0 Capital-Gains/0 Div Taxes 25% tax bracket?

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- Retired
  
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posted
13 years ago

Thu, Nov 18, 2010 7:12 PM

I know that if I'm in the 15% tax bracket tax I would own 0 taxes on capital-gains & qualified dividends for 2010. But what happens if I slip into the 25% tax bracket, would I now owe taxes on the previously tax free capital-gains/dividends? The reason for this question is I'm converting part of my IRA's to a ROTH and need to know how much I should convert. In other words will I owe more taxes only on the portion of my income that puts me in the

25% bracket or in addition, now pay 15% on capital-gains/dividends that stayed in the 15% bracket. For instance married couple $60,000 income Including IRA to Roth Conversion $8000 capital-gains & qualified dividends = 0 Taxes or $62,000 income Including IRA to Roth Conversion $8000 capital-gains & qualified dividends = how much in taxes? What would we pay the 25% rate on? Is there a simple calculator or formula that would help me? Thank you Phil Phil

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- Luka
  
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posted
13 years ago

Thu, Nov 18, 2010 7:45 PM

You will owe 15% tax on any capital gains/qualified dividends that fall into the 25% bracket and no tax on the portion that is still in the 15% bracket.

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posted
13 years ago

Fri, Nov 19, 2010 1:00 AM

Note that the marginal tax rate you EFFECTIVELY pay for every dollar that goes into the 25% bracket is really 30%. That's because (assuming your cap-gains and qualified dividends have spilled into the 25% bracket), for each additional dollar of ordinary income (from your Roth conversion, for instance) you'll pay 15% on that dollar (assuming it's still in the 15% bracket) and 15% on the dollar of cap-gain/qual-div you pushed from the 15% bracket (where it was taxed at 0%) into the 25% bracket (where it's taxed at 15%). So

15% + 15% = 30%. I guess it's a little confusing and maybe counter-intuitive, but test it out on Turbotax and you'll see (Turbotax is great for this kind of "what if").

There's a fairly simple solution to your problem. Roth convert MORE than enough to put you into the 25% bracket, regardless of how the rest of the year pans out. Then, before you file your return, recharacterize EXACTLY as much as it takes to get you back into the 15% bracket. That way you get every possible dollar converted at the 15% rate, and none at the effectively-30% rate.

If you want to get fancy, do two such conversions, of uncorrelated asset classes (eg. stocks & bonds), into separate Roth accounts (and separate from your "main" Roth too). File a "request for extension" in April 2011 (paying as much as you THINK you'll owe). In October 2011, recharacterize whatever it takes to get you back into the 15% bracket. Recharacterize the poorer performing of the two uncorrelated conversions. But I'm getting into a whole new topic - that of "gaming" the Roth IRA conversion process - which you're probably not interested in (unless you're as big a geek as me).