TL;DR PRC appears to be treating Regular Investment Account qualified dividends taxed at the preferred LTCG rate as realized capital gains. Qualified dividends are reducing Capital Loss Carryover to zero before even the first withdrawal. This is not how the tax code works, is it? What am I missing?
My portfolio drawdown strategy is to spend all dividends thrown off by my Taxable “Regular Investment Account” as they are distributed then secondarily withdraw any additionally needed funds from Tax-Deferred. From separate posts we have established that 1) PRC requires reinvestment of Taxable dividends and 2) does not allow Scheduled Withdrawals from Taxable. In effect, I cannot directly access my primary source of retirement funding without setting “Regular” as the first account in the Withdrawal Order under Financial Assets > Management. That’s not my actual real-world practice nor preference, but so be it. I can still use PRC for rough modelling, just not for my actual plan. Alternately, on the Income page, I could define a custom Other Income Stream for “Ordinary Dividends” (Taxation "Regular Income") and another one for “Qualified Dividends” (Taxation "Capital Gains"), specifying the dividend dollar amount I expect to receive each year, along with an annual growth percentage. Then, since I am modelling my own taxable growth explicitly via Other Income Streams, on the Financial Assets > Asset Class Taxation page I can specify 0% for “Growth taxed as simple interest”, 0% for “Growth Taxed Annually as LTCG”, and 100% for “Growth Taxed as LTCG When Withdrawn”.
I am unable to model either of these straightforward approaches in PRC with the expected outcome and have to believe I am missing something obvious. The crux of my difficulty lies with having a rather large Capital Loss Carryover that I am leaning on for a period of tax-free income from my Taxable account, with the carryover losses offsetting all realized, otherwise-taxable capital gains until exhausted.
My frame of understanding…. Taxable assets are taxed on: 1) Annual Earnings and 2) Withdrawals, i.e. Sales. Earnings can be taxed at either the ordinary income rate (interest, non-qualified dividends, and short-term capital gains generated within the asset, not by a sale) or at the preferred LTCG rate (qualified dividends and long-term capital gains generated within the asset, not by a sale). When the investment is sold, it is taxed either as a short-term capital gain/loss (asset held < 1 year) at the ordinary income rate or as a long-term capital gain/loss (asset held > 1 year) at the preferred LTCG rate. It seems to me - and I offer this meekly and with expectation of embarrassment at overlooking something simple - that PRC is conflating the taxation of Earnings (which might happen to be taxed at the preferred LTCG rate) and Sales (which are actual LTCG gains). Qualified dividend growth is TAXED at the preferred LTCG rate but does NOT constitute a long-term capital gain; there has been no sale; there has been no realized gain. A true gain is only realized when the asset is SOLD. Actual LT gains (and losses) directly impact intrinsic portfolio value as losses can offset gains, with large enough harvested losses providing tax-free income from a Taxable account for years, or indefinitely. Qualified dividends taxed at the LTCG rate have no impact beyond a single tax year. (Again, all as I understand it.)
It appears PRC is treating qualified dividends TAXED at the LTCG preferred rate and actual long-term gains REALIZED upon withdrawal and taxed at the LTCG preferred rate as the same thing. On the Financial Assets > Asset Class Taxation page, if I specify a percentage in the “Growth Taxed Annually as LTCG” to model my qualified dividends taxed at the preferred LTCG rate, the calculated growth reduces Tabular Projections > AGI Detail > Residual Capital Loss Carryover commensurate with the calculated dividend growth. I don’t believe Form 1040 Schedule D does this. If I take the second approach above and model the qualified dividend stream as an Income > Other Income Stream with Taxation "Capital Gains", same thing. PRC interprets this as a REALIZED gain also and reduces my Capital Loss Carryover, instead of just TAXING the dividend at the LTCG rate. When I set up my model to withdraw from Tax-Deferred first and let Taxable grow undisturbed (i.e. no withdrawals/sales/gains whatsoever), I see my largish Capital Loss Carryover disappear in just a few years due solely to modelling my qualified dividends as "Growth Taxed Annually as LTCG”. The prospect of a tax-free income stream from the Regular Investment Account goes… poof. Before I’ve sold a thing. Should this be happening? (I do realize a non-zero Capital Loss Carryover will be reduced annually, at a minimum, by the $3,000 offset against ordinary taxable income, even in years with no withdrawals/sales.)
Short of PRC allowing Taxable dividends to flow straight into the Cash account (at the very top of my Christmas wish list for Santa Matthews!), do we need a mechanism to TAX growth at the LTCG rate without REALIZING LTCGs when no sale has actually been made? Is that capability already available in PRC? Modelling qualified earnings growth independently from realizing actual capital gains can make a material difference in portfolio longevity, particularly when a Capital Loss Carryover is in play.
David,
I think I’ve identified two errors in the PRC implementation that explain what you’re reporting here:
- The Capital Loss Carryover balance is being computed incorrectly (just a logic error in the formula) and is causing the carryover balance to be depleted too quickly.
- PRC is indeed applying the Capital Loss Carryover balance to offset the qualified dividends, and shouldn’t be.
I have fixes for these problems undergoing testing right now and plan to get a new release out in the next few days.
Two other notes:
1) If you elect to model dividends via the Other Income method (on the Income page), you need to make sure that you reduce the ROR being modeled via the Financial Assets pages to eliminate the contribution of the dividends, else you'll be exaggerating your income.
2) I think Santa Matthews is going to come through for you: I'm currently in the process of designing the capability to let taxable dividends flow straight into the cash account rather than being reinvested in the 2022 model of PRC Gold. It's possible that I'll encounter an issue that makes me change my mind but I think it's going to work out.
Stuart
Wow, this is some great news! I was pretty certain I was overlooking something or configuring something incorrectly. I’m never entirely confident in how I understand and interpret taxation issues. I’m too cheap to hire a tax expert so I read and research on my own, muddling through as best I can. (I also invest in world-class Personal Finance Model software! ?) But I’m glad my questioning led to identifying the issues with handling of Capital Loss Carryover. Tweaking that will just make PRC all the better. And thanks for pointing out the need to adjust ROR downward if I model my dividend stream as an Other Income Stream. I had completely missed that.
I’ll alert the family that they might not have to worry about getting me anything for Christmas this year. Santa Matthews has got me covered! It really would be wonderful if you can work through the issues to make reinvestment of taxable dividends optional and let them flow into spendable income instead. I’ve noted a couple of others who have posted with the same approach. I wouldn’t be surprised if there are many more of us who follow this strategy, hopefully making this enhancement serve a much larger audience.
I am astounded at your devotion to your product, the speed at which you implement fixes and enhancements, and your overall ethos of partnership with serving your customers. It’s truly refreshing in a world of mediocre customer service, or no service at all, and much appreciated.
First off, a sincere Thank You! for your extraordinary responsiveness in addressing recently-reported issues via PRC 2021.3.6. A lesser developer would have waited to bundle a passel of bug fixes with next year’s release, if then. That being said, I am not seeing a change in behavior with the issue of Residual Capital Loss Carryover being reduced when no capital gain has been realized. I am still seeing income taxed at the preferred LTCG rate reducing Residual Capital Loss Carryover just as if an asset had been sold and a gain realized. If it works, I will attach a simple test file illustrating what I am seeing. It’s just your default Simplified Inputs “Bob & Kit” scenario with a Capital Loss Carryover specified, along with an Other Income Stream taxed at the preferred rate. No unscheduled withdrawals from the Regular Investment Account were made nor were any other capital gains realized otherwise. Under Tabular Projections>AGI Detail, the Residual Capital Loss Carryover column is zeroed out in two years although all the related "Realized capital gains xx" columns are blank. Unless I’m really misunderstanding things, simple income - even if taxed at the preferred LTCG rate - can never reduce a capital loss; only a realized capital gain can reduce a capital loss.
In case the attachment doesn’t work, here are the steps to create this test...
- On Home page, click "Simplified Inputs" then "Populate PRC from These Simple Inputs", taking all defaults
- On Financial Assets>Initial Balances page, enter "Capital Loss Carryover" $50,000
- On Income page, define "Other Income Stream #1" of $20,000, Start 1/1/21, Taxation "Capital Gains"
- On Tabular Projections>AGI Detail page, note:
- "Residual Capital Loss Carryover" is zeroed out in 2 years.
- Year 1: Reduced $23,000 ($20,000 Other Income + $3,000 Ordinary Income Offset) to $27,000
- Year 2: Reduced $23,000 ($20,000 Other Income + $3,000 Ordinary Income Offset) to $4,000
- Year 3: Zeroed out
- All “Realized capital gains xx” columns are blank
Unless I’m really misunderstanding things, simple income - even if taxed at the preferred LTCG rate - can never reduce a capital loss; only a realized capital gain can reduce a capital loss.
I just read my post back and wanted to clarify a likely confusing comment, just to make sure I’m not unnecessarily muddying the waters and am accurately articulating my understanding. I meant to say that I didn’t believe income could reduce a residual capital loss CARRYOVER. I made it sound as if I was thinking the loss itself could be somehow offset or reduced. My understanding is that a carryover loss offsets any realized capital gain - or - up to $3,000 ordinary income per year, until exhausted. In the example case, the $20,000 of Other Income is reducing the capital loss carryover dollar for dollar, with the effect being (presumably - I’m not at my computer to confirm) that the $20K of income is completely offset and never taxed. The reduction of the carryover, i.e. its offsetting of income beyond the per-annum $3,000 of ordinary income, is what I’m thinking shouldn’t be happening. Gotta love our tax code. ?
@ilovemybeagles Hi David, I've deleted and replaced my initial response to the above post. In looking at this a bit more I've convinced myself that it's correct as it stands now. I've checked the IRS forms and worksheets again and believe that carryover losses can be used to offset any amount of capital gains plus up to $3000 in loss each year. In your example, this would result in a $23,000 reduction in the carryover loss balance each year until the carryover loss is exhausted. Further, even when no capital gains are reported, the carryover loss can be used to offset up to $3000 of ordinary income (in which case the carryover loss will be reduced by $3000 per year).
@smatthews51 Hi Mr. Matthews, thanks for the same-day response! Outstanding. I actually agree 100% with your explanation of how a capital loss carryover offsets both capital gains in addition to $3,000 of ordinary income. (I see this in action on my tax return annually.) And in the example given, the $20,000 of capital gains + $3,000 of ordinary income would indeed be offset by the $50,000 capital loss carryover IF - big IF - the $20,000 were an actual capital gain. With what I’m trying to model, it is not. I am trying to model an income stream representing my qualified dividends. My take: Qualified dividends are taxed, coincidentally, at the preferred long-term capital gains rate, but they are not actual capital gains (no asset has been sold at a higher price than its cost basis so no gain has been realized). Whether qualified dividends are modelled as an explicit income stream, as I’m trying to do here, or are calculated as portfolio growth based on the “Growth Taxed Annually as LTCG” percentage on the Financial Assets>Asset Class Taxation page, qualified dividends are not capital gains, are not offset by the capital loss carryover, do not reduce the capital loss carryover, and really have no relationship to capital gains/losses whatsoever beyond the fact that they happen to be taxed at the same rate as a long-term capital gain. Only when a capital gain is realized (sale of real property, withdrawal from the Regular Investment Account, etc.) would the Residual Capital Loss Carryover be relevant and reduced commensurately.
As a quick summary of my situation, the dividends from my Taxable account are my primary source of retirement income. PRC will not let me access that income directly because it forces dividend reinvestment and does not allow me to specify a scheduled withdrawal from the Regular Investment Account. I think what is tripping me up is that when I define the Other Income Stream for the qualified dividends, I select "Taxation Capital Gains”. PRC is obviously interpreting that as a literal capital gain, i.e. something has been sold at a price above its cost basis, when I am wanting only the “Taxation” part of it (tax the income at the capital gains rate but do not deem it as an actual capital gain). Whatever PRC is doing on the Financial Assets>Asset Class Taxation page to tax annual portfolio growth as “Growth Taxed Annually at LTCG” WITHOUT deeming that growth as true capital gains (it’s just growth, no sale of assets, no relationship to Residual Capital Loss Carryover at all) is what I need to be able to do somehow or another to model my situation.
@ilovemybeagles OK, I'm totally with you now and just need to determine the correct way forward. The Other Income streams are implemented as an alternative mechanism for representing actual capital gains but you're assuming they're implemented as an alternative mechanism for representing qualified dividends (and need to be done this way because PRC doesn't currently allow dividends to be spent rather than reinvested). As I think through this again now, I'm inclined to believe treating Other Income (taxed as capital gains) as dividends makes more sense than treating it as real capital gains so I'm going to make that change in v3.8.
Great news! Thank you for bearing with me and hanging on long enough to decipher what I was trying to say. Again, no tax authority here so I appreciate your patience and affability throughout this exchange.
My need for modelling my Qualified dividends will certainly be met by making option "Taxation Capital Gains” tax my Other Income Stream at the preferred long-terms capital gain rate while not simultaneously treating it as a realized capital gain (and thereby turning around and immediately offsetting the amount by any available Residual Capital Loss Carryover and then reducing the Carryover commensurately). I also believe this will benefit other customers I’ve noted asking you how to tap their taxable account dividend income stream as well. I do wonder, however, whether other customers might be relying on the current treatment of “Taxation Capital Gains” to define an annual stream of true realized capital gains? I couldn’t think of many real-life scenarios - perhaps someone selling off an acre of land each year for ten years? - but perhaps you might want to consider offering both options in the “Taxation” dropdown, say “Taxation Unrealized Capital Gains” and “Taxation Realized Capital Gains”? This would provide ultimate flexibility and place another feature arrow in PRC’s quiver, if not too complex to implement. Just a thought and may not be worth the complication (and no need to offer a justifying explanation for whatever you decide to implement).
One final observation and I’ll give it a rest… I noticed a couple of places where, in my humble opinion, there is some misleading and confusing verbiage in PRC. In the hover help (red triangle) for Financial Assets>Asset Class Taxation>Growth Taxed Annually as LTCG it states “This is the portion of the growth of this asset class that is taxed as realized long term capital gains”. Since “realized” is the financial synonym for “asset is sold” I don’t believe this applies to annual growth since nothing is sold. Annual growth is actually unrealized capital gains. “Growth Taxed as LTCG when Withdrawn” is for the realized gains (“withdrawn” denoting “sold”), which is essentially communicated in its hover help, though the clarifying term “realized" is not specified outright. The same incorrect (in my view) verbiage carries over to Tabular Projections>AGI Detail where the resulting calculation is presented as “Realized capital gains on regular savings”. I believe those gains represent the calculated growth and are, again, unrealized, not realized. The realized gains are presented in the adjacent companion field “Realized gains resulting from withdrawals from regular savings”. In other words, they are not both realized: one is unrealized (growth) and one is realized (withdrawn or sold). I might suggest eliminating the inapt “Realized” terminology from these couple of instances.
Thanks again for hearing me out! I may come across as hypercritical or nitpicking or accusatory or some other offense against civility, but really my only motivation is just wanting to contribute in a very tiny way to helping make PRC the best it can be, for all of us relying on it for some pretty impactful insights. Please accept my verbose ramblings in that spirit.
@ilovemybeagles David, I appreciate the critical thinking and associated feedback. I think I've made the appropriate changes to the text in the course of making the implementation changes we've discussed. I like your idea of the additional option on the pull-down menu on the Other Income taxation field and will probably add that as a 2022 enhancement. PRC2021 v3.8 was just released this morning, so please check it out and let me know how it works for you now. Thanks!
For now, to approximately model my desire to spend dividends, I made an estimate of the dividend stream for the years up to RMDs starting. I added that amount into an after tax account such as a Qualified HSA or Roth, and removed the same amount from taxable, (also ensured the growth rate my artificial account is equal to the growth rate in taxable). That lets the dividends grow similarly to what would happen to your actual dividends and then I used the Financial Assets-Management-Scheduled Withdrawals Table to withdraw the dividends from this artificial account, which gets them back into the cash account. For increased accuracy, you can break up your withdrawals into several batches so you use the average of just a few years at a time. Make sure there is a little extra in the artificial account, as PRC gets confused if you are asking for more than is in the account, v3.8 won't do a withdrawal at all if it isn't fully funded.
Of course that's not going to be quite right as the artificially lower initial value in taxable in this scheme will now generate capital gains that are slightly too low, but I can live with that since my cash management is much better represented. Looking forward to next year's version where we can do it for real!
@ricke What a positively ingenious workaround! I wish I had thought of it. Hopefully we'll get spendable taxable dividends in our stockings this Christmas so come January we won't need to be so creative. ?
@smatthews51 Your responsiveness and speed continue to amaze! Both are truly very much valued and appreciated.
I spent quite a while this evening playing around with unrealized capital gains (growth), realized capital gains (withdrawals), offset of realized gains by the Residual Capital Loss Carryover with proportionate Carryover reduction, and taxation. Everything worked exactly as it should, as I understand it. (And the clarifications in related verbiage seem spot on to me.) Beautiful, just beautiful. Now I can commence with the business of optimization and kicking the tires on some of the more advanced PRC features.
Thank you! ?
@ilovemybeagles Thanks, David! I'm happy to hear that it's now working as expected.
