Do Dividend Income and Capital Gain Income increase which Ordinary Income tax bracket we are in?

[Think57]

Ordinary Income such as IRA RMD, Taxable Annuity Income, Interest, etc)

$150,000

Qualified Dividend Income

$30,000

Long Term Capital Gains

$30,000

For our Ordinary Income, for 2024, is our marginal Ordinary Income Tax bracket 22% or 24%?

Trying to understand if Qualified Dividend Income and Long Term Capital gains get added to our Ordinary Income to determine the marginal tax bracket for our Ordinary Income.

Understand that Qualified Dividend Income and Long Term Capital Gains tax rates are determined by our total income.  However, are those brackets marginal or "cliff" (like the IRMAA).  As in for 2024, if our total income crosses $94,050, is all of our 2024 long term capital gains taxed at 15%, or is a portion of that long term capital gain still taxed at 0% (not sure that would be calculated if that is the case).  Similarly for Qualified Dividends.

Thank you in advance as I try to understand this in trying to figure out how much Estimated Tax to pay in January 2025 for our 2024 taxes.

[Bsch4477]

While these calculators are for 2023 they should give you a good approximation answer your questions. 

https://turbotax.intuit.com/tax-tools/calculators/self-employed/?srsltid=AfmBOoohvFL7CuPE8y-frMAulwy...

[Think57]

Thanks Champ.  Took a look and seems it is not answering what I am trying to understand.  Let me try another angle:  The "Annual Taxable Income" used by the Tax Bracket Calculator to calculate the marginal tax rate, does it include Dividends and Capital Gains?

Asking because we know that the tax rates for Ordinary Income are not applied to Dividend and Capital Gains income as the latter two have a separate set of brackets for determining the income tax on those earnings.  So are the tax rates for Ordinary Income, as set forth in the "brackets", only determined by the amount of Ordinary Income we have?

Again, thanks in advance, Think57

[VolvoGirl]

Will this help?   The tax rate for qualified dividends and long-term capital gain is based on your total taxable income, including the capital gain. It's the taxable income on Form 1040 line 15.

See this discussion,
https://ttlc.intuit.com/community/after-you-file/discussion/capital-gain-tax-for-married-filing-join...

[rjs · Accepted solution]

Since the Tax Bracket Calculator does not ask about qualified dividends and long-term capital gain, I have to assume that it does not take those into consideration. You can use it to determine the marginal tax bracket for your ordinary income by entering only your taxable ordinary income.

Qualified dividends and long-term capital gain do not increase the tax on your ordinary income. They do not push ordinary income into a higher bracket. (It's the other way around. Additional ordinary income can push some of your qualified dividends and long-term capital gain into a higher bracket. Qualified dividends and long-term capital gain are "stacked" on top of ordinary income to calculate the tax.)

The brackets for qualified dividends and long-term capital gain are, in your terms, "marginal," like the brackets for ordinary income. They are not "cliff." So your qualified dividends and long-term capital gain are not necessarily all taxed at the same rate. It can straddle brackets, like ordinary income does.

Note that the tax calculation for both ordinary income and qualified dividends and long-term capital gain is based on taxable income, not total income. The tax bracket tables are based on taxable income.

You can see exactly how the tax calculation is done by looking at the Qualified Dividends and Capital Gain Tax Worksheet on page 37 of the 2023 IRS Instructions for Form 1040. The 2024 version of the worksheet is not available yet. If you want to use it to do your tax calculation you would have to adjust the amounts on lines 6 and 13 for 2024, and use the 2024 brackets for the tax calculations on lines 22 and 24.

[rjs]

You said you're trying to calculate how much estimated tax to pay in January. Instead of trying to do all the complicated calculations now, it would be much simpler and easier to wait until the TurboTax software for 2024 is available. You can then use TurboTax to do a preliminary calculation of your 2024 tax. The preliminary desktop TurboTax software will be available for download in mid to late November, and TurboTax Online will be available in early December. That still gives you plenty of time to calculate how much to pay in January.

[Think57]

Thanks rjs.  This is what I was looking for.  It will take some time to work through this material, however, I can see that what you shared will allow me to understand what I have been picking at this last week or two.  And also thanks for your suggestion to use the preliminary version of Turbo Tax for 2024 taxes to estimate my taxes.  However, having already set up a "pro forma 2024 income tax" file using Turbo Tax for 2023 with my 2024 income estimates, will continue using it knowing that the tax brackets have been adjusted for the 2024 tax year.  Thanks again, Think57.

[Think57]

Hello rjs.  Again, thanks for your response.  I have worked through Qualified Dividends and Caital Gain Tax Worksheet for Line 16.  In lines 22 and 24, based on our numbers, it had us work through the Tax Computation Worksheet.  In doing this, it appears that the tax brackets for Ordinary Income, being based on your taxable income, do include Dividend and Capital Gains income (lines 3b and 7 in Form 1040).

So I have concluded that our dividend income and capital gains income do impact which tax bracket is used for our ordinary income.

Again, thanks for your response, as it has allowed me to get the answers I needed.

[rjs]

You have to read the instructions more carefully.

Line 22 of the worksheet tells you to calculate the tax on the amount on line 5 of the worksheet, not on your total taxable income. Line 5 is your taxable income minus qualified dividends and long-term capital gain. On the Tax Computation Worksheet you use that line 5 amount, not your total taxable income. See the note at the top of the Tax Computation Worksheet:

"Note. If you are required to use this worksheet to figure the tax on an amount from another form or worksheet, such as the Qualified Dividends and Capital Gain Tax Worksheet, . . . enter the amount from that form or worksheet in column (a) of the row that applies to the amount you are looking up."

Qualified dividends are on Form 1040 line 3a, not 3b. The qualified dividends from 1040 line 3a are entered on line 2 of the worksheet, and then subtracted from the taxable income on line 1 of the worksheet.

Form 1040 line 7 is net capital gain. It is not necessarily the same as long-term capital gain. It could include short-term gain, or be reduced by short-term losses. Line 3 of the worksheet takes the long-term capital gain from Schedule D line 15 or 16.

[Think57]

Hi rjs and many thanks for your responses to my questions. 

In working through the Qualified Dividends and Capital Gains Worksheet for Line 16 in the 1040, and using the Tax Computation Worksheet, I have come to the conclusion that the Tax Bracket Calculator does take into account qualified dividends and long term capital gains.  It does this by basing the tax bracket on your Total Taxable Income Line 15 in Form 1040 which includes qualified dividends and long term capital gains.

So Qualified Dividends and Long Term Capital Gains, though taxed differently than Ordinary Income, can push the marginal tax rate for your Ordinary Income into a higher tax bracket.  

Please let me know if you think I am missing something here, or am mis-reading the instructions for completing the Qualified Dividends and Capital Gains Worksheet and using the Tax Computation Worksheet.

Thanks again, Think 57

[rjs]

One thing you seem to be missing is that you do not have just one tax bracket. You have two separate, different tax brackets, one bracket for ordinary income and another, different bracket for qualified dividends and long-term capital gain.

Another thing you are missing is that the TurboTax Tax Bracket Calculator is misleading you because it does not correctly handle your situation. The Tax Bracket Calculator shows you only one tax bracket, so it cannot possibly be right for both ordinary income and for qualified dividends and long-term capital gain. It allows you to enter only one amount for total taxable income. It does not give you any way to enter the amount of qualified dividends and long-term capital gain separately from ordinary income, so it cannot possibly correctly take into account qualified dividends and long-term capital gain. You have to just forget about the Tax Bracket Calculator. It does not have the ability to give you the information that you want. You cannot use it.

Instead of doing calculations yourself on paper, or using the TurboTax Tax Bracket Calculator, try experimenting with a very simplified test tax return either in the 2024 TurboTax software, if you have it, or using the What-If Worksheet in the 2023 TurboTax software. If you use the What-If Worksheet, check the box at the top of the column to use 2024 tax rates. Select a filing status of married filing jointly. Using the figures from your original question, enter $150,000 of ordinary income and a total of $60,000 of qualified dividends and long-term capital gains. (The specific types of income don't matter.) You will get a total tax of $25,682. Disregard any penalty.

Now add $100 of ordinary income. The tax will increase to $25,704. That's an increase of $22. You are in the 22% bracket for ordinary income. Next, remove the added $100 of ordinary income and add $100 of qualified dividends or long-term capital gain. The tax will now be $25,697, which is an increase of $15. You are in the 15% bracket for qualified dividends and long-term capital gain.

If you enter enough additional income to push your AGI over $250,000, the total tax on Form 1040 line 24 or line 62 of the What-If Worksheet will increase by more than 22% or 15%, but that's because Net Investment Income Tax (NIIT) is being added to the basic income tax. To see only the effect of the tax brackets, you have to look at the tax on Form 1040 line 16 or on line 43b of the What-If Worksheet.

You can easily play around with this simple experimental tax return. Add any amount of qualified dividends and long-term capital gains, and then add another $100 of ordinary income. You will see that the bracket for ordinary income remains 22%. Adding qualified dividends and long-term capital gains does not change the bracket for ordinary income.

I can't be sure what you might be doing wrong on the Qualified Dividends and Capital Gain Tax Worksheet because I can't see your worksheet. But I suspect that you are not calculating line 22 correctly. You said that using the Tax Computation Worksheet "it appears that the tax brackets for Ordinary Income [are] based on your taxable income." That's wrong, and it suggests that you are not carefully following the instructions. There's a key point that is not actually in the instructions for the worksheet, but in the Note at the top of the Tax Computation Worksheet. Line 22 tells you to use the Tax Computation Worksheet to calculate the tax "on the amount on line 5" of the Qualified Dividends and Capital Gain Tax Worksheet. When you do that, what you have to enter on the Tax Computation Worksheet is that amount from line 5 of the Qualified Dividends and Capital Gain Tax Worksheet, NOT your taxable income from Form 1040 line 15. It's not that the Tax Computation Worksheet is based on your taxable income. The problem is that you are making it use taxable income because you are using the wrong amount to do the calculation. If you do it correctly the brackets will be based on the line 5 amount, which is only ordinary income, excluding qualified dividends and long-term capital gain.

[rjs]

Another possibility is that you are not correctly calculating line 5 of the Qualified Dividends and Capital Gain Tax Worksheet (though I think this is less likely). The amount on line 5 should be only your ordinary taxable income, excluding qualified dividends and long-term capital gain. Read the instructions for lines 1 through 5 carefully and follow them to the letter.

[rjs]

Thinking about this some more, I realized that you should not be focusing on the tax brackets and the Tax Computation Worksheet at all. Knowing your tax bracket will not tell you what you really want to know. You are trying to determine how much tax you will owe for 2024, and the tax brackets can't tell you that. That's because additional income often has side effects beyond the basic tax on the additional income. The result of the side effects means that the amount of tax that you owe can increase by more than your bracket percentage, so knowing the bracket for a particular type of income will not tell you how much that income will add to your tax.

Here are a few examples of side effects of additional income.

1. As mentioned earlier, additional ordinary income can push some of your qualified dividends and long-term capital gain into a higher bracket. The tax bracket for ordinary income doesn't change, but you pay more tax on the qualified dividends and long-term capital gain.

2. If you have Social Security income, additional income of any kind can increase the amount of your Social Security that is taxable. So your total tax increases by more than the bracket percentage applied to the added income.

3. Many deductions and credits are limited based on Adjusted Gross Income (AGI). Additional income increases your AGI. The higher AGI can reduce or eliminate deductions or credits. The bracket percentage is applied to the added income, but your tax increases by more than the bracket percentage because a deduction or credit was reduced.

The only way to take the possible side effects into account is to use your pro forma 2024 tax return to estimate your tax. Forget about tax brackets, the Tax Computation Worksheet, and the Qualified Dividends and Capital Gain Tax Worksheet. If you want to understand why your tax increases by a certain amount when you add income, you have to compare the Form 1040 line by line before and after to see what changed, then drill down to schedules and worksheets to see the details. The tax brackets are not at all the whole story.

[VolvoGirl]

I once added $6 in interest and the tax went up $12! It pushed me into the next tax bracket. I was right at the line.  Here is the 2023 tax table.  Look at how much the tax increases for each $50 of income.  Like if you are at 42,049 and only added $1 to 42,050 the tax goes up $6.

https://www.irs.gov/pub/irs-pdf/i1040tt.pdf  

[rjs]

@VolvoGirl 

Think57 (the OP) cannot use the Tax Table because his income is over $100,000. He uses the Qualified Dividends and Capital Gain Tax Worksheet and the Tax Computation Worksheet. The Tax Computation Worksheet doesn't have sharp steps like the Tax Table does, so you don't get a jump in tax like you are describing. But side effects of adding income can still cause an increase in tax that is out of proportion to the added income.