Still confused on Capital Gains (long) Tax.

[heather64]

Hi, again. I’ve sought answers here before and you all have been wonderful. I am utterly confused!

I am in NC where long term (CG) capital gains would be taxed as general income at a flat 5.25% rate.

Federally, I’m lost. We are married, filing jointly. Our income is well below the O% capital gains tax rate on (LT) long-term shares (for 2023, 0% up to a combined income of $89,250.)

I understand LT CG “cannot push you into a higher tax bracket.” I understand LT CG are taxes (if at all) separate from income, and are addressed on the 1040 schedule D.

Yet, when I look to validate this, I’m finding conflicting info. When I try the numerous CG tax calculators (knowing they’re flawed, but wanting an idea), they are ALL taxing me at a rate which indicates the CG are added to our income, and taxing us NOT at the 0% federal tax rate for LT CG, but at the next tier. Some of these calculators go so far as to ask for 401k contributions (~$1k), number of kids (2), itemized deductions (we’ll take standard deduction, etc…

There is no capital gains tax in North Carolina; the gains are included as income and taxed at the flat income tax rate of 5.25%. 

I feel like many articles and even responses split hairs in a way that leaves me not understanding what is probably quite simple. 

So, married, filing jointly in NC. Income is well under the threshold (of $89,250) affording a 0% federal tax rate on LT CG.

Where am I going wrong?

Simply put, if our income is so low, and we fall within the 0% LT CG tax rate:

1) do we indeed pay ZERO federal taxes on the LT gains?

2) is there a max/limit on how much stock we can sell at 0% federal tax?

3) do the capital gains ACTUALLY end up bumping us up to a new tax bracket (despite what I wrote above and have read many times), and in that case, are we subjected to LT CG tax after all?

For round numbers as an illustration… let’s assume our joint income is $50k. Assume we sell all of our stock for $100k in long term capital GAINS. Our income is taxed normally, then NC would tax us at a flat 5.75% rate on those gains. However, wouldn’t the federal income tax on the entirety of the gains (all $100k) be taxed at 0% due to our low income and the LT CG tax rates for 2023?

Please help! It’s got to be simple, but I have read a concerning number of articles from seemingly reputable financial agencies and tax agencies, and info in the forums, that tell me I’ve got this all wrong. And if I do t have it wrong, why can’t I find a single tax calculator/estimator whose output is 0% for the LT CG. 

Thank you in advance!

[rjs]

On your federal tax return, long-term capital gain will not push your ordinary income into a higher tax bracket.

The tax rate on your long-term capital gain is determined by your total taxable income, including the long-term gain.

In your example, some of the long-term capital gain will be taxed at the 15% rate because your total taxable income, including the capital gain, will be more than $89,250. But you have to calculate your taxable income. Taxable income is your total income minus adjustments (if any) and either itemized deductions or the standard deduction. We can't calculate the tax because you have not given enough information to calculate the taxable income.

[Mike9241]

@heather64 you are not correct ordinary income can push LT capital gains from being taxed a 0% to being taxed at a higher %

examples for 2023 using standard deduction

1) $40K ordinary income

$70K of LTCG

tax is about $1200 and only the ordinary income is being taxed

2) $50K of ordinary income

$70K of LTCG 

tax is now about $2700

that $10K of additional  ordinary income gets taxed at 10% 

however that additional $10K pushes over $3K of capital gains into the 15% bracket

a recap of tax a) taxable income 50K + 70K less std deduction of 27.7K = 92.3K

                          b) LTCG 70K

                          c) a-b =  22.3K

                          d) LTCG exclusion 89.25K

                          e) d-c LTCG taxed a 0% 66.95K

                          f) b-e LTCG taxed at 15% 3.05K

                          g) tax on ordinary income of 22.3K using tax tables

[Hal_Al]

Among your work sheets, you will have a "Qualified Dividends and Capital Gains Worksheet"* (abbreviated "Qual Div/Cap Gn" on the forms list) showing the tax calculation.

In particular, note lines 9 (the amount of LTCG taxed at 0%) and line 18 (the amount taxed at 15%). 

https://media.hrblock.com/media/KnowledgeDevelopment/ITC/2023Forms/2022_Qualified_Dividends_and_Capi...

*For more complicated returns you will get the "Schedule D Tax Worksheet" (abbreviated "Schedule D Tax").

[heather64]

Thank you, @Mike9241, @Hal_Al & @rjs! Your clarifications were very helpful. I particularly appreciate the breakdown to help me understand the process and sequence (it’s how my brain works things out).

To reiterate my understanding, LTCG CAN push you into a higher tax bracket in the sense that it becomes a part of your total income. However, those LT CGs will NOT put your income (itself) into a higher tax bracket. Income is first taxed at its respective rate, then we add gains, and the tax rate for the LT CG corresponds to what the CG + income puts me in. 

The LTCG are taxed in ‘tiers (not sure the right word), where the delta to get from our income up to the $89.25K, has a 0% tax rate, but the amount that puts us between $89.25K and the next ‘tier’ are taxed at 15%… (Darn, now the flat income tax the state applies is sounding better than the federal rates.)

At the risk of sounding like a mooch for your help and expertise, one of you mentioned “adjustments” which could impact taxable income, along with deductions. We do not have daily childcare to deduct, only $900 in FSA childcare deductions for camp, about $1k in 401k contributions, $300 in educator expenses (teacher), <$10k in HSA contributions, and zero student loan interest or tuition. Together, our gross income is around $70k. We will take the standard deduction of $25,500 vs itemized given the above numbers.

OTHER DEDUCTIONS: 

• I MAY have enough out of pocket medical expenses to deduct, but I’ll determine that when I file… I have to audit it for our family and am not sure we meet the 7.5% against our $70k gross income - we have a HDHP, and I believe we MAY have had out of pocket expenses >$7K which may be deducted… tbd. For my math below, let’s assume I can’t deduct medical expenses.
• We also can deduct our mortgage interest, as well as $4k ($2k x 2 kids) in child tax credit (plus I think there’s some portion of refund for child tax?), but I do NOT think those impact our taxable income. Please let me know if I’m wrong on that.

As I work through my understanding and the math, I have 5 questions/thoughts I would be very grateful for your expertise to verify (or correct) how I’m processing and applying what I understand:

Question 1: does the medical expense deduction, if any, qualify based on whether it >7.5% of our gross income (income before deductions, and excluding any LT CG)?

Question 2: Am I correct in my understanding that the standard $25.5k deduction REPLACES individual deductions [i.e. FSA, HSA, edu expense, 401k, and (if any) medical expenses >$7.5% of gross (?) income?]

Question 3: Would I then take gross income of $70k, and simply deduct the standard deduction of $25.5k, to reach my taxable income amount of $44.5k?

Question 4: IF Q3 is correct, does that mean I can trade stock with LT gains up to $44,700 for 0% LT CG Tax, before NC’s flat 4.5% income tax rate applied to all LTCG?

[Calculated using cap for 0% fed LT CG tier of $89.25K - $44.5K of taxable income = $44.75K in LT CG taxed at 0%.]

Question 5: IF Q4 is correct, then any LT CG BEYOND $44.75K (up to max for that tier, which I won’t hit), is taxed at 15%?

[Q5 Example: if above is correct, and if I sold with LT CG of $100k, $44.7k of that has 0% fed tax, and the remaining $55.25K would be taxed at 15%. This example, with taxable income assumed at $44.5K, would leave me owing $8,287.5 in federal LT CG (calc’d at 15% of $55.25K), PLUS $4,500 in state taxes (calc’d using all $100k of example’s LT gains, at flat NC rate of 4.5%.)]

Thank you, all, again! I appreciate your help!

[rjs]

Question 1: No. The medical expense deduction is the expenses in excess of 7.5% of Adjusted Gross Income (AGI), which is Form 1040 line 11. AGI includes the long-term capital gains.

Adjustments to income are listed in Part II of Schedule 1, and the total adjustments from Schedule 1 are on Form 1040 line 10. Adjusted Gross Income (line 12) is the total income on line 9 minus the adjustments on line 10.

Question 2: Yes, the standard deduction replaces itemized deductions. Medical expenses and mortgage interest are itemized deductions.

HSA contributions and educator expenses are adjustments, not deductions. They have nothing to do with whether you take itemized deductions or the standard deduction.

A dependent care FSA and 401(k) contributions are not deductions.

If you have dependent care FSA benefits in box 10 of your W-2, that amount is already excluded from the wages on your W-2. If you actually used it for child care (day camp) it will not affect your taxable income.

401(k) contributions shown with code D in box 12 of your W-2 are already excluded from the wages on your W-2, so they are not included in your taxable income.

Question 3: You take your Adjusted Gross Income and deduct the standard deduction (or itemized deductions) to get your taxable income.

Why don't you just start entering your information into TurboTax and see how it works out? If you enter estimated amounts, you can go back and change them later when you have the final amounts. If you use the CD/Download TurboTax software, not TurboTax Online, you will be able to see the details on the forms as you go.

[Opus 17]

For round numbers as an illustration… let’s assume our joint income is $50k. Assume we sell all of our stock for $100k in long term capital GAINS. Our income is taxed normally, then NC would tax us at a flat 5.75% rate on those gains. However, wouldn’t the federal income tax on the entirety of the gains (all $100k) be taxed at 0% due to our low income and the LT CG tax rates for 2023?

This is how it works for federal taxes.

With married filing jointly, and $50K of income, you get a standard deduction of $27,700, so your taxable income is $22,300.  The top of the 12% ordinary income tax bracket is $89,450.

That means that the first $67,150 of long term gains is taxed at 0% (because $89,450 minus $22,300 equals $67,150).  Any capital gains on top of that will be taxed at 15%, since your total taxable income is above $89,450 and therefore in the "regular" 22% bracket, so your LTCG rate is 15% on that part of your gain.  But the capital gains does not push your regular income into the 22% bracket.  

[heather64]

Thank you! Super helpful! I’m very appreciative and will start pre filling.