determining tax rates

the calculator suggested my refund next year will be 9k (6k higher than this year).

I assume the $1200 check is taken from the 9k?

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Neither. It's determined by taxable income (AGI minus std/itemized deduction minus personal exemptions).

Nothing special. Any "excess" deductions are taken at the next lower bracket.

For example, lets say the 15%/25% border is at $60,000 of taxable income, your AGI is $70,000 and you have $15,000 of deductions and exemptions. The first $10,000 of that is "taken" at 25% and the last $5,000 is "taken" at 15%.

Just remember that there's nothing special that happens when you "drop" into a lower bracket. Just like there's nothing special when you get into a higher one. Many people (I don't know if you are one) think that when they go into a higher bracket ALL their taxable income is taxed at the new bracket and therefore they (mistakenly) obsess about getting back into a lower bracket. If you're at the very end of the

15% bracket and then make an additional $100, you'll pay an additional $25 in tax, since that $100 is in the 25% bracket. Being in the 25% bracket has no effect on the money that fell into the 10% and 15% brackets.

Effective tax rate is a pretty meaningless number. I suppose it might give you some information retrospectively, but it gives you no information on how to act. Your marginal rate is what drives decisionmaking.

-- Rich Carreiro snipped-for-privacy@rlcarr.com

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Rich- thank you for a detailed and well thought out post. I know how marginal rates work, but do not fully understand the deduction process and where that fit into AGI.

thx.

still learning.

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Jim, I think Rich answered your Q's, let me add a couple things. Yes it's taxable income (line 43 of Form 1040), not AGI, that determines your tax bracket. AGI is the last line on the front page of 1040 and while some things are tied to that figure, AGI doesn't determine your tax bracket. So I think you mean "taxable income" when you say that your AGI was 63330, correct? That would explain why Turbotax said that you got back 25% of your mortgage interest. (no income tax in Ohio?)

If you're using this 25% figure to determine the true cost of your mortgage interest (when deciding whether to pay it off sooner, or refinance), keep in mind that you would have gotten the standard deduction anyway, which was $10,700 in 2007. So look at your itemized deductions in total, and if they're say $12,000 then only the last $1,300 actually netted you a tax benefit. If you were mid-25% bracket with AGI and ended up at 63330 for taxable income, you have some very large itemized deductions, so that isn't much of a factor.

You mentioned a personal deduction for unreimbursed business expenses -- sounds like you filed Schedule C this year? If so that's always an area with potential for reducing tax liability, by turning personal expenses into business expenses (for legitimate items only of course). For example, exclusive use of a room in the home for business.

-Tad

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To make matters worse, it's not your taxable income that determines your tax bracket, but only part of it - the part that's taxable as ordinary income. See the next line of the 1040 tax form, line 44 (tax amount), and the instructions for it on pp. 33-35 of the instruction book.

If you have qualified dividends or long term capital gains*, you'll subtract them off (they're taxed at a nominal 5%/15%). It's only the remaining amount, this "ordinary income", that is taxed according to the usual tax brackets.

(*) There are more obscure forms of income that may be subtracted off, such as gains on collectibles (though if you own ETFs structured as grantor trusts, like GLD, you may be familiar with this one).

Mark Freeland snipped-for-privacy@sbcglobal.net

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jIM, it's line 43 (from 2006 form, should be same this year) "taxable income" that tells me your rate. $63,700 was the cutoff for 15% in 2007.

I'd monitor income and exemptions (congrats on the June twins!) and try to stay right at that 15% cutoff. You see, if you are already under 25%, the Roth does make more sense, as you've probably considered. If you were above the cutoff, a deductible IRA is what I'd choose. A bit of a game, I admit, but if you can maximize 15% income each year, and in a low income year, maybe convert from pre-tax to Roth, you'll keep saving that 10% hit. It adds up. Paying property tax earlier (e.g. December vs January) may also help you.

JOE

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Mortgage interest was above 20k. There are Ohio taxes (we owed the state $200). This was first time in 5 or 6 years where the viscious cycle ended (cycle was to claim more exemptions following year to withhold less federal and then a seperate modification to add more to state withholdings-to reduce the tax owed, yet the federal refund kept getting bigger and we always owed the state more for about 5 straight years).

This was first time in years we did not owe Ohio more than $500.

I appreciate the reponses of everyone. Thank You.

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Joe- based on comments above, it appears AGI being below 15% bracket cap is not really the issue. Are you suggesting otherwise?

According to calculator Elle provided, the refund next year would be

9k. The plan is to change witholdings in wife's paycheck (she currently claims 1 or 0), as I claim 7 now, and my 401k contributions and SS contributions are higher than the actual federal tax withheld from my check.

Are you suggesting to use a non deducatable IRA in place of the Roth?

Thank you for input thus far.

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From the $63,330 AGI, what was the line 43, taxable income? I think for someone on the edge each year, you might consider this approach: Deductible IRA for 25% money, Roth for 15% money. You are not in the middle of the 25%, it starts at $63.7K and ends at $128.5K.

For 2007, if I had my way, your line 43 would show exactly $63,700. Your last dollar would be taxed at 15%. See

see the rates in a nice chart. (I've been accused of paying too much attention to taxes with such proposal of micromanaging these efforts. But consider - If you take $10K pretax, when you are in the 25% bracket (if that were the case), but convert it in a year at 15%, you just found yourself $1000 richer. That sounds like nearly a week's take home pay. Nothing to dismiss offhand. Happy to discuss further if you wish more clarification.

JOE

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See

to see the rates in a nice chart.>

Because I have a 401k, doesn't that take the deductable IRA off the table?

401k contribution for me is 11% (match is capped after 6%). Wife's 401k is 6% (maxes to match). Both Roths are maxed out for the most part. Wife will max 2008 for first time, 2007 we missed maxing by two or three months.

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Specific to your 401(k) issue - Your ability to deduct the IRAs is scaled, full deduction at AGI of $83K, no deduction at $103K (these are

2008 numbers, 07 was just a K or so lower). So all your options are open. I prefer the deductible IRA to 401(k) deposits beyond match, in general, if that's the choice you must make. You then have the conversion trick if you're so inclined.

BTW - your exemptions go from ($3400 x 2) in 2007 to ($3500 x 4) in

2008. i.e. your taxable income will drop due to the new bundles of joy. Good questions/ concerns, keep them coming. JOE

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Very good point! If you have that kind of income, the tax bracket is set by line 43 minus your dividends & capital gains. With those potential

0%-tax scenarios we discussed in Rich's recent thread on LTCGs.

-Tad

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Jim - one possible source of that vicious cycle is your itemized deductions. It sounds like each year you were paying more and more state income tax, and perhaps property tax was going up as well. But your property tax and state income taxes paid are deductible only on your federal return, not on your state return. So there can be big discrepancies between your state taxable income and your federal taxable income (state is higher, by the sum of your property tax and state income taxes paid in prior year) and you need to claim different exemption amounts for state and federal withholding.

Some other federal-to-state adjustments can cause this as well but on the typical tax return (for someone who itemizes) it's property tax and state income taxes.

-Tad

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Jim, I hate to do this to you but you may be in AMT for 2008. Meaning that 15% bracket might not apply.

I guessed at a couple numbers based on your post and it appears you are, with 4 exemptions, and the state-tax itemized deductions (income + property taxes) - this is one of the classic scenarios for AMT. It depends on your specifics though. If it does kick in then there will be a range where your marginal dollar is taxed at 26% + your state tax, not the expected 15% + state taxes. That extra 11% may make a difference in your 401k and IRA decisions.

But...the AMT has been "patched" each year so that millions of individuals like yourself (home + kids) don't get hit by it. If it was amended the same way as it was in 2007, you would no longer be in AMT. So you might not know the best tax planning for 2008 until an AMT bill is passed (or isn't). In 2007 this made tax planning difficult because the patch wasn't passed until December, when it was too late to adjust

401k contribution rates accordingly.

-Tad

PS Will are you out there? This is one of those multi-rate scenarios that is hard to see until you run it in tax software...if he had LTCGs to realize, Jim could easily bridge 0% through 30%+ marginal rates through different combinations of LTCGs, 401k deferral rates, and the timing of any property tax or state estimated tax payments. Even with relatively low LTCGs and under-$10k shifts in these different items.

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Help me again on the deductable IRA (we are talking a traditional IRA which lowers taxable income similar to 401k). my understanding (based on reading years ago) was that if a person is covered by a 401k plan (or other qualified retirement plan), they cannot DEDUCT the traditional IRA contributions.

pub 590

"This is the most that can be contributed regardless of whether the contributions are to one or more traditional IRAs or whether all or part of the contributions are nondeductible. (See Nondeductible Contributions, later.) Qualified reservist repayments do not affect this limit. "

"How Much Can You Deduct? Generally, you can deduct the lesser of:

The contributions to your traditional IRA for the year, or

The general limit (or the spousal IRA limit, if applicable) explained earlier under How Much Can Be Contributed.

However, if you or your spouse was covered by an employer retirement plan, you may not be able to deduct this amount. See Limit if Covered by Employer Plan, later. "

AND THE KICKER: "Full deduction. If neither you nor your spouse was covered for any part of the year by an employer retirement plan, you can take a deduction for total contributions to one or more of your traditional IRAs of up to the lesser of: $4,000 ($5,000 if you are age 50 or older), or

100% of your compensation."

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In effort of full disclosure, here is 401k/Roth/Rollover holdings

160k combined between wife and I.

Each of us has a 401k (mine is 4X size of wife's) Each of us has a Roth (mine is 10X the size of wife's) Each of us has a rollover. My rollover is quite large (90k of the

160k combined).

does size matter? rhetorical question. I think it does, but really doesn't matter for that portion of discussion.

If we need to talk about Roth conversions. I tried converting the rollover (3.6k) to a Roth in Aug of 2005. Last tax season I had to recharactorize because AGI was too high for a conversion (100k limits for conversion, 150k limit to contribute).

In November of 2007 I rolled a portion of my 401k into same rollover IRA, so now the rollover has 90k which could be considered for conversion.

In Sept of 05 we sold a condo and moved to an apartment. In dec of 05 we moved into a much bigger house. There was a reason the conversion did not work (that year) as less mortgage interest made more income taxable.

Maybe I need to rethink the entire rollover (I was considering leaving it as a rollover).

I do want some IRA assets I can 72(t) on in about 18 years- if needed. I think retirement for me is in 18 years (age 53).

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First, I bet anyone with lots of tax knowledge is real busy this time of year. So thank you for chiming in here during your busy season.

Second, what would trigger AMT in my case (specifically) and is there a way to avoid it? I also have a second business (I coach soccer teams) and could really look for some writeoffs here if that would help avoid AMT.

We have one taxable investment- PRPFX. We use this as our "mortgage paydown fund" where instead of paying down mortgage, we invest the extra payments. This has about $1000 in it (we just opened it this month).

401k- I contribute 11%, and max out my Roth (5k for 2008). If I put the 5k into my 401k, would that avoid AMT (by reducing taxable income). My 401k contributions last year were north of 7k.

What exactly would AMT do to me (tax me at a higher rate?). Where does AMT kick in?

thx again for replies.

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Tax year changes for 2008 relative to now:

1) twins coming (two more deductions) 2) wife's income will drop. She is out on bedrest now, disability will end in 11 weeks, then she gets paid 2/3 of what she makes now. 3) more interest. I created a cash based account for an emergency fund in late 2007. $35 in interest for 2007, I think. In 2008 we have 12k in 3 CDs on a 90 day ladder. I am expecting interest in neighborhood of $200-$500 for 2008. I'd like it to be $500, but with rates going down, probably not. 4) here are lines from tax return (for anyone wanting to make an academic study out of this): I pulled this out of turbo tax, so not sure of lines on the return these came from.

income 103k deductions 28k, taxes paid 16k

summary from TT: AGI 103k taxable income $63k total tax 8k tax paid 11k refund was 3k

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I think the reasons for AMT in 2008, given your income level, are your 4 exemptions, plus state income tax and property taxes.

You can't change your exemptions, but if you can shift the timing of state tax payments it can reduce AMT. Not everyone can do that but the basic idea is shifting payments into non-AMT years. Pay a shortfall in

2007 Ohio income taxes during 2007, for example, instead of when filing in April 2008. Some people can shift their property tax payments forward or back in a similar manner. The goal is, reduce the state taxes that are actually paid (by withholding or by check) during AMT years.

If you increase your 401k contributions enough, you should get your income below the range where AMT kicks in. For 4 exemptions I think that should happen somewhere around the $88k level for your net earned income (roughly: salaries, plus Schedule-C net income, minus 401k contributions and 1/2 of your Self employment taxes). But it depends on your exact itemized deductions. And really other things factor into 401k contribution rates...if you're in AMT you just work under the assumption that a dollar of deferral saves you 26 cents in federal taxes (even if you're nominally in the 15% tax bracket).

Again, I want to emphasize that this could all go "poof" with another AMT relief bill, and that is probably your best hope for 2008. The 2007 AMT exemption levels were more than enough to get you out of it. Maybe eyeball all this in August-Sept and see if you should shift gears then. Really the only place you can have much impact is higher 401k deferrals, for your primary jobs or perhaps for the coaching biz if it produces enough income.

-Tad

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