Ep. 9 | Green Diagnosis (low marginal tax rate)
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Speaker 2:Welcome everybody to episode nine of Teaching Tax Flow, the podcast. We're back again with our second of four, or I should say number two of four, our color coding diagnosis, and we are putting Chris on the spot. My co host, Chris Pacquero, I'm John Topolsky, by the way, if you did not know that. The guy that puts Chris on the spot and really extrapolates information, as I like to say, would pull it from your brain and force you to tell everyone. But today's episode actually, Chris, why why don't you give us the intro for this this specific episode as we jump into the green diagnosis?
Speaker 3:Before I get into that, I want to know who wouldn't know that that sound of John Chipolsky just by the Love. Love. The call of his And and, yeah, that that's,
Speaker 2:We have a we we have a good time doing this, though.
Speaker 3:We do have a good time doing this.
Speaker 2:And just so everybody goes, we do not script these at all. I think the only things that we come up with is, well, what episode number we're on and and roughly what the topic is. We don't even have a title for these until we get chatting.
Speaker 3:Well, this is episode nine. It's teaching tax flow's favorite year end green diagnosis tax strategy prescription. And we had a discussion about our favorite red diagnosis, prescription. We discussed diagnose, then prescribe, diagnose, prescribe. And the green diagnosis is, is something Johnny t is gonna tell you about.
Speaker 2:Sure. But let me give you give you the rundown on that. So really quick, let's step back really, really fast. So the red diagnosis that we talked about last week, so that one is really based around an immediate onetime tax deduction with somebody, ideally, that has an MTR, so a marginal tax rate of 25% or higher. So now that we now that we're getting into green, kinda going down the list, this one specifically is somebody currently in a low MTR, so your marginal tax rate, or lower than expected future MTR that can benefit from a taxable income acceleration.
Speaker 2:So this this individual, Chris, if I'm not mistaken, is roughly around the 20% or lower, not the 25% or higher that was the red diagnosis. This green is 20% or lower. Correct?
Speaker 3:Exactly. It's something the green diagnosis is something that a lot of, tax professionals and CPAs don't teach their clients and their or coach their clients to understand. We we're so focused sometimes on tax deferral and tax deductions. Sometimes you have to accelerate your income. Sometimes that your we talk about tax flow does not equal cash flow, one of our three laws of teaching tax flow, that someone can have a significant amount of positive cash flow and very, very little taxable income.
Speaker 2:Drew, can you repeat that one more time?
Speaker 3:Someone can have a significant amount of cash flow and very, very little taxable income. In that case, your green diagnosis, you're in a very low marginal tax rate. So green diagnosis, they're fun. I do have to preface this by saying we're talking about a year end strategy. So I can't pick a strategy that you can apply in 2023 and still count it for 2022.
Speaker 3:We call those strategies or those prescriptions, p as in Paul type prescriptions. So this has to be something that need is executed before the end of the year.
Speaker 2:So once that clock strikes midnight on December 31, there's thirty yeah. Thirty one day thirty one days of December. Once it hits that, times out, you're on to the next year as far as for
Speaker 3:the year. Exactly. Now we didn't do this last episode, but I'm gonna request a a a drum roll for this.
Speaker 2:Oh, I can do that.
Speaker 3:Alrighty. There we go. Ready?
Speaker 2:Okay. What's your favorite? Hit it. Hit us with the babes. What you got?
Speaker 3:Well, the Roth conversion is my favorite green per green diagnosis tax prescription for year end.
Speaker 2:Oh, and why is that? Now I'm I am super curious. I did not know that was your favorite. Back to us not scripting these. So so, really, before you jump into that too, so you just said a Roth conversion.
Speaker 2:Right? So let's talk about the difference between a Roth conversion and a Roth distribution. I know those are two two terms.
Speaker 3:They are definitely two different concepts. A Roth distribution would be a distribution of assets out of a Roth IRA or Roth four zero one k account. And depending on if the trans if if the distribution was a qualified distribution, it's qualified distribution, then it would not be taxable and you wouldn't have to pay any type of early distribution penalty. But at times, a distribution would, could be taxable and it could be subject to penalty. Obviously, you avoid that.
Speaker 3:It's very, very rare we run into a situation where a Roth distribution is penalized. So that's when you take money out. What a Roth conversion is, that occurs when you take money from a pretax retirement account. Let's just say an IRA. It could be a four zero one k.
Speaker 3:Let's just use an IRA at this point. You take money that's pretax, growing tax deferred, purple diagnosis, not tax free, tax deferred, and take those assets and convert them to a Roth IRA, and at that point those assets will grow tax free, assuming you have a qualified distribution. You are taxed on the fair market value of the assets the day you convert them, so there's a lot of tax planning opportunity within that strategy, especially if you have a couple factors. One, you're in a low marginal tax rate or potentially zero marginal tax rate, and two, if you have devalued assets. So if you have a stock that was worth $15 it's gone down in value, now it's worth $5 you still want to hold on to it and you believe it's going to go up in value, you convert that from your IRA to a Roth IRA, you pay tax on the $5 That way if it rebounds up to 15, you don't pay tax on that growth.
Speaker 2:Oh, that's that's something that I've actually never heard of. That's pretty interesting, actually. So, again, that goes back to planning. Right? So kind of then that's a great example of you you're planning it, you're watching for something, and you can't make that decision in five minutes when you go, oh, crap.
Speaker 2:I'm I'm about to go be, you know, tipping bottles here at the at the end of the year. It's something that you guys have worked with with clients on and just kinda being on the lookout for. Right?
Speaker 3:Absolutely. A lot of times most Roth conversions are performed in the last quarter of each year. What you want to do is we have a four step process for tax planning and strategy implementation. The first step is have a tax projection put together. It doesn't have to be perfect.
Speaker 3:You can use some of our calculators in teaching tax flow to do the tax projection, but project where you're at tax wise and determine what your marginal tax rate is, and then you diagnose. So if you're at a low marginal tax rate, like you said, 20% or lower is typically green diagnosis. And then how much in taxable income can you absorb and still stay in that lower marginal tax rate and consider converting that amount of income into the Roth. Because what the Roth is going to do, it's going to allow you to accomplish the gold diagnosis or tax free income. Now there are so the most basic type of Roth conversion would just be putting taking money in a from an IRA and converting it to a Roth.
Speaker 3:There are some more advanced strategies when you're dealing with alternative investments, or there's also a backdoor Roth strategy, which is a little more complex where if you have a taxpayer that due to their income, so their income is too high to make a traditional tax deductible traditional IRA contribution, so you make a non deductible traditional IRA contribution and immediately convert it to a Roth and now you are not really a green diagnosis at that point but you are getting the gold diagnosis of tax free income. So if you are going to be involved in a backdoor Roth contribution or conversion then that's where you're gonna wanna work with, it's more of an advanced tax strategy, not basic, and you're gonna wanna work with the people in your, on your board of directors as we
Speaker 2:talk about all the time. And, actually, one topic too, if we can just kinda reiterate it. I know we we discussed this in previous episodes. I think we almost harp on this just as much as, how much we love or I love, I should say, the board of directors. So let's talk really, really briefly about the comparison between MTR, so your marginal tax rate and tax bracket.
Speaker 2:For for those that are listening, I I think, you know, kinda growing up, we're kind of, you know, beaten to death with, oh, well, what's your tax bracket? What's your bracket? What's your bracket? So MTR may be a new approach or a new concept or a new way of thinking for some individuals. So so looking at that, comparing them, and really seeing which one is most beneficial.
Speaker 2:And then after we jump into that briefly, again, I'd love for you to to really walk us through that, looking at those comparisons. I know on on some of our material that we've created for teaching tax flow, there's a few other few other items. I think there's five specifically that really fall under that, under the green category, if you will, of the diagnose and prescribe. So let's let's maybe look at those really briefly. I know we heard about your favorites, but but, again, give a give us kind of the rundown of that comparison between MTR and tax bracket, if you could.
Speaker 2:Correct.
Speaker 3:Well, I'm gonna step back again talking about our process where we do a tax projection. We diagnose, prescribe, IQ test, implement. When we are doing our tax projection, we're coming up with a marginal tax rate. Your marginal tax rate is the amount of tax you pay for each additional dollar of taxable income and the amount of tax you save for each additional dollar of tax deduction. Marginal tax rate is not your tax bracket, so there's a big difference there.
Speaker 3:Why is there a difference? Your tax bracket's a static figure, marginal tax rate's more fluid. Your tax bracket only considers filing status and taxable income. It doesn't include it doesn't factor in the different types of taxable tax you can pay. Not all income is taxed the same, so it doesn't factor in self employment tax, net investment tax, income or net, special tax rates for qualified dividends, long term capital gains, qualified business income deductions, student loan interest, child tax credit limits.
Speaker 3:There are several things that a tax bracket doesn't factor into when it's being looked at, where the marginal tax rate does. So if you're in that 20% or lower marginal tax rate, your green diagnosis, Roth conversion is my favorite, retirement plan distributions at times could be very effective assuming you're not paying the 10% penalty, capital gain harvesting, hunting pigs, which is the standard passive income generation, And then at times, electing out of bonus depreciation, especially for our real estate investors, when they have so much in bonus depreciation available, if their bonus depreciation gets to a point where you're wiping out very little marginal tax rate dollars, we might wanna be locked out and move it forward. But for purposes of this podcast, I'm gonna focus on that Roth conversion strategy. Mhmm.
Speaker 2:So that that one's your favorite and two, I would kick myself if I did not mention it, with MTR, so marginal tax rate. We we've actually created a calculator to to help our listeners and really our our audience and members of Teaching Tech would actually go in there and figure it out for them. So really all all the items that you just listed, it's it's a little overwhelming because it's not just bam. Here here's my taxable income. Here's my tax bracket.
Speaker 2:Very, very simple calculation. I mean, it's literally one row on a spreadsheet, and you could figure out what you're at. So MTR is a little bit more complicated. And, again, that calculator is out there. So to the best of my knowledge, I've never seen that before.
Speaker 2:It's awesome that we have it. We've gotten fantastic feedback from individuals that have tested it earlier on and those that are now using it as well. So that's a tool that we that we have in our ecosystem as well and on the platform. But if you didn't if you weren't able to choose rough conversion
Speaker 3:Mhmm.
Speaker 2:As your favorite on Grain. And, of course, as you all know from listening to this, I like to poke the bear with Chris and and kind of put him on the spot a little bit. Which one's your second favorite? Would it be capital gain harvesting, retirement plan distribution?
Speaker 3:I would definitely say capital gain harvesting, and we're gonna do an episode just on that strategy because it's it's more than just selling stock that went up. There are several ways you can plan, especially when you're transitioning your business, into recognizing income as capital gain instead of active income. So a lot, lot more,
Speaker 2:I should say, a higher degree or a higher volume of variables.
Speaker 3:There are several variables and exactly. Capital gain long term capital gains, specifically, are taxed at a lower marginal tax rate than ordinary income. So, really, my my takeaway as we wrap the show up on the green diagnosis, so taxable income acceleration. My takeaway for anyone listening is figure out what your marginal tax rate is. Don't worry about your tax bracket.
Speaker 3:The marginal tax rate dictates dictates your diagnosis, which then in turn tells us what prescriptions to consider. Being in a green margin green diagnosis does not mean that you have poor cash flow, does not mean that you're not wealthy, does not mean that you're not doing well. There are several people that make significant income that are really in the green diagnosis.
Speaker 2:You know, I really expected you to say something about Michigan State being being a good green here.
Speaker 3:I know. Well, you know, I love my Spartans. But but, unfortunately, I I I you know, my favorite teams do not play a role when it comes to tax planning.
Speaker 2:Oh, there you go. That that that's a great response. But, so I I think we kinda wrapped it up. I mean, not not to not to beat a dead horse with that, but Roth conversions, you know, is your favorite. Obviously, there's more in there.
Speaker 2:A lot more detail to come to those. But, again, thank you everybody for for tuning into this. Obviously, as we're getting close to the end of the year here, this is something that, you know, I I should say it's not too late to plan for anything. Obviously, the best day to plan was yesterday. Let's be honest.
Speaker 2:It usually always works that way. So just a little recap. We went last week. We dove into red. That one obviously being the 25% or higher MTR, green being the 20% or lower.
Speaker 2:And then next week, we're I think we're gonna dive into purple. Mhmm. And then from there, we're gonna dive into gold. So, really, we hit all four before the end of the year. Again, any questions, any ideas, please reach out to us.
Speaker 2:A good avenue actually would be on our on our social media. So I know on Facebook, we're pretty active, on any of the platforms.
Speaker 3:Absolutely. And we usually forget to ask for this, but please rate, review, and subscribe. This podcast is for you. This podcast is to empower people to think openly about the power of tax planning and strategy. So thank you so much, and we look forward to seeing you next week.
Speaker 3:Take care.
Speaker 2:And anything lower than a five star, your MTR will automatically go up. It's it's it'll double. It's kinda wild how that works. But all joking aside, thank you everybody and we will see you next week as always.
