Wrapping my head around capital gains vs. ordinary income tax

[RedmondStash]

Okay. Strategizing IRA conversions and also capital gains income for 2018. I'm trying to understand which chunks of income get taxed how, to estimate a total tax bill.

Hypothetically, for 2018, married filing jointly, let's say we have this income:

No employment income
$50k ordinary income, from IRA -> Roth conversion
$100k long-term capital gains

$150k income total

The 2018 tax table shows that income between $77,401 and $165,000 is taxed at 22%. But I know capital gains over $77,200 (and less than $600k) are taxed at 15%.

So does that $150k of income mean that part of our ordinary income is taxed at 22%, because the total amount is over $77,401? Or is the ordinary income all taxed at no more than 12%, and the capital gains taxed at no more than 15%? I'm trying to figure out how to keep our tax rate under 15% for all chunks of income.

Thanks.

[MDM]

$50k ordinary income minus $24K std. deduction = $26K taxable ordinary income.  Tax on $26K = $2,739

Top of 0% LTCG bracket = $77,200.

$77,200 minus $26K ordinary income = $51,200 LTCG taxed at 0%.

$100K long-term capital gains minus $51,200 LTCG taxed at 0% = $48,800 LTCG taxed at 15% = $7,320.

Total tax = $2,739 + $7,320 = $10,059.

[seattlecyclone]

So does that $150k of income mean that part of our ordinary income is taxed at 22%, because the total amount is over $77,401? Or is the ordinary income all taxed at no more than 12%, and the capital gains taxed at no more than 15%? I'm trying to figure out how to keep our tax rate under 15% for all chunks of income.

@MDM and @lhamo gave some good-looking specific numbers. The main concept is that you start with calculating the tax on your ordinary income, as if the capital gains didn't exist. Then you add on capital gains tax. Looks like in this situation you'll be paying in the 10% and 12% regular income brackets. Part of the capital gains would be taxed at 0%, and 15% for the rest.

[BTDretire]

According to this calculator as a married couple you would owe $14,787 in tax on the $200,000 in total income (50k real income + 150k LTCG).

https://smartasset.com/investing/capital-gains-tax-calculator#WWFI9z51x2

This article by Kitces explains the underlying math (though it uses the old figures, not 2018 deduction levels):

https://www.kitces.com/blog/understanding-the-mechanics-of-the-0-long-term-capital-gains-tax-rate-how-to-harvest-capital-gains-for-a-free-step-up-in-basis/
 
I did calculator math a few different ways and came up with this:

50,000 Roth - 24,000 MFJ standard deduction = 26,000 real income

77,400 - 26,000 = 51,400 of LTCG at 0 rate

Remaining 98,600 LTCG x .15 rate = 14,790 LTCG owed

Pretty close to a match on the calculator figure....

Looks like you used $150,000 capital gains, OP said $100,000 capital gains.

[SeattleCPA]

Income gets poured into the brackets and deductions so you always optimize.

E.g., your highest taxed income gets poured into your standard deduction/itemized deduction/personal exemptions space.

This blog post explains using rates from last year, but the logic works the same:

https://evergreensmallbusiness.com/income-tax-buckets-not-income-tax-brackets/

[RedmondStash]

Many thanks, all! I think I'm starting to get the hang of this.

[MustacheAndaHalf]

I find it useful to optimize by "buckets", each of which has different tax characteristics.  First your income spills into the buckets, then your long-term capital gains layer on top of your ordinary income.  So for 2018 taxes if you earn $50,000 income with $10,000 long-term capital gains (I'm rounding off here to send the signal that you can't rely on this for tax advice):

up to $12k, income tax of 0% (standard deduction), $0 owed
$12k - $21k, income tax 10%, $900 owed
$21k - $50k, income tax 12%, $4700 owed
$50k - $60k, capital gains taxed at 15%, $1500 owed

First you figure out your tax on ordinary income, then you get taxed on capital gains.