The 0% Tax Rate
ZERO, ZIP, ZILCH
Apologies for the click-bait title but the IRS does have two 0% tax rates that you should be aware of:
1 - The 0% rate on total taxable income
This is the first tax bracket applies to the first $22,000 (for Married Filing Joint in 2023) of your overall taxable income. So every year, you can take solace in the fact that at least a small portion of your income is taxed at 0%. But as a practicing dentist, the vast majority of your income will be taxed at the increasingly higher tax brackets.
2 - The 0% rate on investment income
This rate ONLY applies to investment income (net long-term capital gains and qualified dividend income) from investments in taxable accounts, NOT tax-sheltered retirement accounts such as traditional IRAs or 401(k)s. The income limits for this rate are much higher than the total income bracket above (the MFJ limit for 2023 is $89,250) so if managed properly you can pay 0% on your investment income.
This strategy works best for:
Young taxpayers (as long as they are no longer dependents) with low wage income but significant investment earnings (like crypto back in 2020).
Taxpayers in a work transition like moving from associate to practice owner, where the earned income is low but they have investments they can sell to fund a practice purchase.
Retirees in the early phase of retirement, where they are delaying SS payments and not required to take RMDs from IRAs yet.
While EVERY situation is unique and you should create a plan with your advisor, here are some key details on the 0% investment income tax rate and how you can take advantage of that rate:
What Income Qualifies
Net long-term capital gains and most dividends. That is it.
Planning Tip - Investments will need to be made in publicly traded companies with growth potential and/or dividend pay-outs.
It does NOT reduce rates on wages, taxable interest (as from bank accounts or bond funds), pensions, net short-term capital gains on investments held a year or less, taxable Social Security payments, active and passive partnership investments, IRA or 401(k) distributions or Roth IRA conversion income.
The Stacking Rules
This is crucial and important to plan around. The eligible investment income “stacks” on top of your other income. The more other income (like wages or SS) there is, the less ability there is to use the 0% rate. Here are two simplified examples:
Working dentist with a $250,000 wage and investment income of $8,000. The wage income pushes the dentist past the income limit so the 0% rates does NOT apply to the investment income.
Retired dentist and spouse with $25,000 in rental income and $50,000 in qualified investment income would pay tax (at a pretty low rate) on the rental income but pay 0% on the investment income because the total income is under the limit.
Planning Tip - Use a double whammy of funding the early years of retirement with a taxable investment account and ROTH distribution (as they come out tax free) to minimize tax payments. Warning - This strategy works best if you have a large percentage of your retirement funds in ROTH accounts. If not, you may be better off making ROTH conversions during the early years of retirement to reduce future tax bills.
Rebalancing the Portfolio
If you don’t need the spending money, but still find yourself with limited earned income during a transitional period, you can use the 0% rate to rebalance your taxable investment portfolio without incurring taxes.
Planning Tip - That stock you purchased five years ago has done well but is making up a large chunk of your balance and the future looks murky. You can sell that stock, harvest that gain and purchase other investments tax free if you can stay under the applicable income limits.
As you can see, the 0% rate is not a myth but it does have some narrow windows of applicability so ensure that you are working with a qualified advisor to help you plan.