A convoluted Phase Out question

I've studied how the effect of taxation of Social Security benefits can create a phantom 46.25% 'bracket' for a single who would otherwise be at

25%. And I think that for those who are at a taxable income in that sweat spot, a bit of maneuvering pre-retirement and just after can help mitigate the lifetime tax bill of a retiree.

I am now in the midst of an analysis in which three phaseouts are all in play and am trying to understand the best outcome. This is for 2013, and the variability is based on a Roth conversion which will be partially undone to achieve the desired taxable income for 2013.

By way of introduction, this is a joint return, the couple has Schedule E real estate losses that were carried forward until now, nearly $100K accumulated. Also $8000 worth of AMT that shows as forwarded from 2012.

Now for the numbers -

A $14,000 conversion results in a taxable $65,164 and tax bill of $3822. AMT credit $4062, Child Tax Credit $1000.

A $28,000 conversion results in a taxable $86,164 and tax bill of $9282. AMT credit $4119, Child Tax Credit $0.

You see that the taxable number crossed the 25% bracket, but I did this in $1000 increments, and the change was the same. I understood the real estate loss phaseout as AGI was over $100K, so this incremental $14,000 was a delta of $21,000 in taxable income. The AMT and Child Credit drop as well over this range.

In trying to decide on the optimum number, I note that the AMT and Real Estate loss carry forward. But the Child Tax Credit is lost any year it's not taken. So my gut says to stop exactly at the pint where the child credit is left in tact, at $1000. Absent the other two phaseouts this $1000 over the $14 range is a 7% marginal tax I can help avoid for the remaining year the child helps the couple qualify (i.e. it's 2013 &

14, child will turn 17 in '15, so this issue evaporates.)

Once the Child Tax credit is gone and AMT is 'used up' the yearly analysis should get much simpler.

Reply to
JoeTaxpayer
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What does it look like with no Roth conversion at all? Is there any long-term gain or QDI? There's a child tax credit, is there a dependent care credit too?

-Tad

Reply to
Tad Borek

Added 'no conversion' above. No gains. $3000 loss for the next decade or two thanks to the crash of '08. Child is 15, no care paid for. And the credit looks like it's just this year and next. Tax on $44164 showed as $5734 wiped away by credits. Just $4000 conversion leaves zero tax, but the $14000 conversion is the limit to not lose the child tax credit.

It's pretty odd to see an incremental $1000 creating an immediate 39% phantom rate. Literally, from 0 to 39. If I didn't mention - the child credit is gone in '15, as will be the leftover AMT. The only oddity left will be the real estate loss phaseout. Which I at least can get my arms around.

Reply to
JoeTaxpayer

It's not though, because it sounds like you have high credits to use up. If the credits are nonrefundable, you don't see a refund that gets smaller as you increase income, you just see $0 due for a wide range of income inputs. Then with credits used up, you see what bracket that marginal dollar of income is actually sitting in. If you looked at the total tax before credits, it would look less steppy. In this specific scenario, it sounds, your incremental dollar of income happens to get amplified by the reduction in above-the-line real estate loss deductions, and then loss of the child tax credit. Maybe other things, but just the PALs would be enough to explain most of it.

Seems the safe plan would be to covert $4k only, given the numbers you're stating. Against that zero-tax baseline, going up to $14k means voluntarily paying $3822, or 38.2% tax, on $10,000 of IRA assets (is there state tax too?). Not many retirees pay that kind of marginal rate.

-Tad

Reply to
Tad Borek

Probably so. I just was wondering if I was missing something. Once the AMT is used up and the Child credit not allowed, I'd look to top off the 15% bracket each year.

Again, thanks for the discussion.

Reply to
JoeTaxpayer

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