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I came across an interesting tax return the other day while volunteering at a local AARP TaxAide center. This is my 7th year doing free tax returns and I’m still learning. In this case, I didn’t prepare the return; I was the quality reviewer and did the outtake with the client. The client was a retired single woman in her mid-70s. Her income was modest and she didn’t have any fancy or complicated investments. What made her case interesting was her near obsession with making sure that she paid zero tax for the year, and the steps she was willing to take to make sure she accomplished her goal.
Here are the facts of her case.
Her gross income, excluding SS, was $16,900. Her standard deduction is $16,500. This left her with $400 of taxable income. But this also put her just over the $25,000 limit when calculating if any of her SS benefits were taxable. Her “provisional income,” equal to her gross income plus half her SS benefit, was $25,958. Half of the $958 excess, or $479, was taxable. This resulted in $879 of taxable income. At a 10% marginal tax rate, you would expect a tax bill of $88.
But recall that $620 of her income was from qualified dividends. This income is eligible for the long-term capital gains (LTCG) rate. Since she is in the lowest marginal income tax bracket, that rate is 0%. This sheltered $620 of her $879 of taxable income from any tax. This made her tax bill approximately $25.
The client had anticipated that she was close to owing some income tax, so she made a preemptive sale of a stock to harvest a long-term capital loss. She sold an airline stock for a loss of about $2,100. This dropped her gross income below the standard deduction, and her combined income below the level at which any of her SS benefit would be taxable. Thus, she had no taxable income and no tax bill for the year. Additionally, she has a $1,700 loss carryover that she can use next year.
She was pleased with this result, but had a number of questions to make sure we had only used the taxable portion of her pension, and we had used any loss carryover from previous years. I was able to show her that we had met her expectations. She then wanted to know how she could plan ahead to make sure she had enough of a loss to ensure she had no tax bill in future years. I thought about how I could best help her understand the complex interactions of the tax code, and a comment by Bill Perry on one of my previous Forum posts came to mind.
Bill commented that he used the AARP Tax Calculator to provide a check on his calculations. I had never use it, but I brought it up, and in just a few minutes I was able to generate a simple estimate of her 2024 tax return that very closely matched the official one I had prepared for her. I explained to the client how they could use the calculator later in the year to guide her in her financial transactions to achieve her tax goal.
Later that day, I used the calculator to do a quality check on our Turbo Tax prepared federal tax return. It matched closely. It also was a good check against my spreadsheet that I use to track our tax bill during the year. All three provided basically the same answer, and I feel confident filing our return. Many thanks to Bill for a great suggestion.
I have a spreadsheet that tracks current income and calculated Federal and state tax. I keep it updated as my income changes through the year, and it is pretty accurate. If you are tracking IRMAA brackets this sort of thing can be very useful.
I compared our 2024 tax return results from 1) our accountant; 2) the AARP tax calculator; and 3) http://www.irscalculators.com/tax-calculator. All 3 were within a few 10’s of dollars. We have been using irscalculators for a few years for tax planning. The AARP calculator does handle more items than irscalculators but if using the standard deduction with the common income sources it is fine. Two advantages irscalculators provides is that it can calculate your state income tax, and the tax year can be selected. Unless I missed something the AARP calculator is only for the current tax year. Not sure when it is updated to the next. I have already used irscalculators for 2025 tax planning including: 1) our currently planned IRA distribution for spending; 2) with a small Roth conversion keeping our income within our current marginal rate; and 3) with a larger Roth conversion up to just below the next IRMAA threshold.
I just used the AARP Tax Calculator/Estimator for the first time to do an idiot-check of my TurboTax results. The two answers are close enough that I have a high confidence in the TT results.
Now I wish AARP would create a calculator/estimator for state taxes! But since each state does that differently (or not at all) so it’s probably not feasible.
From the description it sounds like she cleverly arranged to have a negative taxable income (TI) for the year. Let’s say it was the $1700 loss carryover amount that took her negative. Her objective is to have a TI of -0-. She could have pulled an additional $1700 out of her tIRA as a Roth conversion to slay several aerialists at once while bringing her TI back up to -0-.
When I help folks with their tax planning for the current year I show them how to keep a close eye on not wasting below-zero TI space.
You are correct that the client took a LTC loss to assure she had no tax for the year. The stock sale in 2024 provided an additional $1700 of current loss, and reduced her taxable income to a negative $1700. It also prevented any of her SS benefits from being taxed. She could have withdrawn an additional $1700 from her trad IRA tax free had she chosen. Because she had $620 of qualified dividends, she could have withdrawn $1910 from her Trad IRA with no tax. This is because that amount of additional income, in addition to the $409 of SS benefits that would be taxable, amount to a taxable income of $619. The $620 of qualified dividends are eligible for a 0% tax rate and effectively use up all of the taxable income. I tried to explain this interaction to her, but it was a challenging conversation. Additionally, we are discouraged from providing “too much” financial planning advice to clients. By the time the clients get to us it’s often too late to take some steps that would benefit them. I have yet to find an equivalent program to VITA/TaxAide that fills the need for free, modest financial planning for our clients.
Rick, I’m curious why you spend money on TurboTax when you could prepare your own tax return for free using Tax Aide’s TaxSlayer Pro?
Hi Robert. Basically inertia. I have decades of Turbo Tax returns. For many years I asl did our son’s, my parents, and in-laws. I’ve thought about transitioning to TS – many of the people I’ve volunteered with do their’s and family and friends.
I have to admit I never understood the logic of intentionally selling at a loss to create a lower tax bill. Lock in a loss of $2100 to save $25 in taxes? Even the carryover is still a loss. Where is the net gain?
Let’s say you like Verizon (VZ) and have a position for many years and undergo a dividend reinvestment strategy. You love the stock long term for the next 30 years, but along the way, you’ve got some tax lots that are under water at the current price. A simple and effective strategy is to wait until the Ex-Dividend date (get your dividend for that qtr), and then sell the tax lots that have losses and you now have a capital loss. You wait 30 days (to avoid wash sale rules), and buy the stock back with the proceeds. The only risk is the increase in the stock in the 30 days. If it falls, you’re net ahead, if it rises, you’ve lost that amount in the 30 days, but now have a loss to lower your taxable income which will likely net out to 20-ish percent of the amount lost which will likely offset any increase in the 30-day stock price increase.
I resisted this for years and was a fool for doing so. I finally executed the strategy, and I’m sitting on 175K in paper “losses” but I bought back the stock 30 days after I sold it and it’s doing quite nicely since then. My long-term thesis is correct on the stock, but when it took a short-term price shock, I locked in my losses. In the future when I start selling my stocks for retirement income, I won’t pay any capital gains on the first 175K of income. By that time, it’s perfectly conceivable that my VZ stock will have overcome all those losses and then some, but I have the loss on the books.
Clear as mud?
It works when you buy an equivalent stock or fund with the proceeds, which “unlocks” the loss.
How does that mitigate the loss?
It works much better with a total stock fund and the S&P 500 as they can be interchanged. Take the loss, buy the opposite fund the same day and your back in the market, but logged a loss that you can use against 3000.00 in ordinary income or against other capital gains. When the market comes back up, you still have the fund that holds the market gains.
You save on taxes, and you still can make money if your new investment appreciates. Yesterday I swapped out some Vanguard for iShares total stock market ETF.
Sometimes it’s more about limiting the loss than mitigating it. I’ve seen a few folks ride a stick all the way to the bottom to avoid selling at a loss.
Keep three things in mind: 1) it’s better to pay taxes later — that’s the time value of money — and tax-loss harvesting lets you do that; 2) your tax losses lose all value upon your death, so it’s better to use them now; and 3) nobody can forecast which investments will perform well, so it’s better to sell your losers for the tax benefit and buy suitable substitute investments, rather than desperately hang on to existing investments because you hate the idea of selling at a loss.
This makes me feel ever so slightly better about taking a loss on Taiwan Semiconductor some years ago. 😉
its Insane how complicated income taxes has become.
Retirees with high incomes who are paying low taxes aren’t complaining. Filling out complicated forms can really pay off!
I am happy to hear that you were able to make good use of the AARP tax calculator. While using their calculator earlier this year I extended my AARP membership by five years. While AARP strongly promotes using an automatic annual renewal option but I used a different offer to take a discount for paying for an additional five years at one time and that time extension is added on top of any membership period you have. I also think that such annual membership costs will likely rise in the future so buying now may save me the increase down the road if the membership price does increase in the future.
I expect few people make a preemptive sale of a stock to harvest a long-term capital loss to get their taxable income to zero. I have found such people are a joy to work with as a preparer. Good thinking and planning and as much as we can care as preparers no one usually cares as much as when it is your own money.
The SECURE 1.0 tax law change a number of years ago eliminated the over age 70 1/2 age restriction on making traditional IRA can, for those with current earned income, allow the fine tuning of taxable income after year end. I did this myself on my return this year.
For those in the lowest two tax brackets, the 10% and 12% brackets there is a possible unwelcome surprise. As the capital gains tax brackets stack on top of the ordinary income brackets I would expect for those with overall taxable income and qualified dividend income and taxable social security income may find their marginal tax rates are higher than the listed bracket percentage. Example – bracket rate of 10% may have a 18.5% marginal ordinary income tax rate because each dollar of long term capital gain or qualified dividends can make up to 85% of the next dollar of social security taxable. If you have capital gain bracket income in the 0% capital gain bracket the additional SS benefit income may be taxed at 8.5%. If you have 0% capital gain bracket income in 2024 then your rates may be in the what is known as the social security tax torpedo where the 10% tax bracket has a marginal bracket of 18.5% (10.0% x 1.85) or 22.2% (12.0% x 1.85). There is a narrow band where an additional $1 of income makes an additional 50% rather that 85% of the $1 social security taxable. There are also many who are already fully subject to all of their social security benefit being taxable at 85% and thus for the higher income taxpayers their bracket rate and their marginal rate are often the same. Using the AARP tax calculator or one of the many other available tax calculators allow you to change a single item, like a traditional deductible IRA contribution, to estimate the dollars that such a change means for you.
Best, Bill
Bill, thanks for reading and commenting. I agree with you – this client was the only person i’ve met who preemptively takes a capital loss to make sure she has a zero tax bill. She was quite adamant about it. If I had time I could have run several different iterations of her tax return and what the impact of not harvesting a loss, or even taking a modest gain. The AARP calculator did a nice job with this case.
That AARP tax calculator is one of the best quick-estimator tools out there, for Federal taxes. Of course, using the previous year’s tax software is also a great way to get a handle on the current year’s bill. This should also give you a pretty good picture of your state tax as well–provided, of course, your state hasn’t had any major tax-law changes since the previous year.
The main limitation of the AARP calculator (and other quick estimators as well), is it won’t calculate certain tax credits; you have to figure these out on your own, and manually put them in. For example, take a retired married couple where one has a little “earned” income, where they contributed to a 401k, and the other has only pension income. A sharp-eyed tax preparer would immediately recognize, this is one of those few times that the tax code might give a more favorable outcome to MFS vs MFJ. Since the potential Saver’s credit would disappear with pension income if filed MFJ, filing MFS might allow that couple to qualify for the saver’s credit (one of the few that doesn’t disappear with filing MFS).
Such a circumstance of course probably won’t affect most of the high rollers that frequent HD, since much of the readership has six-figure+ incomes. But this is just the kind of thing that several of the volunteer preparers might run into in their work at the local senior center, where incomes tend to be more modest, and might keep an eye out for.
I played with this scenario using TaxSlayer’s Practice Lab and you are correct. Nice catch.
I also use the AARP tax calculator to fine-tune my December final Roth conversion amounts plus the year-end tax obligations for the 4th quarter estimated tax payments due January 15. The AARP tax calculator delivers fairly accurate results to our eventual Turbo Tax submission, but it is much easier to manipulate for scenario planning – say adjusting year-end capital gains versus IRA withdrawals.
The other nice feature is that AARP’s tax calculator retains prior input such as pension, social security, and taxable dividends which are fixed for us, so we can just tweak the changeable variables.
Rick, my first thought was that if the airline stock eventually took flight she’d be out much more than the $25 that she saved in taxes.
Thanks for reminding me of the AARP calculator, I will give that a try.
Dan, I ran a bunch of scenarios with different inputs to show the complexity, and interaction of the various tax treatments of investment, retirement, wages, and SS. For example, $5000 of long term capital gain would have increased her SS that was taxable, but the LTCG is still taxed at 9%. Had she worked part-time and earned the same $5,000, here tax bill would have been $500 higher (10% of the $5,000). I was planning to write this upon as part of this post, but it got too big. I still might write it up as an example oh how different types of income are treated differently, and what the end impact would be.
That would be interesting too.