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Reaching for the 15% Tax Bracket

by retirebyforty on April 15, 2013 · 35 comments

in investing, tax

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Whew! Tax day is almost over. This is the first year that I seriously considered hiring a professional to do our taxes. Our taxes were quite complicated this year and I spent 2-3 hours every weekend since late February to get it done. I decided to keep doing our own taxes because we will be able to plan better next year. Let me complain a bit first and then we’ll see how doing your own taxes can help you plan.

tax day rage

Tony doesn’t like April 15th

  • I had more income sources than ever in 2012 and that means more 1099s than ever.
  • The self employment tax (schedule SE) is complicated. I had to carefully go over every line of expenses and classify them.  Luckily, I kept track of all the income and expenses on a spreadsheet, so that made it much easier to deal with. Also, I depreciated some equipment over several years and have to keep track of those things.
  • Rental reporting is also similar to self employment income. I had to sit down and figure out how to categorize the cost landscaping, roof repair, lease signup fee, and more.
  • Capital gains. I sold a bunch of stocks in 2012 and the broker didn’t keep track of the basis for some of them.  One mutual fund was reinvested over many years and that made it quite difficult to figure out the cost. The search function couldn’t find these particular reinvesting transactions, so I had to dig through the last 6 years of paper and e-statements. Ugh…
  • Peer to peer lending income from Prosper.com also included $41 from a deposit bonus. They categorized this as gift and it took me a while to figure that out. Why don’t they just send a 1099 INT like all the other businesses?
  • I had some income from the short term disability insurance when I took a medical leave of absence in 2012. This income is not taxable, but it complicated the tax filing.

Anyway, it was a pain, but I finally got it done a couple of weeks ago. We reviewed it a few times and it’s finally ready to be filed. When I tried to e-file, I found out that the IRS won’t let us do it because the taxable income from the short term disability was $0. So I printed everything out and I’ll go to the post office to send them off on Monday. It’s down to the wire as usual.

I usually wait until the last week to file our taxes because we always owe the IRS and I want to delay as long as possible before sending off a check. At least this year, we only owe about $300 each to the Fed and state. Last year we owed over $3,000 altogether. That was a painful check to send.

Tax planning

While doing our own taxes was quite painful this year, it really helped us plan for next April. This year, we will have a big drop in income because I left my job and I don’t have a W2 anymore. I used H&R Block At Home and I deleted my W2 to see what our taxes might look like in 2013.

Possible 15% bracket

It turns out that we have a good chance to get down to the 15% bracket this year. All the stars will have to align, but I think we can do it.

  • Self employment – If I gross around $25,000 from self employment, we would be right around the 15% bracket cut off. To be safe, I should open a SEP IRA and use it to shelter 25% of the self employment income. $25,000 would be great because I made much less than that in 2012 online.
  • Mrs. RB40 will have to max out her 401(k) and put them in the traditional plan. She changed to 50/50 Roth/traditional earlier this year, but I’ll have to ask her to change back to 100% traditional.
  • Unless we win the lotto, our AGI (adjusted gross income) will be under $100,000. This will enable us to use all of our deferred rental losses to offset our other income. I think we will have around $20,000 to write off and this should push our AGI under $72,500 (the 15% bracket.)

Why try to get into the 15% bracket?

I’m pretty sure this will be our only chance in the next few years to get into the 15% tax bracket. The rental losses accumulated over a few years and once we write it off, we won’t have nearly as much to offset our income in future years. Still, why try so hard to get into the 15% tax bracket?

The biggest reason to get under the 15% tax bracket is the chance to reset our cost basis. If you are in the 10% or 15% tax bracket, then you won’t have to pay tax on your long term capital gain (and qualified dividend).

Let’s look at an example

I have 500 shares of Leggett & Platt (LEG) and the cost basis is around $11,000. The current value of my LEG holding is about $17,000. I can sell the stock and buy it back right away and my new cost basis will be $17,000. The wash sale rule only applies to a loss. This way, I can avoid paying the 15% tax on the $6,000 gain. That’s $900 in my pocket instead of the IRS. Also, who knows what’s going to happen with the capital gain tax rate in the future. People in the highest tax bracket (39.6%) already have to pay 20% capital gain tax. I’m sure it will roll down to the rest of us at some point with the looming federal deficit.

Caveats

There are a couple of caveats though. I would have to make sure the $6,000 long term capital gain won’t push our AGI above $72,500. If it does, then we’ll be in the 25% bracket. Also, we would have to pay the state tax anyway.  I guess that’s all right. At least the state tax is going back into the local economy.

Some good news when you don’t make as much money

I also found a few more tidbits of good news. We will be able to take advantage of the $1,000 dependent credit in 2013. Yes! We also probably should upgrade our hot water heater so we can take advantage of the home energy credit. Lastly, we will be able to contribute to the Roth IRA for the first time in a few years. We made too much money over the last few years to contribute and we won’t have that problem in 2013.

Hopefully, you finished your tax on time. What do you think about resetting the cost basis? I think it’s a great way to stick it to the IRS while we can. The capital gain tax rate is bound to go up and resetting the cost basis is one way to minimize the impact.

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{ 34 comments… read them below or add one }

Maverick April 15, 2013 at 1:29 am

Thanks for the timely thoughts, Joe. I’m thinking of pulling the trigger on early retirement in the next year and your considerations are thought provoking.

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My Financial Independence Journey April 15, 2013 at 3:01 am

Resetting your cost basis is a very interesting idea. Of course, it doesn’t look like something is really worth while unless you’re in the 15% tax bracket.

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retirebyforty April 15, 2013 at 1:44 pm

I wouldn’t do it if we’re not in the 15% tax bracket. The math doesn’t work out.

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Mike April 15, 2013 at 5:21 am

It seems like a nightmare to have go back 6 years! I can’t imagine having to do that in your position! But hopefully it pays off in the end!

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retirebyforty April 15, 2013 at 1:45 pm

It was nuts, but I figured out that they paid dividend only once per year. Then I could concentrate on finding the right statements from 2 brokers…

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Greg April 15, 2013 at 11:56 pm

I had similar with a mutual fund long ago…
Purchased by my grandmother for me when I was probably in my teens – about $2500 I think. I never paid much attention to it. But did keep the statements.
10 years later I sold it.
That would be about 12-15 years ago now.
But if I remember right, they paid monthly dividends, and were transferred once or twice in some way.
Finances aren’t my strong point, but I do remember going through 10 years of statements (and was only missing a couple!) to try to add up everything that tax year. A lot of work to figure out something that barely went up. And I’m still not even sure I needed to tally things up in the way I did.

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retirebyforty April 16, 2013 at 4:17 pm

It was a pain, but I’m glad I did it right. At least I don’t have to worry about it if the IRS decide to take a closer look…

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Glen @ Monster Piggy Bank April 15, 2013 at 5:30 am

I hate tax time, I think it gets more and more complicated every single year. In Australia our taxes aren’t due until mid year and this year I will be using a tax agent.

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retirebyforty April 15, 2013 at 1:46 pm

I’m afraid what next year is going to look like for us. I will probably have to hire a pro soon.

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SavvyFinancialLatina April 15, 2013 at 6:35 am

Taxes are so confusing. Especially when you add extra business income, rental income, and stock income.

I still don’t understand the concept of cost basis. I have read definitions and examples, but it still puzzles me.

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retirebyforty April 15, 2013 at 1:48 pm

Hi, it’s pretty easy. Cost basis is just how much the equity cost when you purchased it. The reason you need this is because you’ll have to pay tax when you sell. Just take how much sale price – cost basis and you’ll get your capital gain.

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Financial Samurai April 15, 2013 at 7:27 am

I think this is WONDERFUL news! To be able to partake in the $1,000 child credit, to pay lower taxes, to get energy credit subsidies, and to reset your cost base for your investments is awesome!

I’m trying my best to do the same thing but it is hard with my passive and deferred income. The passive losses from property will be nice. But if I don’t get it, then I hope it just raises my cost base since they are losses, to pay less taxes during sale.

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retirebyforty April 15, 2013 at 1:49 pm

I think it’s great too! It sucks to let that child tax credit pass through our hands the last two years.

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Pretired Nick April 15, 2013 at 8:01 am

It’s interesting that although I don’t have a “job” at this point, the combined salary with my wife is still pretty high, so I don’t think we could get there filing jointly. I’ll have to look into the pros and cons of filing separately to try this, I think.

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retirebyforty April 15, 2013 at 1:50 pm

I haven’t looked into filing separately. That might be one way to do it. It’s pretty complicated right? I’m not sure if we could even do it.

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William Cowie April 15, 2013 at 8:20 am

This is good insight. Fortunately, all our stocks are held in various IRAs, so it’s all sitting there on the other side of the tax wall, so to speak.

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retirebyforty April 15, 2013 at 1:50 pm

What do you have in your after tax accounts? Just cash?

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Chris April 15, 2013 at 8:23 am

I was wondering about your 0% on capital gains and how that didn’t pass the smell test. Here is what I found:

If my ordinary income puts me in the 15% tax bracket, can I receive an unlimited amount of long-term capital gain at the 0% rate?
No, the 0% rate applies only to the amount of long-term capital gain and dividend income needed to “fill up” the 15% tax bracket. For example, if your ordinary income is $4,000 below the figure that would put you in the 25% bracket and you have a $10,000 long-term capital gain, you’ll pay 0% on $4,000 of your capital gain and 15% on the rest.

Still a good deal but a little more nuanced. :)

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retirebyforty April 15, 2013 at 1:51 pm

I highlighted the Caveats section a bit more so hopefully people understand that.
That’s why you have to be careful not to go to the next bracket. If you cross the line, you’ll have to pay a bunch more tax.

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Greg April 15, 2013 at 8:46 am

Anything to keep more money away from the government is worth the effort in my eyes! If you are able to reset your cost basis along with other write-offs, that is great!

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Rich Uncle EL April 15, 2013 at 8:53 am

Great job getting complicated taxes done. I appreciate any info on how to manage the tax game better, and the cost basis idea sounds like a no brainer to me.

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John S @ Frugal Rules April 15, 2013 at 9:37 am

Interesting idea on resetting the cost basis. Generally, I would say any time you can keep money in your pocket as opposed to sending it to the Feds is a good idea in my book. I would agree that we’re likely to see the cap gain tax rate trickle down to the rest of us in the near future. I think it’s not a question of if, but when.

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krantcents April 15, 2013 at 1:04 pm

Taking advantage of the tax code is not sticking it to the IRS. It would be foolish not take advantage of every opportunity to lower your taxes. That is one good reason to have a professional do your taxes.

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GregoryT April 16, 2013 at 12:34 am

I’m a TurboTax user and it’s done me well for many years, but I hosed myself on things that past year by moving stuff around on my workstation/server. I can’t find my resulting file from last year or the year before.
It made it much easier to go from one year to the next with the transfer from last year – been doing that since 1993, and I broke the ongoing chain this year.

I can’t say I like doing taxes, but at the same time, doing them myself helps me understand a little better what kinds of things affect them and what kinds of records to keep to make doing them easier.

Typically I get a refund back – $300-$2000 – depending on how my side business does for the year. In that respect, I’d rather end up paying $1000 at tax time, because that would mean my side business pickup up :-)

I’m curious on an aspect of taxes, though…
April 15 is the deadline.
But from what I’ve come across, if you get a refund then it’s really not a deadline.
At least in California, from what I’ve read, if you get a refund, and don’t file by April 15, you get an automatic extension.
And what I read on the federal side, the deadline is the 15th, but if you get a refund, there are no penalties if you don’t file by then. So is it really a deadline, or would the IRS just prefer you don’t ever file to get your refund?

I’m a procrastinator on taxes, and I’m working on them this week, and I already know I’ll get a refund by having entered the basics. But others seem to question the option to file after April 15th, without having filed an extension.

So… aside from the govt making interest on your money, has anybody experienced any negative repurcussions by having filed late, without an extension, if they were due a refund?

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retirebyforty April 16, 2013 at 4:18 pm

That’s interesting. I didn’t know that about the automatic extension. I have never heard of this.

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Jai Catalano April 16, 2013 at 5:17 am

How did you learn to do your own taxes? Did you just do it or did you study? I feel that I have to many complications that would confuse me beyond belief. Although I am sick and tired of paying to have them done.

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retirebyforty April 16, 2013 at 4:20 pm

I just use a software. It was very easy when I just had a W2. Things got more and more complicated over the years, but not all at once.
You should try it. You’re self employed right? It’s a bit more difficult, but I’m sure you can manage it.

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Sidney Levesque April 16, 2013 at 8:11 am

I think it’s wonderful you did your own taxes. As you said, it not only saved you the expense (which can be great depending on the difficulty involved), but it made you more familiar with your money and better able to plan for next year.
Also, I wonder if a tax preparer would have taken the time you did to look into every detail, every tax break, research your capital gains in the way you did, which took you many hours? I think during the busy tax season a professional would be more likely to hurry through it to get to the next customer.

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retirebyforty April 16, 2013 at 4:22 pm

I will bring it by H&R block. I think they have a free review that the software users can take advantage of. We’ll see if they can do better.

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JC @ Passive Income Pursuit April 16, 2013 at 8:27 am

I hadn’t really thought about resetting our cost basis before. I’ll definitely have to keep that in the back of my mind for when I decide to call it quits. It’s worth it to do that because that’s a good chunk that you can keep tax free. Although very important to keep track of where you’re at in relation to the tax bracket thresholds. I think I’ll keep with the self-filing, albeit through TurboTax, until we buy a house or a rental house. At that point it’ll probably be time to at least be consulted some on our taxes.

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mary w April 16, 2013 at 11:24 am

I did something every similar in 2012. It was a bad year in real estate so my income was much less than normal given RE losses rather than income. I figured by Autumn that I would be in the 15% bracket for the 1st time at least in this century. I planned to do the same thing you did, harvest capital gains in the 0% bracket.

After talking to my CPA it was able to do less than I had hoped. I can only sorta explain why. While my taxable income was in the 60′s my modified adjusted gross income (MAGI) was over 100K. It’s MAGI not taxable income or AGI that is used to determine how much RE losses you can write-off. So at some point every dollar I was able to tax at 0% as a capital gain lost me half a dollar of real estate losses which were taxed at 15%. My CPA found the sweet spot for me based on accounting mumbo jumbo which was about half of what I had hoped to convert.

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retirebyforty April 16, 2013 at 4:24 pm

Thanks for your input. I’m pretty sure our MAGI won’t go over 100k. I’ll have to sit down and crank it out before December though.

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Brick By Brick Investing | Marvin April 16, 2013 at 9:04 pm

It’s amazing how much paperwork and headache are involved in regards to taxes when you step outside of being an employee. Glad to hear you might be able to get under 15%.

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Evan April 19, 2013 at 8:52 am

Are you incorporated?

Also, this sounds like such a pain in the ass! Why not for a couple hundred dollars regain 8 weekends?!

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