@pilkman4b - Unfortunately the situation is a lot more complicated than you or I would like. At this point I can't give you an exact calculation of your 2018 tax.
One of the complications is that the IRS has not yet published the forms and instructions for calculating the tax on long-term capital gains for 2018. To answer your question about the "takeaway" I have to make a guess about how it will work, based on the way the tax on long-term capital gains is calculated for 2017 and earlier. Based on that I would say that the "takeaway" that you described is not exactly right. I can't give you exact figures because of some other complications, but it's clear that your taxable income will be less than your long-term gain. See below for some details on taxable income. Again, based on the way the calculation is done for 2017, the royalty income will effectively drop out, and all of your taxable income will be treated as long-term gain. In other words, you won't pay any income tax on the royalty income. There will be no tax on the first $77,200 of taxable income, and the rest will be taxed at 15%.
There are two complications in calculating your taxable income, because the information you have provided is incomplete. First of all, you have not said how old your wife is.
Another complication is that we don't know the nature of your royalty income. You didn't say whether you are the author of the works that you are getting royalties for, or someone else is the author. If you are the author, it is probably self-employment income, and therefore subject to self-employment tax in addition to regular income tax. There is an exception if you only ever wrote one book, as a sideline, and never revised it. If you are not the author - you are collecting royalties on works written by someone else - then it is not self-employment income. (And by the way, if the royalties are not self-employment income, they are not "earned income.") If it is self-employment income, there is an adjustment that affects your taxable income, based on the amount of self-employment tax.
Adding another complication, you said "we will get the next $91,000 in Long Term Capital Gains tax free, and we will pay 15% tax on the next $17,000?" But $91,000 plus $17,000 is only $108,000. You said your long-term gain was $118,000. I suspect that you subtracted the $10,000 of royalties twice. I will assume that $118,000 is the correct amount of long-term gain.
Here's an example of how taxable income would be calculated, but these figures might not be accurate for your situation, because of the complications I have described. The example is based on the following assumptions.
Married filing jointly. Taxpayer is over 65, spouse is under 65.
Royalties of $10,000 are self-employment income.
Long-term capital gain of $118,000.
No other income.
Standard deduction.
Taxable income is total income minus adjustments and the standard deduction.
Total income: $10,000 + $118,000 = $128,000
Adjustment, 1/2 of self-employment tax: - $707
Standard deduction (for one spouse over 65): - $25,300
Taxable income: $101,993
In this example, and based on my assumption about how the tax would be calculated, the income tax would be $3,719.
$101,993 - $77,200 = $24,793
$24,793 x 15% = $3,719
The self-employment tax on $10,000 is $1,413, so the total tax would be $3,719 + $1,413 = $5,132.
To go back to your original question, taking more capital gains will never make the first $77,200 taxable, as long as you don't have any other ordinary income. But if you take enough capital gains you will hit the top of the 15% bracket and any additional long-term gain will be taxed at 20%. In addition, long before you hit the 20% bracket, when your Adjusted Gross Income (AGI) goes over $250,000 you will run into the Net Investment Income Tax which is an additional 3.8% tax on the investment income. Simplifying some complicated rules based on your particular situation, and assuming that the royalties are self-employment income, the additional 3.8% tax would apply to all your capital gains over $240,707.
Also note, as fanfare pointed out, that unless you are in a state with no income tax, your state tax will quite likely treat the long-term gain differently from the way the federal tax treats it.
I wish I could refer you to a web site or software that you could use to calculate your 2018 tax under different scenarios. But I haven't found one that takes all the factors into account and does the calculation correctly. Considering the amount of money involved, it might be worth it to you to consult a local tax professional who could give you detailed information about the effect of taking more capital gains.
