Long-term gains and Tax Bracket

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bh7785
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Long-term gains and Tax Bracket

Post by bh7785 » Tue Jun 12, 2018 3:25 pm

Hi All,

I've searched around but haven't been able to find an answer to my question. Perhaps I'm missing some core concept. I don't understand how specially-taxed income (eg Long term gains, Roth withdrawals) and normal income (eg a paycheck from work) are calculated within the tax bracket. Is the "normal" income taxed at the higher or lower end of the tax bracket?

For example, say I'm a single earner for 2018, and I only have a W-2 for $10,000, and LTG (long-term gains) of $50,000. This puts me in the 22% bracket. How much tax would I owe in this overly-simplified example? More specifically, how is the W-2 taxed?

Method A) W-2 taxed at lower end of tax bracket
W-2
10% x $9,525 = $953
12% x $475 = $57

LTG: $28,600 fits into 0%, $21,400 into 15%
0% x $28,600 = $0
15% x $21,400 = $3,210

Total taxes due: $4,220

Method B) W-2 taxed at higher end of tax bracket
LTG: $38,600 fits into 0%, $11,400 into 15%
15% x $11,400 = $1710

W-2
22% x $10,000 = $2,200
Total taxes due: $3,910

C) Other??? Is the order in which income is calculated irrelevant in the final calculation?

I know this is not a realistic example and it leaves a lot of factors out of the equation. However, I hope it illustrates the crux of my issue. Is there any good reading on this is figured out? I can't seem to find anything.

delamer
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Re: Long-term gains and Tax Bracket

Post by delamer » Tue Jun 12, 2018 3:34 pm

Try the Tax Caster app.

You can input various hypotheticals and it will give calculate your federal income tax.

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dodecahedron
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Re: Long-term gains and Tax Bracket

Post by dodecahedron » Tue Jun 12, 2018 3:52 pm

You said were single, but did not mention if you had any dependents. You also did not mention if you have enough itemized deductions to make it worthwhile itemizing deductions. I will assume no dependents and no itemized deductions. I will also assume no "above-the-line deductions" (e.g., no student loan interest deductions, no HSA contributions, no contributions to deductible IRAs, etc.) I will also assume no credits (e.g., no education credits, no energy credits, etc.) I will also assume you are under 65 and not legally blind.

In that case you have an "Adjusted Gross Income" (AGI) of $60K (bottom line of page 1 of your Form 1040). You can claim a standard deduction of $12K and your "taxable income" will be $48K. The first $10K of your standard deduction fully offsets your wage income and the remaining $2K of your standard deduction partially offsets your $50K of LTCG income.

So your taxable income of $48K is entirely composed of preferrentially taxed LTCG. You have zero "ordinary" taxable income because your standard deduction exceeded your wage income.

The first $38,600 of that $48K will be taxed at 0%. The remaining $9,400 of that $48K will be taxed at 15%. Your total tax liability is 0.15*9400= $1,410.

https://www.marketwatch.com/story/your- ... 2018-04-16
Last edited by dodecahedron on Tue Jun 12, 2018 4:02 pm, edited 2 times in total.

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dodecahedron
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Re: Long-term gains and Tax Bracket

Post by dodecahedron » Tue Jun 12, 2018 3:59 pm

bh7785 wrote:
Tue Jun 12, 2018 3:25 pm
C) Other??? Is the order in which income is calculated irrelevant in the final calculation? Order very much DOES matter!

I know this is not a realistic example and it leaves a lot of factors out of the equation. However, I hope it illustrates the crux of my issue. Is there any good reading on this is figured out? I can't seem to find anything.
Excellent reading on this topic on Michael Kitces on his blog. The post is a classic of clear exposition. The post is a few years old so the breakpoints are slightly different in 2018 than they were in 2014, but conceptually, the order in which the tax computations are done is exactly the same now as it was then. The illustrations in his blog post are REALLY helpful in illuminating how this works. The tax laws actually specify the most favorable possible order for applying the preferential rates.

kaneohe
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Re: Long-term gains and Tax Bracket

Post by kaneohe » Tue Jun 12, 2018 4:27 pm

bh7785 wrote:
Tue Jun 12, 2018 3:25 pm
..................... Perhaps I'm missing some core concept. I don't understand how specially-taxed income (eg Long term gains, Roth withdrawals) and normal income (eg a paycheck from work) are calculated within the tax bracket. Is the "normal" income taxed at the higher or lower end of the tax bracket?

.............................................................
dodecahedron has given you a good answer in words/numbers. The core concept you are missing is that of the stacked bar charts. See tfb's picture (12/11/11 5:26PM) here viewtopic.php?t=86849

The QDIV/LTCG is stacked on top of the ordinary income. The deductions/exemptions subtract from the bottom of the stack of income...........so the ordinary income (wages) are taxed at the bottom end of the brackets. The taxation of the QDIV/LTCG is determined by their favorable rates depending on which bracket they fall in.

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FiveK
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Re: Long-term gains and Tax Bracket

Post by FiveK » Tue Jun 12, 2018 10:42 pm

bh7785 wrote:
Tue Jun 12, 2018 3:25 pm
For example, say I'm a single earner for 2018, and I only have a W-2 for $10,000, and LTG (long-term gains) of $50,000. This puts me in the 22% bracket. How much tax would I owe in this overly-simplified example?
Agree with dodecahedron's $1410.

Below are the marginal rates for your situation on W-2 income assuming you have $50K LTCGs.
Image

Below are the marginal rates for your situation on LTCGs assuming you have $10K W-2 income.
Image

See the personal finance toolbox spreadsheet if you would like to try other cases.

If you have some familiarity with Excel, you could look at the formulas in that spreadsheet, along with Form 1040 and associated forms. That might provide some insight.

bh7785
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Re: Long-term gains and Tax Bracket

Post by bh7785 » Wed Jun 13, 2018 8:19 am

Thank you all, this is exactly what I was looking for. I suspected the order of how the incomes were used was significant, but I couldn't find it in my searching.

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#Cruncher
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Re: Long-term gains and Tax Bracket

Post by #Cruncher » Wed Jun 13, 2018 8:25 am

kaneohe wrote:
Tue Jun 12, 2018 4:27 pm
See tfb's picture (12/11/11 5:26PM) here viewtopic.php?t=86849
Click here to go directly to the post with tfb's chart. Below is a variant of that chart showing, side-by-side, the long term capital gain (LTCG) brackets and the new 2018 brackets for ordinary income. I show the floors of each bracket for a Single and Joint return extracted from the Wiki's Tax Rate Table.

Code: Select all

 ===============================================
|     LTCG Brackets     |  Ord Income Brackets  |
 ===============================================
|          20%          |          37%          |
|                       |  $500,000 / $600,000  |
|                       |-----------------------|
|  $425,800 / $479,000  |          35%          |
|-----------------------|  $200,000 / $400,000  |
|          15%          |-----------------------|
|                       |          32%          |
|                       |  $157,500 / $315,000  }
|                       |-----------------------|

Code: Select all

|                       |          24%          |
|                       |   $82,500 / $165,000  |
|                       |-----------------------|
|                       |          22%          |-------------
|                       |   $38,700 /  $77,400  |   $80,000   |
|   $38,600 /  $77,200  |-----------------------|             |
|-----------------------|          12%          |     LTCG    |
|           0%          |    $9,525 /  $19,050  |-------------
|                       |-----------------------|   $30,000   |
|                       |          10%          |             |
|        $0 /       $0  |        $0 /       $0  |   Ord Inc   |
 ----------------------------------------------- -------------
To illustrate how these work together, on the right side I've shown a modification of the example from the original post with $42,000 wages plus $50,000 LTCG. A $12,000 standard deduction leaves $80,000 of taxable income. The LTCG is "stacked" on top as Kaneohe says. The total tax is $9,620 calculated as follows:

Code: Select all

Tax on ordinary income
     953 = 10% *   9525
   2,457 = 12% * (30000 -  9525)
Tax on LTCG
       0 =  0% * (38600 - 30000)
   6,210 = 15% * (80000 - 38600)
   -----
   9,620 = total tax
Note that increasing wages from $10,000 to $42,000 increases the tax $8,210 from $1,410 (see dodecahedron's first post) to $9,620. This is over 25% of the $32,000 (25.7% = 8210 / 32000). (Shown graphically in the first chart in FiveK's post above.) This happens because after wages reach $12,000 and exceed the standard deduction, not only are they taxed at 10% and then 12%, but each $1 also pushes another $1 of LTCG from the 0% bracket into the 15% bracket.

FiveK wrote:
Tue Jun 12, 2018 10:42 pm
Below are the marginal rates for your situation on LTCGs assuming you have $10K W-2 income.
FiveK, the left side of your second chart looks strange. Why do you show a 7.5% marginal rate from $0 to about $4,000 where it spikes before dropping to 0%?

bh7785
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Re: Long-term gains and Tax Bracket

Post by bh7785 » Wed Jun 13, 2018 9:04 am

dodecahedron wrote:
Tue Jun 12, 2018 3:59 pm
bh7785 wrote:
Tue Jun 12, 2018 3:25 pm
C) Other??? Is the order in which income is calculated irrelevant in the final calculation? Order very much DOES matter!

I know this is not a realistic example and it leaves a lot of factors out of the equation. However, I hope it illustrates the crux of my issue. Is there any good reading on this is figured out? I can't seem to find anything.
Excellent reading on this topic on Michael Kitces on his blog. The post is a classic of clear exposition. The post is a few years old so the breakpoints are slightly different in 2018 than they were in 2014, but conceptually, the order in which the tax computations are done is exactly the same now as it was then. The illustrations in his blog post are REALLY helpful in illuminating how this works. The tax laws actually specify the most favorable possible order for applying the preferential rates.
This was a perfect article for me. Very clear now. Thank you so much.

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FiveK
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Re: Long-term gains and Tax Bracket

Post by FiveK » Wed Jun 13, 2018 12:16 pm

#Cruncher wrote:
Wed Jun 13, 2018 8:25 am
FiveK wrote:
Tue Jun 12, 2018 10:42 pm
Below are the marginal rates for your situation on LTCGs assuming you have $10K W-2 income.
FiveK, the left side of your second chart looks strange. Why do you show a 7.5% marginal rate from $0 to about $4,000 where it spikes before dropping to 0%?
First, great line drawings of the stacked tax zones!

Yes, that part of the chart does look strange - but it is correct. It's due to the earned income tax credit (EITC): a 7.65% phaseout rate on the EITC for income above $8490, and a sudden drop to $0 EITC when unearned income is above $3500.

Alan S.
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Re: Long-term gains and Tax Bracket

Post by Alan S. » Wed Jun 13, 2018 7:26 pm

So, for MFJ taxable income that includes LTCGs between 77,200 and 77,400 you have a LTCG rate of 15%, 3 points HIGHER than the ordinary income rate of 12?

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FiveK
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Re: Long-term gains and Tax Bracket

Post by FiveK » Wed Jun 13, 2018 8:41 pm

Alan S. wrote:
Wed Jun 13, 2018 7:26 pm
So, for MFJ taxable income that includes LTCGs between 77,200 and 77,400 you have a LTCG rate of 15%, 3 points HIGHER than the ordinary income rate of 12?
It depends....

E.g., assume $60K gross for either ordinary income or LTCGs. Then look at the marginal rate as the other income hits $41,200. With a standard deduction of $24K, that's a taxable income of ($60K + $41.2K - $24K = $77,200).

The marginal rate for ordinary income at that point ($60K LTCG and $41.2K ordinary) is 27%.
The marginal rate for LTCGs at that point ($60K ordinary and $41.2K LTCG) is 15%.

For very small amounts of LTCG, one gets "unusual" behavior. E.g., for $100 LTCG, the marginal rates from ordinary income between $101K and $101.5K are
Image.

Note this is using the Tax Computation Worksheet formulas. The picture using Tax Tables would be more jagged.

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#Cruncher
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Re: Long-term gains and Tax Bracket

Post by #Cruncher » Thu Jun 14, 2018 4:38 pm

FiveK wrote:
Wed Jun 13, 2018 8:41 pm
E.g., for $100 LTCG, the marginal rates from ordinary income between $101K and $101.5K are ...
Even though it's of no practical use [*], I felt compelled to understand the strange graph you produced, FiveK, particularly the skinny stalagmite that rises between 101,300 and 101,330. But first it's necessary to understand how the Qualified Dividends and Capital Gain Tax Worksheet works.
  • It computes separately the tax on ordinary income and the tax on Qualified Dividends and Long Term Capital Gains (LTCG). Their sum is shown on line 25 of the form.
  • It computes the tax on total taxable income (including LTCG) as if it were all ordinary income.. This is shown on line 26.
  • The tax owed is the smaller of these two and is shown on line 27.
Given this, here is an explanation of the five places on the graph where the marginal tax rate changes:
  • 101,100 : 12% to 27% : LTCG starts being taxed at 15%
  • 101,180 : 27% to 12% : tax on total taxable income becomes less than sum of tax on ordinary income + tax on LTCG
  • 101,300 : 12% to 22% : total taxable income reaches 22% bracket
  • 101,330 : 22% to 12% : sum of tax on ordinary income + tax on LTCG becomes less than tax on total taxable income
  • 101,400 : 12% to 22% : taxable ordinary income reaches 22% bracket
Here is a table that shows the tax computation every $10 from $101,000 to $101,500. The smaller of line 25 or line 26 is enclosed in brackets ("[ ]").

Code: Select all

                                                  Sum of       Tax on     Smaller  Marg-
      Ordinary Income                          Ord Tax +        Total    of Lines   inal
---------------------------    Total    LTCG    LTCG Tax      Taxable    25 or 26    Tax
 Amount  Taxable      Tax    Taxable     Tax     Line 25      Line 26     Line 27   Rate

Code: Select all

101,000   77,000   8,859.00   77,100           [8,859.00]    8,871.00    8,859.00    12%
101,010   77,010   8,860.20   77,110           [8,860.20]    8,872.20    8,860.20    12%
101,020   77,020   8,861.40   77,120           [8,861.40]    8,873.40    8,861.40    12%
101,030   77,030   8,862.60   77,130           [8,862.60]    8,874.60    8,862.60    12%
101,040   77,040   8,863.80   77,140           [8,863.80]    8,875.80    8,863.80    12%
101,050   77,050   8,865.00   77,150           [8,865.00]    8,877.00    8,865.00    12%
101,060   77,060   8,866.20   77,160           [8,866.20]    8,878.20    8,866.20    12%
101,070   77,070   8,867.40   77,170           [8,867.40]    8,879.40    8,867.40    12%
101,080   77,080   8,868.60   77,180           [8,868.60]    8,880.60    8,868.60    12%
101,090   77,090   8,869.80   77,190           [8,869.80]    8,881.80    8,869.80    12%

101,100   77,100   8,871.00   77,200           [8,871.00]    8,883.00    8,871.00    27%
101,110   77,110   8,872.20   77,210    1.50   [8,873.70]    8,884.20    8,873.70    27%
101,120   77,120   8,873.40   77,220    3.00   [8,876.40]    8,885.40    8,876.40    27%
101,130   77,130   8,874.60   77,230    4.50   [8,879.10]    8,886.60    8,879.10    27%
101,140   77,140   8,875.80   77,240    6.00   [8,881.80]    8,887.80    8,881.80    27%
101,150   77,150   8,877.00   77,250    7.50   [8,884.50]    8,889.00    8,884.50    27%
101,160   77,160   8,878.20   77,260    9.00   [8,887.20]    8,890.20    8,887.20    27%
101,170   77,170   8,879.40   77,270   10.50   [8,889.90]    8,891.40    8,889.90    27%

101,180   77,180   8,880.60   77,280   12.00   [8,892.60]   [8,892.60]   8,892.60    12%
101,190   77,190   8,881.80   77,290   13.50    8,895.30    [8,893.80]   8,893.80    12%
101,200   77,200   8,883.00   77,300   15.00    8,898.00    [8,895.00]   8,895.00    12%
101,210   77,210   8,884.20   77,310   15.00    8,899.20    [8,896.20]   8,896.20    12%
101,220   77,220   8,885.40   77,320   15.00    8,900.40    [8,897.40]   8,897.40    12%
101,230   77,230   8,886.60   77,330   15.00    8,901.60    [8,898.60]   8,898.60    12%
101,240   77,240   8,887.80   77,340   15.00    8,902.80    [8,899.80]   8,899.80    12%
101,250   77,250   8,889.00   77,350   15.00    8,904.00    [8,901.00]   8,901.00    12%
101,260   77,260   8,890.20   77,360   15.00    8,905.20    [8,902.20]   8,902.20    12%
101,270   77,270   8,891.40   77,370   15.00    8,906.40    [8,903.40]   8,903.40    12%
101,280   77,280   8,892.60   77,380   15.00    8,907.60    [8,904.60]   8,904.60    12%
101,290   77,290   8,893.80   77,390   15.00    8,908.80    [8,905.80]   8,905.80    12%

101,300   77,300   8,895.00   77,400   15.00    8,910.00    [8,907.00]   8,907.00    22%
101,310   77,310   8,896.20   77,410   15.00    8,911.20    [8,909.20]   8,909.20    22%
101,320   77,320   8,897.40   77,420   15.00    8,912.40    [8,911.40]   8,911.40    22%

101,330   77,330   8,898.60   77,430   15.00   [8,913.60]   [8,913.60]   8,913.60    12%
101,340   77,340   8,899.80   77,440   15.00   [8,914.80]    8,915.80    8,914.80    12%
101,350   77,350   8,901.00   77,450   15.00   [8,916.00]    8,918.00    8,916.00    12%
101,360   77,360   8,902.20   77,460   15.00   [8,917.20]    8,920.20    8,917.20    12%
101,370   77,370   8,903.40   77,470   15.00   [8,918.40]    8,922.40    8,918.40    12%
101,380   77,380   8,904.60   77,480   15.00   [8,919.60]    8,924.60    8,919.60    12%
101,390   77,390   8,905.80   77,490   15.00   [8,920.80]    8,926.80    8,920.80    12%

101,400   77,400   8,907.00   77,500   15.00   [8,922.00]    8,929.00    8,922.00    22%
101,410   77,410   8,909.20   77,510   15.00   [8,924.20]    8,931.20    8,924.20    22%
101,420   77,420   8,911.40   77,520   15.00   [8,926.40]    8,933.40    8,926.40    22%
101,430   77,430   8,913.60   77,530   15.00   [8,928.60]    8,935.60    8,928.60    22%
101,440   77,440   8,915.80   77,540   15.00   [8,930.80]    8,937.80    8,930.80    22%
101,450   77,450   8,918.00   77,550   15.00   [8,933.00]    8,940.00    8,933.00    22%
101,460   77,460   8,920.20   77,560   15.00   [8,935.20]    8,942.20    8,935.20    22%
101,470   77,470   8,922.40   77,570   15.00   [8,937.40]    8,944.40    8,937.40    22%
101,480   77,480   8,924.60   77,580   15.00   [8,939.60]    8,946.60    8,939.60    22%
101,490   77,490   8,926.80   77,590   15.00   [8,941.80]    8,948.80    8,941.80    22%
101,500   77,500   8,929.00   77,600   15.00   [8,944.00]    8,951.00    8,944.00    22%
* I say this is of no practical use because
  • A filer is unlikely to have such a small LTCG and at the same time have total taxable income so close to the 22% bracket.
  • While I compute tax to the penny using the tax brackets, IRS rules require using tax tables when taxable income is less than $100,000.
  • Congress may very well eliminate the $200 difference between the 22% ordinary income bracket and the 15% LTCG bracket.

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FiveK
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Re: Long-term gains and Tax Bracket

Post by FiveK » Thu Jun 14, 2018 4:54 pm

FiveK wrote:
Wed Jun 13, 2018 8:41 pm
Note this is using the Tax Computation Worksheet formulas. The picture using Tax Tables would be more jagged.
#Cruncher wrote:
Thu Jun 14, 2018 4:38 pm
While I compute tax to the penny using the tax brackets, IRS rules require using tax tables when taxable income is less than $100,000.
Yes. I thought about modifying that spreadsheet to use the tax tables just for ~$77K to $77.5K but couldn't find a 2018 version and, as you say, the practical use is low.... :)

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JoMoney
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Re: Long-term gains and Tax Bracket

Post by JoMoney » Thu Jun 14, 2018 5:31 pm

bh7785 wrote:
Tue Jun 12, 2018 3:25 pm
...
For example, say I'm a single earner for 2018, and I only have a W-2 for $10,000, and LTG (long-term gains) of $50,000. This puts me in the 22% bracket. How much tax would I owe in this overly-simplified example? More specifically, how is the W-2 taxed?...
Others have given you a solid answer with regard to income tax... but don't forget that the W-2 / Earned Income will also have social security and medicare ( 6.2% + 2.9% )
https://www.thebalance.com/earned-incom ... me-2388998
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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