.

[555]

ssc.......I know you like to work things out for yourself so here's your homework

The stacked bars concept comes from here: the qualified dividends & CG worksheet
http://homepage.mac.com/daviddee/Review/files/2009_WS_QDCGT.pdf

If you go thru the worksheet you will recognize from the 1040 line #s the various components of the
calculation : e.g. line 43 taxable income; line 9b (QDIV) and then line 15/16 of Sch D (CG) which are added
up to form the top bar. You will also recognize the 15/25% bracket dividing line (67900 for MFJ last yr).
Then there are various subtractions, etc. The part where you multiply by 15% on line 14 of the worksheet is where you
are multiplying the part of QDIV/CG above the 15/25% bracket dividing line. On line 15, you are calculating
the tax on the ordinary income less adjustments/deductions/exemptions which is the bottom bar. On line 16, you
are adding the 2 components of the tax (ordinary bar and QDIV/CG bar).

I find the worksheet completely non-intuitive when just following the form . The picture of the stacked bars
helps me a lot more.

The way to analyse a form fully is algebra and logic. Don't just enter numbers on the form, enter variables, x,y,z etc., and see what quantites you calculate. It can get complicated as there are if..then's and inequalities etc., though sometimes you can simplify by eliminating cases that do not apply.

[tfb]

Well put, Kaneohe. The use of the stacked bar chart with your description makes the issue most easily understood.

Did I miss something? Is there a link to a stacked bar chart somewhere?

Here, I just created one.



Link to larger size: https://picasaweb.google.com/lh/photo/C ... bedwebsite

[retiredjg]

Isn't that nice! And nice touch to have the stuff below the taxable line. Now just make it actively move up and down!

So, interest goes into "income". Short term cap gains go into "income". Is there any other type of income that needs to be accounted for?

[Bongleur]

The stacked bars concept comes from here: the qualified dividends & CG worksheet
http://homepage.mac.com/daviddee/Review/files/2009_WS_QDCGT.pdf

If you go thru the worksheet you will recognize from the 1040 line #s the various components of the
calculation

I find the worksheet completely non-intuitive when just following the form . The picture of the stacked bars
helps me a lot more.

Would be nice if someone would re-create the form by adding explanatory text for each line of the form, along with a stacked bar that cross-references line numbers.

The stacked bar is new to me; maybe I'll eventually get this. In the meantime Vote --I"M SURE YOU CAN GUESS WHO --

[retiredjg]

tfb, it seems you are fine tuning your thingy. Perhaps "income" should be "ordinary income" since QD and LTCG are income too.

[sscritic]

ssc.......I know you like to work things out for yourself so here's your homework

You know me too well. I love to give people homework so that they can understand what is really going on, so it is only right that you give me homework to help me understand what is really going on. I have been out with family since this morning, but I am going to start my homework right now.

[tfb]

tfb, it seems you are fine tuning your thingy. Perhaps "income" should be "ordinary income" since QD and LTCG are income too.

Fixed.

[retiredjg]

Maybe not-Bob will stop by and give us a long list of the "pre-tax deductions from paychecks". He seems to have a good handle on them.

On the other hand, the original poster towdie may feel hijacked. Maybe we should move along?

[Bob's not my name]

Haha. It's remarkable to me that in all the political debate about the tax rates the rich and poor pay nobody comments on the insane marginal rates that result accidentally from the ridiculous tax code. My favorite example is the widowed mother of three college kids who is in the AOC phaseout and therefore has a marginal rate over 100% (if she has a state income tax), so she'll be begging her boss not to give her that $5,000 bonus because she'll have to pay $5,300 of taxes on it. Fortunately for her, her financial aid is unaffected because the de facto financial aid tax is 47% of income net after federal taxes, but since her federal marginal rate is 100% there's nothing left to tax (except by her state, which takes the empty milkshake cup from the slurparrific federal government and sucks the entire cup and lid through the straw in a feat of liposuctive inversion).

This year I've had the interesting (but nutty) challenge of trying to manage the taxation of a revocable trust. There's an old loss carryover that is disallowed under the AMT, so basically my bogey is the AMT threshold, up to which the grantor will pay no federal tax whatsoever. There are QDs, STCGs, LTCGs, taxable interest, tax-free interest, SS income, pension income, a Roth recharacterization and reconversion, a last RMD, foreign tax credits, massive deductible medical expenses, charitable remainder trust distributions of dividends, interest, and capital gains, bypass trust distributions of interest and dividend income, and $5 checks from a life insurance policy from the Great Depression (for which I somehow found and preserved the original paperwork, which ought to be framed).

Back on topic: the effective 30% rate on ordinary income due to QD/LTCG being pushed into the next bracket, as Alan points out, has always seemed a particularly remarkable quirk of the code to me.

[retiredjg]

Back on topic: the effective 30% rate on ordinary income due to QD/LTCG being pushed into the next bracket, as Alan points out, has always seemed a particularly remarkable quirk of the code to me.

You lost me on that one. Assuming this is not related to the original poster, but an example of a quirk?

Sounds like you've had a real headache of a tax year!

[Bob's not my name]

Back on topic: the effective 30% rate on ordinary income due to QD/LTCG being pushed into the next bracket, as Alan points out, has always seemed a particularly remarkable quirk of the code to me.

You lost me on that one. Assuming this is not related to the original poster, but an example of a quirk?

It's related to the original post in that a taxpayer who has QD straddling the 15%/25% line (like the OP) is effectively in a 30% bracket for ordinary income. If he makes another $1,000 of ordinary income, it's taxed at 15% but it also displaces $1,000 of QD into the 25% bracket, where it is taxed at 15% vs. 0%. So the $1,000 increment of extra ordinary income results in $300 of extra tax. Alan pointed this out above.

[retiredjg]

Back on topic: the effective 30% rate on ordinary income due to QD/LTCG being pushed into the next bracket, as Alan points out, has always seemed a particularly remarkable quirk of the code to me.

You lost me on that one. Assuming this is not related to the original poster, but an example of a quirk?

It's related to the original post in that a taxpayer who has QD straddling the 15%/25% line (like the OP) is effectively in a 30% bracket for ordinary income. If he makes another $1,000 of ordinary income, it's taxed at 15% but it also displaces $1,000 of QD into the 25% bracket, where it is taxed at 15% vs. 0%. So the $1,000 increment of extra ordinary income results in $300 of extra tax. Alan pointed this out above.

Oh. Guess I just needed the simpler explanation to understand. Part of me thinks this is an exercise in "playing with numbers". Part of me thinks it might be important. I'll have to cogitate on it awhile.

[Bob's not my name]

Marginal rate is important. Alan gives a good example: you may think you're doing your Roth conversion in the 15% bracket, but it could effectively be 30%. The first seems sound, the second not so much.

When I realized how high my marginal rate really was, it was a factor in my giving up a higher salary job for a lower salary job with better tax-sheltered benefits (double digit 403b matching and tax-free scholarships for my kids).

[retiredjg]

Marginal rate is important. Alan gives a good example: you may think you're doing your Roth conversion in the 15% bracket, but it could effectively be 30%. The first seems sound, the second not so much.

Bear with me on this - I do math poorly after sundown!

If the QD/LTCG income straddles the limit of the 15% bracket, then the person is in the marginal 25% bracket, not the 15% bracket. (This is an assumption and how I see it - I'm not stating that it is fact. Perhaps you and/or Alan S need to change my mind. ) In that case, a Roth conversion would be done in the 25% bracket, not the 15% bracket. Yes, it is true the conversion would effectively be done in the 30% bracket, but that should be rightly compared to the 25% bracket, not the 15% bracket. So yes, it is worse, but not twice as worse. (Poor grammar in there for fun.)

Am I way off base here?

When I realized how high my marginal rate really was, it was a factor in my giving up a higher salary job for a lower salary job with better tax-sheltered benefits (double digit 403b matching and tax-free scholarships for my kids).

You're a smart guy!

[Alan S.]

Yes, technically you are right on the QDI nominal bracket point. With the SS inclusion, all that actually IS in the nominal 15% bracket.

For the QDIs however, when taxable income spills over to the nominal 25% bracket, the QDIs are taxed at 15% which intuitively might make a taxpayer feel that as long as the spillover is just QDIs they effectively remain in the 15% bracket, and that is not the case. The actual tax cost is 30% because the added income is taxed at 15%, and the QDIs that spill over are simultaneously taxed at 15%. This results in those conversion dollars being taxed at 30% until all the QDIs are absorbed. Then it drops to 25%.

It all means that in some cases the nominal bracket rates do not represent what is actually paid on may types of marginal income within that nominal bracket. And when you spill over to the next nominal bracket (eg 25%) the tax cost may be higher than 25% or lower depending on the circumstances.

[Bongleur]

> displaces $1,000 of QD into the 25% bracket, where it is taxed at 15% vs. 0%.

That statement is logically inconsistant. If money is in a category titled "25%" then it can't logically be taxed at some other rate.

[retiredjg]

> displaces $1,000 of QD into the 25% bracket, where it is taxed at 15% vs. 0%.

That statement is logically inconsistant. If money is in a category titled "25%" then it can't logically be taxed at some other rate.

But....in the 25% tax bracket, long term capital gains and qualified dividends are taxed at 15%. Logically inconsistent, perhaps, but I think that's the way it works.

[sscritic]

The name of a category is not important. The Red Zone is not red.

If you have social security and are in the 25% bracket and the numbers are just right, $100 of interest will cost you $46.25.
http://www.bogleheads.org/wiki/Taxation ... y_benefits

The "25% bracket" is a name of a bracket. It has nothing to do with your marginal tax rate which could be anywhere from 15% for LTCG to 46.25% with the right amount of social security and other income or perhaps some other percent outside that range. Oh, that's right. If you are in the "25% bracket," your municipal bond interest is taxed at the 0% rate, unless it makes more of your social security taxable, in which case your tax-free bonds aren't.

[jebmke]

It can get even more complicated when you also roll in state income taxes. I advised a TaxAide "client" recently who wanted to know if she could sell some stock without incurring CG taxes. Because the cliff of coming out of the zero bracket in MD is lower than the US, I found that at one point her marginal tax rate exceeded 300% without any federal tax involved.

[dbr]

The name of a category is not important. The Red Zone is not red.

If you have social security and are in the 25% bracket and the numbers are just right, $100 of interest will cost you $46.25.
http://www.bogleheads.org/wiki/Taxation ... y_benefits

The "25% bracket" is a name of a bracket. It has nothing to do with your marginal tax rate which could be anywhere from 15% for LTCG to 46.25% with the right amount of social security and other income or perhaps some other percent outside that range. Oh, that's right. If you are in the "25% bracket," your municipal bond interest is taxed at the 0% rate, unless it makes more of your social security taxable, in which case your tax-free bonds aren't.

Excellent. It is hard to remember that tax brackets are just part of an algorithm for computing taxes, and it is complex enough that it can be hard to see the effect of adding income here and there without actually running out the final result and comparing.

[kaneohe]

"With the 1/2 thing and 50% and 85% calculations, it's difficult to even describe with just sink/float or represent it with a graph"
The Finance Buff - tfb
***********************************************************************************************************************************
hey tfb.........just had a brainstorm for your SS graph and, as w/ all brainstorms, it's free but you aren't supposed to snicker,at least publicly, at it. You want to show SS as a variable amount of the ordinary income so perhaps a bar on top of the "regular" ordinary income and just below the QDIV/CG bar. You also want to show that it's value is variable qualitatively so somehow show that........you seem to have some graphic arts talents so I'm sure you can come up w/ something better but I was thinking
of like this jack you use to raise the car to change the tire. http://www.amazon.com/Powerbuilt-640819-Mechanical-Scissor-Jack/dp/B002INP6QU

You could then imagine the QDIV/CG bar being raised/lowered and changing the tax on that part of the income. That doesn't solve how to represent the quantitative nature of how the SS component is determined. Just put a f(x) symbol on the SS bar and refer them to some worksheet.

[Sidney]

It is hard to remember that tax brackets are just part of an algorithm for computing taxes, and it is complex enough that it can be hard to see the effect of adding income here and there without actually running out the final result and comparing.

Making any kind of material maneuver (e.g. Roth conversion, stock option exercise etc.) without running a proforma return using tax software is like playing Russian roulette IMO.

[Bongleur]

Maybe a second bar for SS, with a line dividing the taxable amount from the non-taxable, and an arrow pointing the taxable amount into the main stack?

Making these animated, showing how lines move when dollars are changed in any category, would be interesting.

[555]

You just need one-dimension per variable.

[Alan S.]

And remember to show how the lack of inflation adjustments to the SS inclusion thresholds causes the 85% tier to effectively cannibalize the 50% tier for many recipients.

[tfb]

You want to show SS as a variable amount of the ordinary income so perhaps a bar on top of the "regular" ordinary income and just below the QDIV/CG bar. You also want to show that it's value is variable qualitatively so somehow show that........you seem to have some graphic arts talents so I'm sure you can come up w/ something better but I was thinking
of like this jack you use to raise the car to change the tire. http://www.amazon.com/Powerbuilt-640819-Mechanical-Scissor-Jack/dp/B002INP6QU

You could then imagine the QDIV/CG bar being raised/lowered and changing the tax on that part of the income. That doesn't solve how to represent the quantitative nature of how the SS component is determined. Just put a f(x) symbol on the SS bar and refer them to some worksheet.

Thank you for the suggestion. I think I will need two bars, one feeding into another. LTCG affects how much SS is taxed, which affects how much LTCG is taxed.

And remember to show how the lack of inflation adjustments to the SS inclusion thresholds causes the 85% tier to effectively cannibalize the 50% tier for many recipients.

Just treating it all as ordinary income will make it so much easier to understand. Adjust other variables to make it revenue-neutral.