Roth 401k. But you can roll it back into a Roth IRA right after that (if you wanted). Not all 401ks have a Roth option, but many do. It depends on what was set up by your employer.

Bill,

Assuming you had no income you could take your standard deduction + the Long term capital gains rate 0% for a total of $105,100. Keep in mind depending on your state, you may have some state tax to pay.

I have a question regarding the Stacking Rule, Foreign Earned Income Exclusion, Foreign Housing Exclusion, and long-term capital gains.

We work overseas and are able to exempt ALL of our income using the Foreign Earned Income Exclusion. Our effective AGI is $0.00. My question is, can we go into our brokerage account and harvest gains, up to $109,000, and pay no taxes on this as we would be in the 0% long-term capital gains bracket? Or, for tax purposes does the FEIE and Foreign Housing Exclusion get added back in (stacked) on top of the LTCG to determine our taxable income? 

Example: We earn $108,700 and wipe this out with our FEIE. We then take $109,000 from our brokerage account and step this up. 

If the stacking rule applies would it be
$109,000 + $108,700 = $217,700 resulting in all of the $109,000 LTCG being taxed at 15%?

If so, how would all of the credits and standard deduction work (standard deduction, child tax credits, child dependent car credits, foreign tax credits, etc.)?  Would these credits and deductions be able to be used to reduce income thereby allowing us to effectively eliminate the LTCG? For example 15% of $109,000 = $16,350 dollars in taxes; however, would we not have access to the Standard Deduction and the rest of the credits to effectively wipe these taxes out?

Follow-up questions:

1) Are all exclusions added back into income to determine taxes? For example, the Foreign Housing Exclusion, FEIE?

2) What about a situation where we sell our primary home in the U.S. (assuming we are now living full time and this is our primary residence), and have a gain of $500,000. We know this is a housing exclusion, but what if we also harvested $50,000 from our brokerage account in the same year. Does all of this get stacked back on top of our income for determining taxes, or is the housing gain excluded? If so, why is this excluded but not (if this is the case) the FEIE?

I so appreciate your willingness (fingers crossed) in answering this question

Great article just what I needed to read. I “feel” like I have about 85% of your sharing but that 15% is really important for me to grasp and am hoping you can fill in the gaps.

1) we work overseas at an international school in Singapore. We use the FEIE, Foreign Tax Credits, Housing Allowance, as well as various credits (Child Tax Credits, Child Dependent Care Credit).

2) Utilizing the above we wipe out nearly all of our earned Income; however, we still have about $40,000 of AGI (outside the FEIE). We manage to wipe this $40,000 with our standard deduction and various credits.

3) My Question: (sorry it took a while to get here): Can Harvest gains in our brokerage account to the tune of roughly $70,000? The stacking rule would put the AGI of $40,000 back in the mix, but could we take an additional 70,000, remaining in the 0% tax bracket for LTCG? OR are all the exclusions added back resulting in us being well past the 0% bracket.

I “feel” like I’m close to understanding this. I would so appreciate clarification on this.

Warm Singapore Regards,
Jeff

Andrew, reading your response to Stephanie, I have a follow up question to the proposed solution for the pro-rata rule. You stated that one can roll their pre-tax dollars into a 401k, then do the Roth conversion. If I’m tracking what you’re saying, you would then be doing the Roth conversion on the dollars in the 401k account, correct? If so, are you converting them to a Roth 401k account or a Roth IRA? Also, do all 401k plans permit a Roth conversion?

Thanks for your nice comment!

The first tranche of your capital gain is taxed at 0%, so you don’t need standard deduction for that anyway. Standard deduction is only useful in this regard against ordinary income.

Regarding your point about “So at a minimum, you can earn $25.1k + $80,800 = $105.9k and pay zero taxes!”, if I just sell stock from my taxable account with total long-term capital gain of $105.9k do I still pay $0 taxes? I am not sure if I can also offset the long-term capital gains with the $25.1k standard deduction. I hope this makes sense.

Thank you,

Billy

Hey Kate.
1. It depends largely on the tax rate that you’re taxed at in each scenario: rolling over now vs. keeping it in the 401k. You only know one of them so you have to make an educated guess about the other one.
2. Because this example assumes you are self-employed (freelancing gigs) – you can deduct if you are self-employed or if you itemize.
3. I don’t think I have a post specific to backdoor Roths, but I might have something on the podcast (I forget at the moment). But TLDR = yes there are limits, it’s the same limits that apply to an after-tax IRA $6,000 if you’re under 50 for 2021.