Tax ? (solved) Interest taxed at 27% Federal

Figured it out. I did some capital gains harvesting at the zero LTCG rate (first time being eligible now that taxable income is lower in early retirement.) I cut it too close and didnt account for the interest income (free $ from account sign up bonuses.) Thus, every $ of interest was taxed at 12% and caused a dollar of LTCG to be taxed at 15%. The trick was figuring that the interest should be taxed at 12% bracket so somewhere another 15% is being levied (LTCG on the gain harvesting).

I got away from the screen and went for a short bike ride and it came to me.

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Figured it out. I did some capital gains harvesting at the zero LTCG rate (first time being eligible now that taxable income is lower in early retirement.) I cut it too close and didnt account for the interest income (free $ from account sign up bonuses.) Thus, every $ of interest was taxed at 12% and caused a dollar of LTCG to be taxed at 15%. The trick was figuring that the interest should be taxed at 12% bracket so somewhere another 15% is being levied (LTCG on the gain harvesting)

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I call that bracket drag... when additional $1 of income "drags" $1 of qualified income from the 0% rate to the 15% rate... resulting in the additional dollar of income having an effective federal tax rate of 27%.

A similar thing happens with Social Security benefits. Up to 85% of benefits are taxed based on a formila that takes into effect half of your benefits plus all of your other income. So earning an additional $1 of income can cause an additional $1 of Social Security benefits to go from being tax free to being taxed. I call that Social Security drag.

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This was my first time gain harvesting. I need to find a better way to accurately estimate all dividend, interest and capital gains distributions so I can avoid this next time. I intend to sell as much as possible in zero LTCG bracket each year so I can reinvest at a higher basis.

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It's hard if you own a lot of mutual funds.