Why Parallel Taxation

Like it said in my disclaimer, I’m not a CPA or Tax Accountant. I looked on-line for the proper term to describe how our Social Security benefits and Long Term Gains are given to us basically tax free and then are slowly taxed as our other income increases. I posted on-line and some of the responses called it delayed taxation, others called it deferred taxation, but none of those terms agreed with the definitions in Investopedia.

So I created my spreadsheet and plotted the three income streams that are being taxed at the same time that caused the ultra high marginal tax brackets. It looked like the taxation lines were in parallel to each other, so I coined the phrase “Parallel Taxation” and started building this website.

This is what the graph looked like with a $35,000 Social Security benefits and $4,000 in Long Term Capital Gains.

The dotted red line represents the standard tax brackets for taxing your normal income. The dotted green line show were 50%, then 85%, of your Social Security benefits are being taxed at the same time as your normal income. Since we are already taxing your SSB at the 50% level when the standard 10% Federal Bracket starts, these two dotted lines combine to create the solid red line indicating that your actual marginal tax rate starts at 15%.

Note how at about the $68,000 gross income level, the third dotted blue line exists indicating the 15% taxation of your LTCGs. When all three income sources are being taxed simultaneously, in parallel, your marginal tax rate jumps to 49.95%.

When we look at the graph from the other end of the retirement income spectrum, $12,000 of Social Security benefits and $3,000 in Long Term Capital Gains:

The dotted green taxation of your Social Security has not started when the taxation of your other income starts, so your initial Marginal Tax Rate is only the standard 10% Federal Tax Bracket. The taxation of your Social Security ends before the taxation of your Long Term Gains begins, which caused your Marginal Tax Rate to drop back down to 12% before the 15% taxation of your LTCGs begins. Since the parallel taxation at this point is limited to the 12% standard bracket and the 15% LTCG tax rate, the Marginal Tax Rate only jumps to 27%.

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