Tax question my CPA answered wrong last year

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JHart
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Tax question my CPA answered wrong last year

Post by JHart » Sat Dec 17, 2016 5:34 pm

So once again it's December and I am struggling with the same tax question I do every year. Last year I took everything to an accountant, paid for an answer and then it ended up being wrong! Maybe Bogleheads will be better than my CPA...

We are married filing jointly with two dependent kids. My husband makes $79K (I'm stay at home) and maxes out a 403b ($18K), a 457 ($18K) and a 401a (~$5K). Those deductions, coupled with deductions for medical insurance, bring his federal taxable gross down to $35K for 2016. That puts us in the 0% capital gains tax bracket. So we want to harvest as many gains in our taxable account as possible at the 0% rate before the end of the year. Making sense?

We have $24K in dividend income, $21K of which is qualified. So I think we just have to keep our taxable income below $75,300 to pay 0% capital gains. How many capital gains can I harvest this year?? I thought it would be about $75K-$35K-$24K = $16K but Tax Caster is letting me have over $40K in gains without paying additional tax. Anyone know what the true answer is?

Punta Cana DR
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Re: Tax question my CPA answered wrong last year

Post by Punta Cana DR » Sat Dec 17, 2016 6:16 pm

JHart,

Capital gains are taxed either ST or LT rate. LT will result in lower 15% rate.

I think your CPA might be correct.

Thanks

JHart
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Re: Tax question my CPA answered wrong last year

Post by JHart » Sat Dec 17, 2016 6:21 pm

The gains are long-term. But I thought our income was low enough to get us to 0%...

nalor511
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Re: Tax question my CPA answered wrong last year

Post by nalor511 » Sat Dec 17, 2016 6:31 pm

The best answer is to mock up a return with your real numbers using hrblock,taxact,TurboTax,etc. You can use 2015 software since 2016 has not yet loaded all the forms, and it will be pretty close. Good luck

DSInvestor
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Re: Tax question my CPA answered wrong last year

Post by DSInvestor » Sat Dec 17, 2016 6:32 pm

JHart wrote:So once again it's December and I am struggling with the same tax question I do every year. Last year I took everything to an accountant, paid for an answer and then it ended up being wrong! Maybe Bogleheads will be better than my CPA...

We are married filing jointly with two dependent kids. My husband makes $79K (I'm stay at home) and maxes out a 403b ($18K), a 457 ($18K) and a 401a (~$5K). Those deductions, coupled with deductions for medical insurance, bring his federal taxable gross down to $35K for 2016. That puts us in the 0% capital gains tax bracket. So we want to harvest as many gains in our taxable account as possible at the 0% rate before the end of the year. Making sense?

We have $24K in dividend income, $21K of which is qualified. So I think we just have to keep our taxable income below $75,300 to pay 0% capital gains. How many capital gains can I harvest this year?? I thought it would be about $75K-$35K-$24K = $16K but Tax Caster is letting me have over $40K in gains without paying additional tax. Anyone know what the true answer is?


Welcome to the forum. I think you forgot deductions and exemptions which is critical when determining one's tax bracket.

Tax brackets are based on Taxable Income (line 43 of 1040 tax form).

Taxable Income = Adjusted Gross Income (AGI) - deductions - exemptions.

Do you itemize deductions or take the standard deduction? The standard deduction for Married Filing Jointly is 12,600. Each exemption is $4050. You will have 4 exemptions.

Are the contributions to 403b and 457b Traditional or Roth? Traditional contributions to 403b and 457b will reduce W-2 box 1 which flows into 1040 line 7 and contributes to your AGI.

Assuming 36K of Traditional 403b/457b contributions, standard deduction and 4 exemptions:
Gross Salary = 79K
AGI = 79K - 18K - 18K + 24K = 67K <- This does not include 401a contribution as I'm not sure if that reduces AGI.

Taxable Income = AGI 67K - Std Deduction 12,600 - exemptions 16,200 = 38,200.

The top of the 15% Fed Tax bracket is 75,300.

Note that your taxable holdings may be distributing dividends and capital gains distributions later in December so make sure you monitor those before committing to realizing your capital gains to TLH. If you break into the 25% bracket, only the amount that falls in the higher brackets are taxed at the higher rate.

Be aware that while LTCG and QDI receive 0% tax rate for Fed Taxes, your state will likely tax them as ordinary income. If you're receiving an ACA premium tax credit, the higher AGI with your LTCG could reduce or eliminate your tax credit. Run your numbers carefully. Tax software is probably the best way to run these scenarios, especially if ACA tax credit is in the mix.
Last edited by DSInvestor on Sat Dec 17, 2016 6:50 pm, edited 2 times in total.

pshonore
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Re: Tax question my CPA answered wrong last year

Post by pshonore » Sat Dec 17, 2016 6:37 pm

I wouldn't trust Taxcaster but the 15% is based on taxable income - basically whats in Box of his W2 + other income like dividends, the gains, etc minus itemized or standard deductions minus personal exemptions. Don't forget to add the dividends. Any dividends/cap gains that fall in the 25% bracket, ( > 76K) , will be taxed at 15%.

JHart
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Re: Tax question my CPA answered wrong last year

Post by JHart » Sat Dec 17, 2016 7:05 pm

I hadn't thought of just running the 2015 TurboTax/HRBlock etc. Good suggestion. I will give it a try if I have time.

DSInvestor,

We take the standard deduction. 403b and 457 contributions are traditional. The 401a is called a "before-tax" deduction on the pay stub, which is why I lumped it with the 403b and 457 contributions. So yes, all the assumptions you made were correct. We get health insurance through an employer plan, so no ACA involved. The $24K in dividends includes estimated December dividends put forth in this Vanguard document: https://personal.vanguard.com/us/insights/article/cap-gains. For some reason, I think I should realize the gains before the distribution, which means I have to do it on Monday.

Yes, I'm in Arizona and the capital gains are taxed here at about 4%. My thought was that unless we move to a state with no income tax, which is unlikely, 4% is about the lowest rate we'll ever pay on capital gains so we should go for it while we have the opportunity.

I think your final figure of 38,200 taxable income is pretty on the mark. Perhaps I might factor in the 401a contributions. I'm thinking of realizing 30,000 in gains, which I'm thinking will be conservative. Then if I do go over somehow I would compensate by making traditional IRA contributions rather than our normal Roth IRA contributions. This is what I did last year when our accountant's estimate was over by about 8,000.

Thanks for your detailed analysis. I had completely forgotten about standard deduction and exemptions, which I think accounts for why my own calculations were so far off of Tax Caster.

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badbreath
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Re: Tax question my CPA answered wrong last year

Post by badbreath » Sat Dec 17, 2016 7:29 pm

I would post this question also on the http://www.fairmark.com/forum/ websight. You will get answers from CPAs
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ofckrupke
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Re: Tax question my CPA answered wrong last year

Post by ofckrupke » Sat Dec 17, 2016 7:43 pm

Another way to do this is work backward from the maximum you want to see on the Taxable Income line on form 1040. So add the 28.8k of standard deduction & exemptions to the 75.3k and that puts you at an AGI of 104.1k. For the stay-at-home spouse (who is therefore not covered by a retirement plan), this is way below the phaseout of the traditional IRA deduction, so as much as 5.5k could be deducted as an above-the-line adjustment, which (working backward) means Total Income on form 1040 line 22 could be as high as 109.6k. [Conveniently this means MAGI above the top of the TIRA deduction phaseout for the employed spouse - whose 401a constitutes coverage by a retirement plan - so their IRA contribution should be 100% Roth from the get-go.]

So, if there aren't any other adjustments (non-payroll HSA deductions, age 50+ IRA "catchup" - figured not since 403b/457b were 18k instead of 24k, etc), I think you have ballpark 109.6k - 35k (W2 Gross) -24k (other income) = 50.6k of headroom for gain harvesting - if the non-employed spouse makes a 5.5k TIRA contribution, and still get the QDiv and LT part of the gains in at 0% federal taxation. If the non-employed spouse contributes Roth instead, it will be taxed at 30% effectively: because absent the TIRA deduction, that amount of LTCG/QDiv will get pushed into the 25% bracket and be taxed at 15% instead of 0%.

Alan S.
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Re: Tax question my CPA answered wrong last year

Post by Alan S. » Sat Dec 17, 2016 7:56 pm

Note that AZ offers a subtraction of 25% of the LTCGs generated on shares purchased after 12/31/2011. For example, if you hold a fund which was purchased after that date or to which you added shares after that date from reinvested divs and cap gains, you can subtract 25% of the cap gains paid out on those shares whether it is from a cap gain distribution or a redemption. From the AZ Form 140 Inst:

You may subtract 25% (.25) of any net long-term capital gain included in your federal adjusted gross income that is derived from an investment in an asset acquired after December 31, 2011. Use the worksheet on page 29 of these instructions, Worksheet for Net Long-Term Capital Gain Subtraction for Assets Acquired after December 31, 2011, to determine the allowable subtraction. Keep the worksheet for your records.

Assume you have a fund for which reports 8000 of cap gains or your sale produces a LT cap gain of 8000. Half the shares were purchased prior to 2012 and half after that date. Therefore 4000 of your cap gains are eligible for subtraction. 25% of 4000 = 1,000. which shows as a subtraction on your AZ 140. Effectively, this reduces the rate you pay on these gains by 25% regardless of which marginal bracket you are in. If it is the 4% bracket, then you actual rate becomes 3%.

Good opportunity to check last years return to see if your accountant is using his tax program correctly. I would assume his tax program includes this, but is he taking the time to capture and enter this info? Check lines 21 and 22 of last year's AZ return.

This is not big bucks as in whether you pay 0 or 15 on your federal return - but it IS a way to tell if your CPA is doing the job or not.

Also FYI - you can harvest gains before or after the fund's dividend/cap gain distribution. But if you do not sell all the shares before the record date, remember to factor in what additional gains will be distributed on the shares you did not sell.

JHart
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Re: Tax question my CPA answered wrong last year

Post by JHart » Sun Dec 18, 2016 12:39 am

More great responses here - thank you.

OfcKrupke, all your assumptions are correct. 50K is a lot of room to work with. I think I will not include the TIRA and instead plan on a Roth IRA, but will do TIRA instead if my calculations are off and I need more deductions.

Alan, thanks for this tip! I actually do my own taxes with TurboTax or Taxact (just went to the CPA that one time trying to get an answer) and I'm sure I've never taken the 25%. The fund I was going to sell was the 500 Index, which I'm trying to get rid of as I migrate toward the four-fund strategy (total stock market, total bond market, total intl stock market, total intl bond market). All of my 500 Index at this point was acquired before 2012. I do have Total Stock Market shares acquired in 2012 or later. I could harvest the gains from there, but doesn't Vanguard have some sort of frequent trading prohibition such that I couldn't buy right back into the fund? I suppose I could park the money in Extended Market for two months and then buy back into Total Stock Market. That would probably be worth the $400 I'd save...

One hiccup I should mention generally is that I did some tax loss harvesting earlier in the year and had 3,300 in long-term losses. I am anticipating a long-term capital gains distribution next week of about 3,500. I'm assuming a long-term loss cancels out a long-term gains distribution. Please someone speak up if I'm wrong on that.

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celia
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Re: Tax question my CPA answered wrong last year

Post by celia » Sun Dec 18, 2016 2:21 am

While I remember, yes, the LT gain and LT loss will cancel each other out, giving you a Net LT gain of $200 if your numbers hold.

My answer involves the same thought process as OfcKrupke, but with slightly different inputs into the tax software (which I am not using for this answer).
JHart wrote:We are married filing jointly with two dependent kids. My husband makes $79K (I'm stay at home) and maxes out a 403b ($18K), a 457 ($18K) and a 401a (~$5K). Those deductions, coupled with deductions for medical insurance, bring his federal taxable gross down to $35K for 2016. That puts us in the 0% capital gains tax bracket. So we want to harvest as many gains in our taxable account as possible at the 0% rate before the end of the year. Making sense?

No. How are you deducting $3,000 of medical insurance premiums(???) ? Do you mean a HSA contribution on Form 1040, line 25? Or Self-Employment Health Insurance on line 29? How can it be a "deduction" unless you already have $12,600 of deductions?

Without understanding the medical insurance, I will ignore it. That makes Taxable wages of 79K -18K -18K -5k = 38K.

...How many capital gains can I harvest this year?? I thought it would be about $75K-$35K-$24K = $16K but Tax Caster is letting me have over $40K in gains without paying additional tax. Anyone know what the true answer is?

Following OfcKrupke's thought process, work backwards from line 43 Taxable Income, to get the top of the 15% bracket for your family: 75,300 + 12,600 (standard deductions for MFJ) + 16,200 (4 exemptions) = $104,100. I will ignore the IRA contribution to be made early next year as that can act to compensate for unexpected changes in the numbers. If the numbers hold come tax time, you can put $5,500 into a Roth.

Now we have $104K AGI - 38K (taxable income) -3K (taxable dividends) -21K (qualified dividends) = $42K remaining for LT gains to still be in the 15% bracket. Enter that into your practice tax software to confirm it.

Sorry, I'm not familar with your state taxes.

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celia
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Re: Tax question my CPA answered wrong last year

Post by celia » Sun Dec 18, 2016 4:13 am

JHart wrote:The gains are long-term. But I thought our income was low enough to get us to 0%...

Just in case you were thinking your whole tax return will end up having no taxes, no, it is only the qualified dividends and LT gains that will be tax free in the 15% bracket. But your $38K (taxable wages) and $3K non-qualified dividends by themselves give an AGI of $41K. Subtract $12K (standand deduction) and $16K (exemptions) for a Taxable Income of $13K. That is within the 10% tax bracket, so your taxes are about $1,300 with or without the qualified dividends and LT gains.

I think with you being at such a low tax rate now and your husband stuffing so much into retirement accounts for later, you are better off contributing to Roth for 2016. Your retirement tax rate may not be less than 10%.

livesoft
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Re: Tax question my CPA answered wrong last year

Post by livesoft » Sun Dec 18, 2016 8:14 am

celia wrote:No. How are you deducting $3,000 of medical insurance premiums(???) ? Do you mean a HSA contribution on Form 1040, line 25? Or Self-Employment Health Insurance on line 29? How can it be a "deduction" unless you already have $12,600 of deductions?

Without understanding the medical insurance, I will ignore it. That makes Taxable wages of 79K -18K -18K -5k = 38K.

The OP''s situation appears to be similar to our own. They are paying expenses from selling investments to realize LTCG while socking away almost all of one person's earned income into retirement plans. If health insurance is provided by employer, then premiums for that are coming out of his paycheck before tax, too. This is quite typical and described in some of my ZERO income tax threads.

Just be sure to have some earned income leftover in order to contribute to IRAs, too. :)
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Alan S.
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Re: Tax question my CPA answered wrong last year

Post by Alan S. » Sun Dec 18, 2016 3:46 pm

JHart wrote:More great responses here - thank you.

OfcKrupke, all your assumptions are correct. 50K is a lot of room to work with. I think I will not include the TIRA and instead plan on a Roth IRA, but will do TIRA instead if my calculations are off and I need more deductions.

Alan, thanks for this tip! I actually do my own taxes with TurboTax or Taxact (just went to the CPA that one time trying to get an answer) and I'm sure I've never taken the 25%. The fund I was going to sell was the 500 Index, which I'm trying to get rid of as I migrate toward the four-fund strategy (total stock market, total bond market, total intl stock market, total intl bond market). All of my 500 Index at this point was acquired before 2012. I do have Total Stock Market shares acquired in 2012 or later. I could harvest the gains from there, but doesn't Vanguard have some sort of frequent trading prohibition such that I couldn't buy right back into the fund? I suppose I could park the money in Extended Market for two months and then buy back into Total Stock Market. That would probably be worth the $400 I'd save...

One hiccup I should mention generally is that I did some tax loss harvesting earlier in the year and had 3,300 in long-term losses. I am anticipating a long-term capital gains distribution next week of about 3,500. I'm assuming a long-term loss cancels out a long-term gains distribution. Please someone speak up if I'm wrong on that.


Remember that even if you purchased the index funds prior to 2012, if you are reinvesting dividends and the dividend is 2% per year, you would have 5 years or nearly 10% of your fund shares acquired after 2011 if you sold the entire fund. Therefore, you would still get to subtract some cap gains on the AZ return, and the amount would rise each year. Of course, your cap losses would reduce current year gains and therefore reduce the subtracted amount. If you are NOT reinvesting dividends and purchased all your shares prior to 2012, then you would not qualify for any subtraction.

JHart
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Re: Tax question my CPA answered wrong last year

Post by JHart » Sun Dec 18, 2016 11:10 pm

Alan, I haven't been reinvesting into the 500 Index for some time since I'm trying to migrate away from it, but thanks for bringing it up. I use SpecID for cost basis so I can see the reinvestment lots in the funds where they are happening.

Celia and livesoft, yes, it's employer-sponsored health insurance premiums and it does look like they are being deducted on the pay stub.

I'm curious: I thought both my and my husband's IRA contributions could be either traditional or Roth, which would give me 11,000 in error room, but it sounds from some of the posts like his contribution must be Roth - is this correct?

Alan S.
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Re: Tax question my CPA answered wrong last year

Post by Alan S. » Sun Dec 18, 2016 11:24 pm

JHart wrote:Alan, I haven't been reinvesting into the 500 Index for some time since I'm trying to migrate away from it, but thanks for bringing it up. I use SpecID for cost basis so I can see the reinvestment lots in the funds where they are happening.

Celia and livesoft, yes, it's employer-sponsored health insurance premiums and it does look like they are being deducted on the pay stub.

I'm curious: I thought both my and my husband's IRA contributions could be either traditional or Roth, which would give me 11,000 in error room, but it sounds from some of the posts like his contribution must be Roth - is this correct?


It sounded like your joint modified AGI was under 70k - as long as it is under 98k, both of you can take a full deduction for your TIRA contribution, or you could make Roth contributions. If you wanted to one of you could go TIRA and the other Roth. Your joint MAGI is low enough so that you do not have any contribution restrictions due to income.

JHart
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Re: Tax question my CPA answered wrong last year

Post by JHart » Tue Dec 20, 2016 12:35 pm

Thanks for all the great responses. I tried doing Turbotax but don't have a lot of confidence in my predictions of the W-2 and 1099 numbers, so I think I'll go with a conservative 30-35K and see how it goes in February. Thanks again!

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