## Just wanted to clarify how taxation works on LTCG rate and Roth conversion

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gilgamesh
Posts: 1174
Joined: Sun Jan 10, 2016 9:29 am

### Just wanted to clarify how taxation works on LTCG rate and Roth conversion

Just a hypothetical question to understand how this works.

Let’s say MFJ with only the \$24k standard deduction. Only income is either through Roth conversion or LTCG. No other income. Tax year 2018.

Say \$20k in LTCG. Then I do a Roth conversion for \$81,200.

After deducting \$24k in standard deduction, I’ll have to pay ordinary income tax on \$57,200 ( \$81,200- \$24,000 ...first \$19,500 at 10%, the remaining \$37,700 at 12%)

Now, adding the \$20k LTCG to the \$57,200 brings it up to \$77,200. That is 0% LTCG rate. So no more taxes.

I assume I’m correct so far...

My question is, now every \$1 more of Roth conversion will result in an additional 27 cent tax (the 12% ordinary tax for the \$1 and as it pushes LTCG into 15%, a \$1 of that will also be taxed at 15%). However, if I were to incur an additional \$1 of LTCG, then that only results in an additional 15% tax all the way to \$342,800 (\$400k 15% LTCG threshold - \$57,200). Is this correct?

Thank you!

jebmke
Posts: 8459
Joined: Thu Apr 05, 2007 2:44 pm

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

This looks correct to me. You have discovered the stack that creates a hidden marginal rate that isn't even on the charts. It used to be the hidden "30% rate" but now it is 27%. It is often overlooked when doing ROTH conversions and creates an unwelcome surprise. This demonstrates why you should not use the bracket rates as marginal rates when making significant decisions like a ROTH conversion.
When you discover that you are riding a dead horse, the best strategy is to dismount.

gilgamesh
Posts: 1174
Joined: Sun Jan 10, 2016 9:29 am

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

jebmke wrote:
Sat May 26, 2018 7:38 am
This looks correct to me. You have discovered the stack that creates a hidden marginal rate that isn't even on the charts. It used to be the hidden "30% rate" but now it is 27%. It is often overlooked when doing ROTH conversions and creates an unwelcome surprise. This demonstrates why you should not use the bracket rates as marginal rates when making significant decisions like a ROTH conversion.
I was aware of this hidden marginal tax rate previously - thanks to that Kitces article. However, I was just now wondering whether there’s an optimal strategy where one could incur more of the 15% LTCG. Just thinking out loud for now.

But, wanted to make sure the basics on my first post are correct.

DSInvestor
Posts: 10901
Joined: Sat Oct 04, 2008 11:42 am

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

Are you on a healthcare exchange health insurance plan that would allow you to get the Premium Tax Credit? If so, make sure you run your numbers with this in mind. The premium tax credit can be worth many thousands of dollars depending on your tax situation and you don't want to lose all of this subsidy by falling off the ACA premium subsidy cliff. If living off your taxable account, you have some control of LTCG using specific share identification. Maybe leave Roth conversions until later in the year when you will have a better picture of your total LTCG, STCG, dividend income etc.

If you live in a state with state income tax, your state will most likely count the LTCG as ordinary income (taxed at your state marginal rates) even if Fed taxes LTCG at 0%.

If you're on social security, be aware that the larger AGI with LTCG and Roth conversions may make more of the social security benefit be taxable. For example, a conversion of an extra \$1000 that causes more your SS benefit to be taxable may cause your AGI and taxable income to increase by more than \$1000.

I suggest using tax software to run your numbers.

manedark
Posts: 242
Joined: Sun Apr 22, 2018 2:05 pm

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

gilgamesh wrote:
Sat May 26, 2018 7:21 am
My question is, now every \$1 more of Roth conversion will result in an additional 27 cent tax (the 12% ordinary tax for the \$1 and as it pushes LTCG into 15%, a \$1 of that will also be taxed at 15%).
Aren't you assuming that the entire \$1 coming for the Roth conversion is a long term capital gain? Is that a valid assumption?

kaneohe
Posts: 5148
Joined: Mon Sep 22, 2008 12:38 pm

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

manedark wrote:
Sat May 26, 2018 11:17 am
gilgamesh wrote:
Sat May 26, 2018 7:21 am
My question is, now every \$1 more of Roth conversion will result in an additional 27 cent tax (the 12% ordinary tax for the \$1 and as it pushes LTCG into 15%, a \$1 of that will also be taxed at 15%).
Aren't you assuming that the entire \$1 coming for the Roth conversion is a long term capital gain? Is that a valid assumption?
OP is assuming 2 sources of income...LTCG from a taxable acct and ordinary income from the Roth conversion.

manedark
Posts: 242
Joined: Sun Apr 22, 2018 2:05 pm

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

kaneohe wrote:
Sat May 26, 2018 11:57 am
manedark wrote:
Sat May 26, 2018 11:17 am
gilgamesh wrote:
Sat May 26, 2018 7:21 am
My question is, now every \$1 more of Roth conversion will result in an additional 27 cent tax (the 12% ordinary tax for the \$1 and as it pushes LTCG into 15%, a \$1 of that will also be taxed at 15%).
Aren't you assuming that the entire \$1 coming for the Roth conversion is a long term capital gain? Is that a valid assumption?
OP is assuming 2 sources of income...LTCG from a taxable acct and ordinary income from the Roth conversion.
I got that, but how does he pay 27% tax on any dollar? He pays 15% on capital gains and 12% on Roth conversion - its not right to add that to say that you are being taxed 27 cents to a dollar, isnt it ?

gilgamesh
Posts: 1174
Joined: Sun Jan 10, 2016 9:29 am

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

manedark wrote:
Sat May 26, 2018 11:17 am
gilgamesh wrote:
Sat May 26, 2018 7:21 am
My question is, now every \$1 more of Roth conversion will result in an additional 27 cent tax (the 12% ordinary tax for the \$1 and as it pushes LTCG into 15%, a \$1 of that will also be taxed at 15%).
Aren't you assuming that the entire \$1 coming for the Roth conversion is a long term capital gain? Is that a valid assumption?
No...the entire \$1 from Roth conversion is only taxed as ordinary income tax. However that \$1 also pushes a \$1 of LTCG into 15% LTCG rate from 0%.

Even though I am not talkin a \$1 more of LTCG, the \$1 of ordinary income also pushes a \$1 of LTCG into 15%.... Important to understand that

gilgamesh
Posts: 1174
Joined: Sun Jan 10, 2016 9:29 am

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

DSInvestor wrote:
Sat May 26, 2018 10:53 am
Are you on a healthcare exchange health insurance plan that would allow you to get the Premium Tax Credit? If so, make sure you run your numbers with this in mind. The premium tax credit can be worth many thousands of dollars depending on your tax situation and you don't want to lose all of this subsidy by falling off the ACA premium subsidy cliff. If living off your taxable account, you have some control of LTCG using specific share identification. Maybe leave Roth conversions until later in the year when you will have a better picture of your total LTCG, STCG, dividend income etc.

If you live in a state with state income tax, your state will most likely count the LTCG as ordinary income (taxed at your state marginal rates) even if Fed taxes LTCG at 0%.

If you're on social security, be aware that the larger AGI with LTCG and Roth conversions may make more of the social security benefit be taxable. For example, a conversion of an extra \$1000 that causes more your SS benefit to be taxable may cause your AGI and taxable income to increase by more than \$1000.

I suggest using tax software to run your numbers.
These are all good points...just to clarify, I'm 8-10 years away from retirement. I'm just thinking things through...

I have compiled a long list of things to consider for Roth conversion.

manedark
Posts: 242
Joined: Sun Apr 22, 2018 2:05 pm

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

gilgamesh wrote:
Sat May 26, 2018 12:09 pm
manedark wrote:
Sat May 26, 2018 11:17 am
gilgamesh wrote:
Sat May 26, 2018 7:21 am
My question is, now every \$1 more of Roth conversion will result in an additional 27 cent tax (the 12% ordinary tax for the \$1 and as it pushes LTCG into 15%, a \$1 of that will also be taxed at 15%).
Aren't you assuming that the entire \$1 coming for the Roth conversion is a long term capital gain? Is that a valid assumption?
No...the entire \$1 from Roth conversion is only taxed as ordinary income tax. However that \$1 also pushes a \$1 of LTCG into 15% LTCG rate from 0%.

Even though I am not talkin a \$1 more of LTCG, the \$1 of ordinary income also pushes a \$1 of LTCG into 15%.... Important to understand that
Again I understand that LTCG was pushed to 15% - my qualm is with you saying that you pay 27 cents to dollar as tax. I cant wrap my head around how you are paying 27% as tax.
Say \$20k in LTCG. Then I do a Roth conversion for \$81,200.
After deducting \$24k in standard deduction, I’ll have to pay ordinary income tax on \$57,200 ( \$81,200- \$24,000 ...first \$19,500 at 10%, the remaining \$37,700 at 12%)
Now, adding the \$20k LTCG to the \$57,200 brings it up to \$77,200. That is 0% LTCG rate. So no more taxes.
Say you increase Roth conversion by another 10K, that will be taxed at 12%, but that also puts your LTCG of 20K in 15% tax category.
You are paying 12% and 15% on different amounts, it is NOT 27% tax. isnt it?

RCL
Posts: 310
Joined: Sat Jul 05, 2014 2:48 am

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

gilgamesh wrote:
Sat May 26, 2018 7:21 am
Just a hypothetical question to understand how this works.

Say \$20k in LTCG. Then I do a Roth conversion for \$81,200.

After deducting \$24k in standard deduction, I’ll have to pay ordinary income tax on \$57,200 ( \$81,200- \$24,000 ...first \$19,500 at 10%, the remaining \$37,700 at 12%)

Now, adding the \$20k LTCG to the \$57,200 brings it up to \$77,200. That is 0% LTCG rate. So no more taxes.
I know this is just a hypothetical, but isn't the 10% bracket for MFJ \$0 - \$19050 leaving \$38,150 taxable at 12%?

Also, Isn't the top of the 12%^ bracket \$77,400? I vaguely remember someone on this board explaining why it was \$77,200, but can't recall the details.
It Is Best To Consult Others Before Taking Unusual Actions

retiredjg
Posts: 34382
Joined: Thu Jan 10, 2008 12:56 pm

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

manedark wrote:
Sat May 26, 2018 12:18 pm
Say you increase Roth conversion by another 10K, that will be taxed at 12%, but that also puts your LTCG of 20K in 15% tax category.
You are paying 12% and 15% on different amounts, it is NOT 27% tax. isnt it?
Maybe hearing it a different way will help.

If you add a \$1 of ordinary income, that dollar is taxed at 12% (12 cents) AND it causes a dollar of CTCG to be taxed at 15% (15 cents) instead of 0. So each dollar that is added to income results in 27 cents in federal taxes. That is the same as a 27% marginal rate.

kaneohe
Posts: 5148
Joined: Mon Sep 22, 2008 12:38 pm

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

viewtopic.php?t=86849

or perhaps seeing it in a picture might help.....see tfb's stacked bar chart (post from 12/11/11).
If you have LTCG to the top of the 15% (ordinary) bracket, then the addition of ordinary income will displace a similar amount of LTCG into the next higher bracket.........the amount of extra tax (marginal) will be the tax on the ordinary income and the tax on the LTCG displaced into the next bracket.

manedark
Posts: 242
Joined: Sun Apr 22, 2018 2:05 pm

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

retiredjg wrote:
Sat May 26, 2018 2:22 pm
manedark wrote:
Sat May 26, 2018 12:18 pm
Say you increase Roth conversion by another 10K, that will be taxed at 12%, but that also puts your LTCG of 20K in 15% tax category.
You are paying 12% and 15% on different amounts, it is NOT 27% tax. isnt it?
Maybe hearing it a different way will help.

If you add a \$1 of ordinary income, that dollar is taxed at 12% (12 cents) AND it causes a dollar of CTCG to be taxed at 15% (15 cents) instead of 0. So each dollar that is added to income results in 27 cents in federal taxes. That is the same as a 27% marginal rate.
Thanks. I guess the confusion arose because of "marginal" vs "effective" tax rate. I had a problem because I assumed 27% to be "effective" tax rate from the way the phrase was put.

cas
Posts: 374
Joined: Wed Apr 26, 2017 8:41 am

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

gilgamesh wrote:
Sat May 26, 2018 7:21 am
However, if I were to incur an additional \$1 of LTCG, then that only results in an additional 15% tax all the way to \$342,800 (\$400k 15% LTCG threshold - \$57,200). Is this correct?
This may not be what you were asking (you may have just been confirming the mechanics of how LTCG behave around the 0%/15% border, rather than about any additional tax types), but...

At \$250,000 MAGI (MFJ), the NIIT (Net Investment Income Tax) kicks in at an additional 3.8%. (So every \$1 of LTCG either incurred directly or "pushed up above" (by an additional \$1 of ordinary income) that \$250,000 (MFJ) would be taxed at 15% + 3.8% = 18.8%)

People who are doing Roth conversions while (plus the 2 years before) receiving Medicare Pt B and/or D have to watch out for IRMAA brackets (Income Related Monthly Adjustment Amount thresholds for the Medicare premiums). First bracket to watch out for is currently \$170,000 MAGI (MFJ) or \$85,000 (single). \$1 of any additional income can suddenly mean hundreds or thousands (depending on which bracket threshold was crossed, marriage status, and spouse's Medicare status) more \$ in Medicare Premiums. (This isn't an IRS tax, but it is related to MAGI.)

Phase-in/Phase-outs (e.g. phase-in of SS taxation is often relevant to retirees) can cause marginal tax rates much higher than the nominal 10%/12% brackets. See the Wiki on "Marginal Tax Rates" and "Taxation of Social Security" or some such titles.

gilgamesh
Posts: 1174
Joined: Sun Jan 10, 2016 9:29 am

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

RCL wrote:
Sat May 26, 2018 2:11 pm
gilgamesh wrote:
Sat May 26, 2018 7:21 am
Just a hypothetical question to understand how this works.

Say \$20k in LTCG. Then I do a Roth conversion for \$81,200.

After deducting \$24k in standard deduction, I’ll have to pay ordinary income tax on \$57,200 ( \$81,200- \$24,000 ...first \$19,500 at 10%, the remaining \$37,700 at 12%)

Now, adding the \$20k LTCG to the \$57,200 brings it up to \$77,200. That is 0% LTCG rate. So no more taxes.
I know this is just a hypothetical, but isn't the 10% bracket for MFJ \$0 - \$19050 leaving \$38,150 taxable at 12%?

Also, Isn't the top of the 12%^ bracket \$77,400? I vaguely remember someone on this board explaining why it was \$77,200, but can't recall the details.
Yes! You are right about the 10% bracket is up to \$19050 and not \$19,500

The top end of the 12% bracket is indeed \$77,400, however the top of the 0% LTCG tax rate is \$77,200.
Last edited by gilgamesh on Sat May 26, 2018 3:45 pm, edited 1 time in total.

gilgamesh
Posts: 1174
Joined: Sun Jan 10, 2016 9:29 am

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

cas wrote:
Sat May 26, 2018 3:00 pm
gilgamesh wrote:
Sat May 26, 2018 7:21 am
However, if I were to incur an additional \$1 of LTCG, then that only results in an additional 15% tax all the way to \$342,800 (\$400k 15% LTCG threshold - \$57,200). Is this correct?
This may not be what you were asking (you may have just been confirming the mechanics of how LTCG behave around the 0%/15% border, rather than about any additional tax types), but...

At \$250,000 MAGI (MFJ), the NIIT (Net Investment Income Tax) kicks in at an additional 3.8%. (So every \$1 of LTCG either incurred directly or "pushed up above" (by an additional \$1 of ordinary income) that \$250,000 (MFJ) would be taxed at 15% + 3.8% = 18.8%)

People who are doing Roth conversions while (plus the 2 years before) receiving Medicare Pt B and/or D have to watch out for IRMAA brackets (Income Related Monthly Adjustment Amount thresholds for the Medicare premiums). First bracket to watch out for is currently \$170,000 MAGI (MFJ) or \$85,000 (single). \$1 of any additional income can suddenly mean hundreds or thousands (depending on which bracket threshold was crossed, marriage status, and spouse's Medicare status) more \$ in Medicare Premiums. (This isn't an IRS tax, but it is related to MAGI.)

Phase-in/Phase-outs (e.g. phase-in of SS taxation is often relevant to retirees) can cause marginal tax rates much higher than the nominal 10%/12% brackets. See the Wiki on "Marginal Tax Rates" and "Taxation of Social Security" or some such titles.
This is also great info...

The purpose of the post was just to make sure I got the basics right to analyze whether it helps to maximize the 15% LTCG tax bracket in one year, so as to enjoy 0% LTCG in remaining years and to do as much Roth conversion as possible, each year (taking into account all other confounding factors)

Your information is just exactly what's needed to get to the bottom of it.

RCL
Posts: 310
Joined: Sat Jul 05, 2014 2:48 am

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

gilgamesh wrote:
Sat May 26, 2018 3:42 pm
RCL wrote:
Sat May 26, 2018 2:11 pm
gilgamesh wrote:
Sat May 26, 2018 7:21 am
Just a hypothetical question to understand how this works.

Say \$20k in LTCG. Then I do a Roth conversion for \$81,200.

After deducting \$24k in standard deduction, I’ll have to pay ordinary income tax on \$57,200 ( \$81,200- \$24,000 ...first \$19,500 at 10%, the remaining \$37,700 at 12%)

Now, adding the \$20k LTCG to the \$57,200 brings it up to \$77,200. That is 0% LTCG rate. So no more taxes.
I know this is just a hypothetical, but isn't the 10% bracket for MFJ \$0 - \$19050 leaving \$38,150 taxable at 12%?

Also, Isn't the top of the 12%^ bracket \$77,400? I vaguely remember someone on this board explaining why it was \$77,200, but can't recall the details.
Yes! You are right about the 10% bracket is up to \$19050 and not \$19,500

The top end of the 12% bracket is indeed \$77,400, however the top of the 0% LTCG tax rate is \$77,200.
Thanks for the clarification; now, on to find out why there is that \$200 difference
It Is Best To Consult Others Before Taking Unusual Actions

retiredjg
Posts: 34382
Joined: Thu Jan 10, 2008 12:56 pm

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

RCL wrote:
Sat May 26, 2018 4:22 pm
Thanks for the clarification; now, on to find out why there is that \$200 difference
It's a glitch in the new tax laws. Ordinarily, these two limits are the same and they are likely to be made the same by an administrative adjustment before tax day. If not, the first \$200 of LTCG will be taxed at 15% even though the person is only in the 12% bracket. That would be pretty messed up.

RCL
Posts: 310
Joined: Sat Jul 05, 2014 2:48 am

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

retiredjg wrote:
Sat May 26, 2018 4:51 pm
RCL wrote:
Sat May 26, 2018 4:22 pm
Thanks for the clarification; now, on to find out why there is that \$200 difference
It's a glitch in the new tax laws. Ordinarily, these two limits are the same and they are likely to be made the same by an administrative adjustment before tax day. If not, the first \$200 of LTCG will be taxed at 15% even though the person is only in the 12% bracket. That would be pretty messed up.
Thanks for explaining this, as I was not able to find anything about the why's. You saved me some work!
That would be messed up, but considering the source...
It Is Best To Consult Others Before Taking Unusual Actions

retiredjg
Posts: 34382
Joined: Thu Jan 10, 2008 12:56 pm

### Re: Just wanted to clarify how taxation works on LTCG rate and Roth conversion

If I remember correctly, it had to do with some things that get increased each year and some things that were just "set" by the new law. In this case, they were supposed to be the same but one got the yearly increase in 2018 and the other one was set to the 2017 number. Or something along that line.

Seems like I read that in the very long and complete Michael Kitces article when the new tax law was passed.