Income Tax Calculation?

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winski58
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Income Tax Calculation?

Postby winski58 » Sun Jun 18, 2017 4:00 pm

Filing joint return. Here are the numbers:

SS 62,374
RMD 30,265
Pension 4,860
Gross 97,499
Tax 4,604 (TaxCaster)

SS 62,374
RMD 30,265
Distribution 20,000
Pension 4,860
Gross 117,499
Tax 10,154 (TaxCaster)

Question: Why does an additional $20,000 distribution increase the total tax by so much when we are still within the 15% Marginal Tax Rate? My obviously incorrect assumption is an increased tax of $3,000. (15% of 20,000)

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dodecahedron
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Re: Income Tax Calculation?

Postby dodecahedron » Sun Jun 18, 2017 4:05 pm

The additional 20K distribution will cause more of your SS to be subject to taxation and therefore your AGI and taxable income go up by more than $20K.

More explanation here: https://www.kitces.com/blog/the-taxatio ... -increase/

winski58
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Re: Income Tax Calculation?

Postby winski58 » Sun Jun 18, 2017 4:21 pm

dodecahedron wrote:The additional 20K distribution will cause more of your SS to be subject to taxation and therefore your AGI and taxable income go up by more than $20K.

More explanation here: https://www.kitces.com/blog/the-taxatio ... -increase/


Thanks...This may change our plan to rollover a portion of our 401K funds to a ROTH.

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#Cruncher
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Re: Income Tax Calculation?

Postby #Cruncher » Sun Jun 18, 2017 4:27 pm

winski58 wrote:Why does an additional $20,000 distribution increase the total tax by so much ... ?
Because the extra $20,000 income makes $17,000 more of your Social Security benefits taxable. This makes your tax go up $5,550 (37000 * 15%), 27.75% of the extra income. See the Wiki's Taxation of Social Security benefits for an explanation.

It's also shown in this table I prepared with the Compare sheet of my Marginal Tax Rates spreadsheet:

Code: Select all

Social Security 50% threshhold    32,000   ----->
Social Security 85% threshhold    44,000   ----->
Ord Income Tax Bracket 15%        18,550   ----->
Ord Income Tax Bracket 25%        75,300   ----->
Ord Income Tax Bracket 28%       151,900   ----->
Non-SS Ordinary Income            35,125   55,125
Social Security Benefit           62,374   62,374
SS Relevant Income                66,312   86,312
50% SS taxable                     6,000    6,000
85% SS taxable                    18,965   35,965
Total SS taxable                  24,965   41,965

Code: Select all

Adjusted gross income             60,090   97,090
Deductions plus Exemptions        23,200   23,200
Taxable Income                    36,890   73,890
Ordinary taxable @ 15%            18,340   55,340
Ordinary taxable @ 10%            18,550   18,550
Ordinary tax @ 15%                 2,751    8,301
Ordinary tax @ 10%                 1,855    1,855
Total tax                          4,606   10,156
Increased income                       20,000
Increased taxable SS                   17,000
Increased tax                           5,550
Marginal SS taxable                    85.00%
Marginal tax rate                      27.75%
(For a 2016 Joint return with standard deduction for couple both aged 65+.)

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tennisplyr
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Re: Income Tax Calculation?

Postby tennisplyr » Sun Jun 18, 2017 6:21 pm

I like using Taxcaster from TurboTax.

https://turbotax.intuit.com/tax-tools/c ... /taxcaster
Those who move forward with a happy spirit will find that things always work out.

Silk McCue
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Re: Income Tax Calculation?

Postby Silk McCue » Sun Jun 18, 2017 6:39 pm

If you give to charity you can perform a Qualified Charitable Distribution (QCD) to reduce your taxable income from your RMD amount and thus allow more room for Roth Conversion.

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dodecahedron
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Re: Income Tax Calculation?

Postby dodecahedron » Sun Jun 18, 2017 7:21 pm

tennisplyr wrote:I like using Taxcaster from TurboTax.

https://turbotax.intuit.com/tax-tools/c ... /taxcaster


The OP was already using Taxcaster, but it is a fairly opaque black box that sheds little light on what is actually going on "under the hood." #Cruncher's spreadsheet is much more illuminating for this purpose.

Regular tax software (e.g., Turbotax itself, HRBlock, etc.) can also be helpful in understanding what's going on if it is a version that has an easily accessible "forms view."

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Taz
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Re: Income Tax Calculation?

Postby Taz » Sun Jun 18, 2017 7:49 pm

#Cruncher wrote:
winski58 wrote:Why does an additional $20,000 distribution increase the total tax by so much ... ?
Because the extra $20,000 income makes $17,000 more of your Social Security benefits taxable. This makes your tax go up $5,550 (37000 * 15%), 27.75% of the extra income. See the Wiki's Taxation of Social Security benefits for an explanation.


Not that I'm that close to collecting SS, but that is an eye opener - particularly for those who have pensions and will be withdrawing a mix of Roth, traditional, and TSP.
The destination matters.

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#Cruncher
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Re: Income Tax Calculation?

Postby #Cruncher » Sun Jun 18, 2017 11:25 pm

Taz in previous post wrote:
#Cruncher wrote:... This makes your tax go up ... 27.75% of the extra income. ...
... that is an eye opener ...
Wait, it gets even better! If, besides the $35,125 of RMD and pension, the original poster converted $20,762 to a Roth (not just $20,000), he'd reach the 25% tax bracket. The next $12,241 of Roth conversions (or any other ordinary income) after that would therefore be subject to a 46.25% marginal rate (25% * 1.85). Then finally after $33,003 (20762 + 12241) of Roth conversions, the maximum $53,018 of SS (62374 * 85%) will have been taxed. He'd have passed the "SS tax hump" and any more ordinary income would only increase taxes at the bracket rate.

Code: Select all

Social Security 50% threshhold    32,000   -------------->
Social Security 85% threshhold    44,000   -------------->
Ord Income Tax Bracket 15%        18,550   -------------->
Ord Income Tax Bracket 25%        75,300   -------------->
Non-SS Ordinary Income            35,125   55,887   68,128
Social Security Benefit           62,374   62,374   62,374
SS Relevant Income                66,312   87,074   99,315
50% SS taxable                     6,000    6,000    6,000
85% SS taxable                    18,965   36,613   47,018
Total SS taxable                  24,965   42,613   53,018
Adjusted gross income             60,090   98,500  121,146
Deductions plus Exemptions        23,200   23,200   23,200
Taxable Income                    36,890   75,300   97,946

Code: Select all

Ordinary taxable @ 25%               -        -     22,646
Ordinary taxable @ 15%            18,340   56,750   56,750
Ordinary taxable @ 10%            18,550   18,550   18,550
Ordinary tax @ 25%                   -        -      5,661
Ordinary tax @ 15%                 2,751    8,512    8,513
Ordinary tax @ 10%                 1,855    1,855    1,855
Total tax                          4,606   10,367   16,029
Increased income                       20,762   12,241
Increased taxable SS                   17,648   10,405
Increased tax                           5,761    5,661
Marginal SS taxable                    85.00%   85.00%
Marginal tax rate                      27.75%   46.25%

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FiveK
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Re: Income Tax Calculation?

Postby FiveK » Sun Jun 18, 2017 11:55 pm

winski58 wrote:Question: Why does an additional $20,000 distribution increase the total tax by so much when we are still within the 15% Marginal Tax Rate? My obviously incorrect assumption is an increased tax of $3,000. (15% of 20,000)
As already noted, the 15% bracket does not guarantee a 15% Marginal tax rate.

In fact, given the other income amounts, there is never a 15% marginal rate for the next dollar of tIRA withdrawals. See Tools and calculators - Personal_finance_toolbox - Bogleheads if you'd like to look at other scenarios, but in picture form based on the OP numbers:
Image

jebmke
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Re: Income Tax Calculation?

Postby jebmke » Mon Jun 19, 2017 7:59 am

Using the published tax brackets as if they are marginal tax rates is risky.
When you discover that you are riding a dead horse, the best strategy is to dismount.

winski58
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Re: Income Tax Calculation?

Postby winski58 » Mon Jun 19, 2017 9:07 am

I just entered (using TaxCaster) $20,000 in long-term capital gains/qualified dividends instead of taking an extra $20,000 from 401k and the tax is $7,154. So selling a few shares from my after-tax mutual fund appears to be a much better strategy. Is this because a long-term capital gain or stock qualified dividends withdrawal does not increase the percentage of social security that is subject to tax?

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Re: Income Tax Calculation?

Postby jebmke » Mon Jun 19, 2017 9:11 am

winski58 wrote:I just entered (using TaxCaster) $20,000 in long-term capital gains/qualified dividends instead of taking an extra $20,000 from 401k and the tax is $7,154. So selling a few shares from my after-tax mutual fund appears to be a much better strategy. Is this because a long-term capital gain or stock qualified dividends withdrawal does not increase the percentage of social security that is subject to tax?

True, but under certain conditions your income can bump into the pesky 30% marginal rate [which isn't even a published rate] so it always pays to run the numbers through a tax program/tool and not rely on statutory rates for one classification of income.
When you discover that you are riding a dead horse, the best strategy is to dismount.

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FiveK
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Re: Income Tax Calculation?

Postby FiveK » Mon Jun 19, 2017 9:30 am

winski58 wrote:I just entered (using TaxCaster) $20,000 in long-term capital gains/qualified dividends instead of taking an extra $20,000 from 401k and the tax is $7,154. So selling a few shares from my after-tax mutual fund appears to be a much better strategy. Is this because a long-term capital gain or stock qualified dividends withdrawal does not increase the percentage of social security that is subject to tax?
No, LTCG&QD affect your SS taxable amount the same as ordinary income.

The LTCG themselves, however, are not taxed the same as ordinary income. See chart below for your marginal tax rates (again, given all the other income amounts) on LTCGs.

Note that $20K is just under a large step change in marginal rates. Seeing the overview in graphical form can help with strategy development: e.g., either stop short of that step change or plow through and have a very large LTCG amount.

Image

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#Cruncher
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Re: Income Tax Calculation?

Postby #Cruncher » Tue Jun 20, 2017 7:56 am

FiveK in previous post wrote:Note that $20K is just under a large step change in marginal rates.
Indeed! A $20,732 long term capital gain (LTCG) along with the $35,125 of non-SS ordinary income and $62,374 of SS benefits mentioned in the original post exhausts the "space" where LTCG are not taxed. (For a 2017 joint return with standard deduction for two spouses age 65+.)

Additional LTCG results in a 40.5% marginal tax rate. But additional non-SS ordinary income results in an even higher 55.5% marginal rate. The following table, prepared with the Compare sheet of my Marginal Tax Rates spreadsheet, illustrates this for a $10,000 increase in LTCG and in ordinary income:

Code: Select all

Social Security 50% threshhold    32,000   ----->     -------------->
Social Security 85% threshhold    44,000   ----->     -------------->
Ord Income Tax Bracket 15%        18,550   ----->     -------------->
Ord Income Tax Bracket 25%        75,300   ----->     -------------->
LTCG & QDI Tax Bracket 15%        75,300   ----->     -------------->

Code: Select all

                                     LTCG +$10K        Ord Inc +$10K
Non-SS Ordinary Income            35,125   35,125     35,125   45,125
LTCG & Qualified Div Income       20,762   30,762     20,762   20,762
Social Security Benefit           62,374   62,374     62,374   62,374
SS Relevant Income                87,074   97,074     87,074   97,074
50% SS taxable                     6,000    6,000      6,000    6,000
85% SS taxable                    36,613   45,113     36,613   45,113
Total SS taxable                  42,613   51,113     42,613   51,113
Adjusted gross income             98,500  117,000     98,500  117,000
Deductions plus Exemptions        23,200   23,200     23,200   23,200
Taxable Income                    75,300   93,800     75,300   93,800
LTCG & QDI Taxable                20,762   30,762     20,762   20,762
Ordinary Taxable                  54,538   63,038     54,538   73,038

Code: Select all

Ordinary taxable @ 15%            35,988   44,488     35,988   54,488 [*]
Ordinary taxable @ 10%            18,550   18,550     18,550   18,550
LTCG & QDI taxable @ 15%             -     18,500        -     18,500 [*]
LTCG & QDI taxable @ 0%           20,762   12,262     20,762    2,262
Ordinary tax @ 15%                 5,398    6,673      5,398    8,173
Ordinary tax @ 10%                 1,855    1,855      1,855    1,855
LTCG & QDI tax @ 15%                 -      2,775        -      2,775
Total tax                          7,253   11,303      7,253   12,803
Increased income                       10,000              10,000
Increased taxable SS                    8,500               8,500
Increased tax                           4,050               5,550     [*]
Marginal SS taxable                    85.00%              85.00%
Marginal tax rate                      40.50%              55.50%
* When the $10K increase is LTCG, it is taxed at 15%. But it also makes $8,500 more SS taxable which in turn pushes another $8,500 of LTCG into the 15% bracket. So the overall tax increase is $4,050 (8500 * 15% + 18500 * 15%). When the $10K increase is ordinary income, it is taxed at 15%. But it also makes $8,500 more SS taxable. These together push $18,500 of LTCG into the 15% bracket. So the overall tax increase is $5,550 (18500 * 15% + 18500 * 15%).

FiveK in same post wrote:Seeing the overview in graphical form can help with strategy development ...
II agree. But it took me a long time to figure out how FiveK's graph was prepared. To help others use it, here are some hints:
  1. Click on his Wiki link.
  2. From there, click on the link, the spreadsheet itself to open a web view of the Google docs spreadsheet. Note this is a multi-purpose spreadsheet that does many things besides determine marginal tax rates.
  3. Click the Download icon and save the file to your computer.
  4. Open the file. It's not necessary to enable Macros.
  5. The graph is located over cell J73 on the Calculations sheet. It is based on data stored in the range P64:R565 to the right of the graph. Those familiar with Excel who plan to reuse the spreadsheet, may want to name this range, making it easier to select.
  6. As explained on rows 3 and 4 of the Instructions sheet, in colored cells on the Calculations sheet enter filing information in cells G2:H9, and income in cells B2:B38. Note that the income needs to be entered per month.
  7. Carefully look at rows 15 to 32 on the Instructions sheet. They tell how to choose the independent variable for the data range on which the graph is based. To create the table shown in FiveK's post, enter "B26" as the "Column input cell".
  8. After entering the cell for the independent variable, the graph's data is calculated by Excel's Data Table feature. Since I'd never used this before, it took me a while to figure out what Excel was doing.
  9. If necessary, adjust the step value of $3 per month in cell P64 on the Calculations sheet to get the desired range displayed on the graph. I changed it to $10.
  10. To get rid of the negative bottom half of the graph, I had to right click on the vertical axis and choose "Format Axis". I then chose "Scale" and changed Minimum from "-0.5" to "0".
You can also prepare graphs of marginal tax rates using the Main sheet of my Marginal Tax Rates spreadsheet or the spreadsheet prepared by PapaGeek and explained in the Wiki's Social Security tax impact calculator.

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FiveK
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Re: Income Tax Calculation?

Postby FiveK » Tue Jun 20, 2017 10:19 am

#Cruncher wrote:To help others use it, here are some hints:....
Nicely written!

If you have suggestions for the author of that tool, Case Study Spreadsheet updates is a thread for that purpose. Responses to requests seem reasonable.

ubermax
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Re: Income Tax Calculation?

Postby ubermax » Thu Jun 22, 2017 12:31 pm

I think Cruncher and FiveK have done a good job dissecting the question in the original post ; after finishing our taxes for 2016 and completing the first year of double RMDs , I wanted to see the tax impact ( Federal + State) of prospectively taking additional withdrawals from our tIRA accounts in the event of planned & unplanned big ticket expense items .

I created an Excel workbook that mirrored our tax forms and determined the impact of additional annual withdrawals ranging from 5K to 20K ; the effective tax rate , i.e. (tax liability)/AGI stayed close to 14% over the range of withdrawals and tax liability as a percent of taxable income stayed close to 18% - but the additional tax as a percent of the additional withdrawal averaged just under 40 % - and so to net 20K we'd have to pull out around 33K , pull from taxable or possibly apply for a HELOC :-(

With the creation of the Roth , I think the younger folks who are coming up through the ranks have more tools and firepower to mitigate the tax bite later on .

vtMaps
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Re: Income Tax Calculation?

Postby vtMaps » Thu Jun 22, 2017 1:32 pm

ubermax wrote: I wanted to see the tax impact ( Federal + State) of prospectively taking additional withdrawals from our tIRA accounts in the event of planned & unplanned big ticket expense items .
If you think your situation is bad now, wait until one of you passes. The survivor will have lower SS income, higher tax bracket, and (more or less) the same RMDs as the two of you have. Virtually all of our assets are in pretax IRAs, and it makes sense for us to blast through the SS tax hump for a couple of years to build up our roth IRAs. Paying some taxes now (roth conversion) will lower our RMDs and greatly reduce taxes for the survivor. See the example here: viewtopic.php?f=2&t=220140
Our SS income for four years (age 66-70 = spousal + my retirement) will be about $31k. We would like to draw down our tIRA as much as we can during those 4 years.

Here are three ways we could drawdown $210,740 over 4 years (assume zero inflation):

if we draw $52,685 each year for 4 years, our total income tax would be: $29,711

If we draw $147,635 for 1 year and $21,035 for 3 years, our total income tax would be: $29,149

If we draw $72,845 for 2 years and $32,525 for 2 years, our total income tax would be: $24,633
--vtMaps
The optimist proclaims that we live in the best of all possible worlds; and the pessimist fears this is true. --James Branch Cabell

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dratkinson
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Re: Income Tax Calculation?

Postby dratkinson » Thu Jun 22, 2017 5:57 pm

ubermax wrote:...
I created an Excel workbook that mirrored our tax forms and determined the impact of additional annual withdrawals...


Have you tried playing with excel1040.com?
d.r.a, not dr.a. | I'm a novice investor, you are forewarned.


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