Taking (Tax) Advantage of a Low Income Year

We are reaching the end of our first year with basically no income.  We can easily pay little to no taxes, but there are strategic moves we can also make with Roth conversions and tax gains harvesting to help with future tax savings too.  Let's take a look at what these concepts are and then what we are actually doing in 2023.

We have money invested in three types of funds – Traditional IRAs, Roth IRAs, and a taxable investment account.  Our end goal is to eventually sell all these investments and use the money to live off of.  Moving money within and between those accounts will cause tax implications and we can be strategic as to when that happens.  Let’s start with some explanations of concepts and then I will share how we're using each. And a big caveat here – I am NOT a tax advisor and this is for educational purposes only. 

Roth Conversion:

When you put money into a Traditional IRA, that money was deducted from your taxes.  This means that income wasn’t accounted for and wasn’t taxed.  Whenever in life you choose to take it out of the Traditional IRA that money, and any growth it has made, will be taxed as income in that calendar year.  Taking the money straight out of a Traditional IRA account before age 59.5 will also cause an additional 10% penalty tax.  But, at any point that money can be transferred into a Roth IRA (which hold post-tax retirement investments) and it will be taxed as income that year without the additional penalty.  In years of low income, it can be advantageous to do a “Roth Conversion” so the retirement investment is taxed as earned income that year instead of a higher income year in the future.  And big bonus - once in a Roth account, all future growth is tax-free too!

Standard Deduction:

Deductions are things that offset your income, meaning it lowers the income amount you pay taxes on.  Think of it like a business that has revenue (money in), but also expenses (money out), and when you subtract the two you end up with the profit (money left over) which the business pay taxes on.  Deductions work the same way for individuals.  You could go through and do itemized deductions of all the possible expenses you are allowed to subtract, or the IRS has an option to take the “standard deduction” which is a blanket number that you can subtract from your income.  In many, but not all, cases the standard deduction is higher so take advantage of it!

Here’s a look at the 2023 Standard Deduction rates:

Tax Filing Status	Standard Deduction
Single	$13,850
Married Filing Separately	$13,850
Married Filing Jointly	$27,700
Head of Household	$20,800

Capital Gains & Harvesting:

There are two ways to make money – income and asset appreciation.  Income is the money that you make from the work that you do.  Appreciation on the other hand is the increased value of something you own, also called “capital gains.” Think of a house that is purchased for $300,000 and then later sold for $500,000.  No one worked to earn that $200,000 it just went up in value on its own.  But guess what?  You still have to pay taxes on that money.  If you have owned the asset (thing) for more than a year it’s considered “long term capital gains” and it’s still taxed, but at a lower rate than your ordinary income.  If, however, you sell it within a year of purchasing, you pay tax on it as “short term capital gains” which means it’s thrown in with your ordinary income and taxed at that rate. 

Investments in the stock market work the same way because they are assets that grow in value.  When you sell them, the difference between what you paid for them and what you sell them for is considered a capital gain.  The money you paid for the stock is called the “basis” and when you sell it, you compare the sale price to your basis to see what you gained.  Most people don’t want to cause a taxable event by selling stocks, but it can be to your advantage in a low income year.  While there are rules about selling and repurchasing to LOWER your basis and report a loss on your tax return (wash sale rule) there is nothing stopping you from selling and then immediately repurchasing the same stocks at a gain.  Say you purchase 1 share of a stock for $10/share.  This means your basis is $10.  In a few years it goes up to $30/share.  If you sell it, you will pay capital gains tax on the $20 increase.  You could also immediately repurchase it at $30/share and your basis is now $30.  I assume at some point in your life you want to sell that stock and use the money to live off of.  Until then, you can choose to sell and immediately repurchase it to raise your basis and pay taxes on the gains that specific year instead of waiting until the year you actually want the money and have to pay the taxes on all the gains it has ever made.  This process is called “tax gains harvesting” and is a process of making these taxable events happen strategically.   

Big NOTE here:  Any stock purchases and sales within your IRAs are NOT taxable events.  Money in IRAs are only taxed when the money is taken OUT of the IRA. 

Long Term Capital Gains Tax:

As I mentioned, long term capital gains are taxed, but at a lower rate than earned income.  There’s even a 0% tax bracket!  That means you could have capital gains and pay NO TAX!  Seriously, don’t pass this up if it applies to you.  The long term capital gains tax brackets are listed below.  Note, this one’s a little confusing because the “income” here is a combined ordinary income and capital gains income after deductions. 

Long Term Gapital Gains Tax Brackets in 2023:

Tax Filing Status	Taxable Income for 0% Tax Rate	Taxable Income for 15% Tax Rate	Taxable Income for 20% Tax Rate
Single	$0 - $44,625	$44,626 - $492,300	$492,301 +
Married Filing Jointly	$0 - $89,250	$89,251 - $553,850	$553,851 +
Married Filing Separately	$0 - $44,625	$44,626 - $276,900	$276,901 +
Head of Household	$0 - $59,750	$59,751 - $523,050	$523,051 +

So, what’s our 2023 0% tax plan?

Here are the steps, along with a graph to visualize each step:

1. Calculate our 2023 income, which from side jobs, side businesses income/loss, and interest is about $2,500.   

2. Figure out our standard deduction, which in 2023 for “married filing jointly” is $27,700.  Subtract the standard deduction from our income $2,500 - $27,700 = - $25,200.

3. Do a Roth conversion of $25,200 to bring our taxable income to exactly $0.

4. Figure out the maximum income for the 0% long term capital gains tax, which in 2023 for “married filing jointly” is $89,250.  Subtract any taxable income from that amount $89,250 - $0 = $89,250.  Do tax gains harvesting of long term investments (held more than a year) up to $89,250. 

And BOOM.  We just converted $25,200 from a Traditional IRA to a Roth IRA and raised our tax basis on $89,250 of investments without paying any taxes. 

Obviously, this is a very simplistic look at the very, very, very complicated process calculating taxes.  There are many other things at play when figuring out taxes including interest income, short term capital gains income, credits, subsidies, and everything else that fills the thousands of pages of tax code so our exact numbers will be different than these once we get into the weeds.  Do your research and consult a professional as needed.  Just remember to not let a low tax year go to waste!

And let me say it again - I am not a financial or tax advisor. Do you own research and consult a professional as needed.