This email exchange was from early August.

Q-1:

Subject: 2005-1040

Kerry,

I have doing some tax planning and have been trying to find out what amounts that the IRS will use for tax year 2005 for standard deductions and exceptions. The only place I could find what I was looking for was on your website, which I am a bit skeptical about. One reason for my skepticism is you show "Updated Tuesday February 01." I doubt that the IRS would have known what those numbers would be last Feb. It shows the 10% bracket extended to $14,600 which was surprising, as I didn't know it was indexed to inflation, and if it were would indicate an inflation rate of 4.3%. 

A-1:

The current update date showing up on that page is just the last date I made any modifications to that page.  My FrontPage program automatically inserts the date whenever I change anything.

The info on that page was actually posted on 9/23/04, as mentioned in this blog post.

Thousands of people have linked to my page with the 2005 rates since I posted it on 9/24/04 and you are the very first to express any doubt as to its accuracy.

You can see the same info on the 2005 1040-ES form.

What may have you confused is the fact that when things like the standard deduction are adjusted for inflation, that can only be done in increments of $50, which does often give us a little more bump up than the actual change in the CPI.

I hope this clears up your confusion.

Kerry Kerstetter

Q-2:

Kerry,

 

Thank you for your prompt response. My skepticism was in part because I tried to Google that information up and hit a dead end everywhere but for your website. I thought if this information were valid that I would have likely also found it somewhere else.

 

The reason for my wanting to know this is for tax planning purposes. A couple of years ago I made what for me was a surprising discovery. Going through the 18-page worksheet to determine how much of my S/S was taxable was not difficult but I could not understand just what it was that they were doing to me. In order to help comprehend what was going on I put together a spreadsheet increasing taxable income (line 3) $1,000 per column and the results was surprising.

 

As an accountant you may be aware of what follows, if so I have wasted my time but if not I think you would be interested in this.

 

I knew that when they started taxing S/S that you are taxed on $1.50 for every extra $1.00 of income. What I did not realize was that this also effectively caused a narrowing of the 10% bracket. Suppose the bracket is $14K wide and you start pay taxes on S/S after using $8K worth. You only have $4K of the 10% bracket left as the taxing S/S effectively narrows the bracket by $2K.

 

When S/S begins being taxed your effective marginal rate (EMR) is 15%, (10% of $1.50). Once you get to the 15% bracket, your EMR is 22.5% (15% of $1.50). If you reach the trip point where $1.85 is taxed for every $1.00 of income you EMR is 27.75% (15% of $1.85). After 85% of you S/S is taxed you go back to 15%.

 

I realize that knowing this is of no use to most people but I find myself in a unique situation where I think I can use this to my benefit or the benefit of my heirs. Instead of minimizing current taxes I am trying to optimize taxes for the longer term. As I receive a non-taxable disability benefit from the VA we have adequate income without paying any income taxes. I have about $500K in regular IRAs and as I am not yet required to take minimum distributions I think it is to my benefit to move regular IRA money to a Roth. I feel that if I don't move those assets now it is likely to cause me or my heirs to pay more taxes later on. I feel that at a minimum I should move enough money to use up the 10% bracket. However I am less sure that I am on the right track doing what I am doing, which is to have a target income that just avoids the EMR of 22.5%.

 

I did read your letter opining that Roths will likely be taxed in the future and I fully realize that tax planning is often futile because of the fickle ways of Washington.

You certainly do a lot of number crunching to work with that nefarious penalty on "evil rich" SS recipients.  You are absolutely right that the effective marginal tax rates are frequently higher than those in the official IRS schedules because of the things triggered by AGI, such as credit and deduction phase-outs, as well as the taxability of SS.

Converting conventional IRAs to Roths would compound these ripple effects for the years in which you report the income on the conversion.  Whether the tax hit now will be worth it down the road is a bit of a guessing game.  However, I do still have serious doubts that our rulers will leave the tax free status of Roths intact for those they consider to be evil rich.  I hope I'm wrong; but you are already experiencing the effects of the exact same kind of  promise-breaking with taxes on your SS.

I hope you have set up a computerized worksheet for these calculations because this would be a lot of work by hand.
 
Good luck.

Kerry

Q-3:

Kerry,
I spent quite a bit of time laboring over this spreadsheet and now the number crunching is all done automatically. I imagine it would have been pretty easy for someone that is fluent in Excel but I am kind of a self-taught klutz so it was slow going for me. The first 18 lines mimic the 18-line worksheet in instructions for 1040. The added lines compute your EMR and the dollar amount of taxable income that triggers the change in EMRs. Anyone can use it by inputting the dollar amounts into those cells shown in red to reflect their personal situation.

A-3:

Thanks for sharing that Excel worksheet.  That is a very interesting approach to looking at the effective tax rate on your SS benefits.

I hope you've seen the 2006 tax rate schedules which I have posted on my website.

Kerry

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 10/31/2005 10:02:00 PM Send this post: