Today’s episode focuses on outlining the basic differences between long-term capital gains and ordinary income taxes, and showing how they interact with each other from a taxation perspective. The idea for the topic actually came from a question one of David’s POZ advisors had received ahead of a recent webinar David hosted.
Long-term capital gains typically get added to your Adjusted Gross Income (AGI), which is important, because your AGI determines whether you can contribute to Roth IRAs, or when you get phased out of certain deductions.
Despite this, it’s important to keep in mind that long-term capital gains get taxed in a completely different tax cylinder when compared to ordinary income.
Long-term capital gains are completely different from short-term capital gains, in that they have their own tax cylinder that includes only three tax rates: 0, 15, and 20. The rate at which long-term capital gains get taxed depends on what your ordinary income tax rate is in a particular year.
As David explains, it’s important to remember that the amount of ordinary income you have – the actual amount of net taxable income – informs the taxes you pay on your long-term capital gains.
For David, once you understand the difference between the two taxes, there are several interesting strategies you can implement.
It’s paramount to remember that ordinary income on the Roth conversion gets taxed first, while the long-term capital gains calculation takes place after that.
