PFwise.com
Search
  • Home
  • Blog
  • Tools
  • Know-how
    • Insurance 101
    • Annuity 101
    • College Planning
    • Real Estate
    • Retirement Planning
    • Smart Investment
    • Stock Ideas
    • Tax Planning
  • About Us
  • 中文
  • Resources
    • Personal Finance Reading List
    • Financial Aid Resources
    • Personal Finance Calendar
    • Retirement Planning Calendar
    • ETF list
    • Financial Glossary
  • Newsletters Archive

Key Considerations of Tax Arbitrage Transactions

12/23/2013

0 Comments

 
Picture
In our previous blogs, we introduced what is tax arbitrage, how to use Roth conversion and Capital harvesting to conduct tax arbitrage.  In order to effectively harvest income to take advantage of potential tax arbitrage opportunities, the first key is to recognize that the income itself must be recognized by the end of the year, which means the Roth conversion or the gains-harvesting trade must be done by December 31st.

Roth Conversion Recharacterization
Beyond just executing the transaction, though, the reality is that because these strategies are very sensitive to getting tax rates right, and making sure to take enough income to fill a currently-favorable tax bracket but not rise into the next one, effective implementation also requires doing a tax projection for the current year just to determine where those tax thresholds are, given income and deductions for the year.  Fortunately, the recharacterization opportunity for Roth conversions gives a little more flexibility, though; it's always an option to just deliberately convert more than enough, and simply recharacterize the exact amount that turned out to be "too much" early next year once all the final numbers are in for the tax return.  With harvesting gains, though, estimating the appropriate amount based on a tax projection is the best that can be done (the more accurate the estimates of income and deductions, the more precise the gains harvesting can be).

Consider More Than Tax Brackets
In addition, it's important to bear in mind that income creation strategies can impact more than just the obvious tax brackets themselves.  Going forward, creating income may make ultra-low income individuals eligible for premium assistance tax credits, though "too much" income can also render them ineligible, resulting in a potentially significant loss of tax credits and an indirect increase in the marginal tax rate as a result of phasing out the credits. 


Similarly, for many retired people, additional income can trigger the taxation of Social Security benefits, or higher Medicare Part B and Part D income-related premium adjustments; while neither of these makes it unequivocally "wrong" to create income, both represent situations that boost the marginal tax rate higher than "just" what tax brackets alone imply, yet must be accounted for when considering the value of harvesting gains or doing Roth conversions. 


For others, state taxation may be a factor; if there is a planned move (in the coming years, or perhaps at the retirement transition), the difference in state tax rates should be considered, and may either make Roth conversions and gains harvesting much more appealing (if the future state would have a higher tax rate) or less appealing (if the future state will have a lower tax rate). 

And of course, if the individual doesn't expect to use the IRA or appreciated investments at all, and they're likely held until death, it's important to consider the likely tax bracket of the beneficiaries (if lower, they may prefer to inherit a traditional IRA and not a Roth!) and the available step-up in basis at death (which essentially represents a "free" gains harvesting tax event).


0 Comments



Leave a Reply.

    Author

    PFwise's goal is to help ordinary people make wise personal finance decisions.

    Archives

    April 2022
    March 2022
    February 2022
    January 2022
    December 2021
    November 2021
    October 2021
    September 2021
    August 2021
    July 2021
    June 2021
    May 2021
    April 2021
    March 2021
    February 2021
    January 2021
    December 2020
    November 2020
    October 2020
    September 2020
    August 2020
    July 2020
    June 2020
    May 2020
    April 2020
    March 2020
    February 2020
    January 2020
    December 2019
    November 2019
    October 2019
    September 2019
    August 2019
    July 2019
    June 2019
    May 2019
    April 2019
    March 2019
    February 2019
    January 2019
    December 2018
    November 2018
    October 2018
    September 2018
    August 2018
    July 2018
    June 2018
    May 2018
    April 2018
    March 2018
    February 2018
    January 2018
    December 2017
    November 2017
    October 2017
    September 2017
    August 2017
    July 2017
    June 2017
    May 2017
    April 2017
    March 2017
    February 2017
    January 2017
    December 2016
    November 2016
    October 2016
    September 2016
    August 2016
    July 2016
    June 2016
    May 2016
    April 2016
    March 2016
    February 2016
    January 2016
    December 2015
    November 2015
    October 2015
    September 2015
    August 2015
    July 2015
    June 2015
    May 2015
    April 2015
    March 2015
    February 2015
    January 2015
    December 2014
    November 2014
    October 2014
    September 2014
    August 2014
    July 2014
    June 2014
    May 2014
    April 2014
    March 2014
    February 2014
    January 2014
    December 2013
    November 2013
    October 2013
    September 2013
    August 2013
    July 2013
    June 2013
    May 2013

    Categories

    All
    Annuity
    Book Reviews
    College Finance
    Finance In Formula
    Financial Scams
    For Entrepreneurs
    Healthcare
    Insurance
    Investment
    Miscellaneous
    Real Estate
    Retirement
    Savings
    Savings Ideas
    Stock-ideas
    Tax
    Tax-related

    RSS Feed

Copyright © 2013 - 2022 PFWise.com, All Rights Reserved. 
IMPORTANT DISCLOSURES
PFwise.com does not provide investment, tax, or legal advice. The information presented here is not specific to any individual's personal circumstances.

To the extent that any material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
About Us | Contact Us 
中文