Hello everybody, it's Sam from Financial Samurai and in this episode I want to talk about taxes, short-term and long-term capital gains, tax rates for 2023, but more importantly, what should be the ideal passive income target we should all strive for as singles or as married couples filing jointly. So taxes obviously are our largest ongoing liability.

We can't escape them, we got to pay them, otherwise we're going to get fined or we might get thrown into jail. Who knows, we got to pay our taxes, but it's fine because if we pay our taxes we help ensure the continuation of our society, we help young people, we support old people.

It's part of being a citizen, right? We got to pay, but we don't want to pay too much, otherwise we'll start feeling taken advantage of. And we might leave the workforce altogether, thereby losing a lot of tax revenue. The government doesn't want that either, so there has to be some kind of balance.

And I've been thinking about this trade-off between time and making money for a long time now, actually since 1999 when I started having to get into the office at 5 30 a.m when it was still dark. And I've been thinking more about it recently since I decided to take things down a notch in 2023 because I'm tired.

And this is a great exercise, this podcast and this post that I'll link to in the show notes is a great exercise into thinking what is the ideal amount of income to make and what is the best composition of your income between ordinary income, active income, and passive income or hopefully long-term capital gains.

So let me first talk to y'all single individuals. For 2023, if you're single, the largest tax spread difference between short-term and long-term is if you make between $231,251 to $578,125 in taxable income. So in other words, if you have active income between that range, you're paying a 35% marginal income tax rate, a federal, right?

But if you have that income in terms of long-term capital gains, you know, qualified dividends, long-term asset sales like stocks or real estate, you only have to pay a 15% rate. That's pretty good. So that is the largest spread 35% minus a 15% tax rate. That's a 20% spread everywhere else underneath or above the spread is not as great.

So this is something to think about in terms of how much in long-term capital gains, or how much in passive investment income you want to make. It's a target amount. Obviously, it's a very large amount. So if we use a 4% rate of return, you would require about 5.8 to $14.4 million to generate $231,000 to $578,000 in long-term capital gains, or passive investment income.

Now, obviously, most of us will not be able to get there. But it's just a target. It's just something to think about. And here's another very important item. You can earn as a single individual up to $44,625 in long-term capital gains without having to pay any taxes. So you have a 0% tax rate.

Now, that's only possible if you have zero ordinary income. Most of us have ordinary income because we do work, we consult, you know, we type on a blog, and actually, I don't make any income from this podcast. So income on this podcast doesn't count. And I know there's some confusion on how to calculate long-term capital gains taxes if you have ordinary income.

So in the show notes, I have written another post about various examples to see what your tax liability will be. So you can't make, let's say, $10 million a year in ordinary income. So yeah, you'll pay the 37% top marginal income tax rate. And then if you have, let's say, $40,000 in long-term capital gains, you still have to pay a long-term capital gains tax rate equal to 20%.

It's not 0% because the IRS wants its money. So in other words, you have to look at your total income. And if your total income is crossing these various long-term capital gains tax rate thresholds, then you have to pay that tax accordingly. And I'll talk about some examples in later on in this podcast episode.

All right, so let's move on to married filing jointly. What is the most tax-efficient passive income amount to make for married couples? To find out, let's look at the income range where the difference between short-term and long-term tax rates is the largest. So that income range is $462,501 to $693,750 in 2023 for married couples filing jointly.

The tax rate difference is also 20%. We are talking about a 35% ordinary marginal federal income tax rate and a 15% long-term capital gains tax rate. Therefore, you would need at a 4% rate of return about $11.6 million to $17.4 million in invested capital to generate $462,501 to $693,750 in passive investment income or long-term capital gains.

Now again, this is just an exercise. If you're trying to figure out what is the ideal amount of passive income to make, be aware of the net investment income tax which is 3.8%. It applies to whichever is smaller, your net investment income or the amount by which your modified adjusted gross income exceeds the amounts listed which are $250,000 for married couples filing jointly or $200,000 for singles.

And again, look at the post, read the post to get some clarification on how that tax liability is calculated. But let me share one example of how long-term capital gains taxes calculated when you have ordinary income. So let's say you bought ABC stock on March 1st, 2010 for $10,000 and you sold it more than a year later for $20,000.

So you've got $10,000 in capital gains. Let's say you're single and your income is $65,000. Well, you would be in the 15% capital gains tax bracket. Why is this? Why is it not 0% capital gains tax bracket since you only had $10,000 in long-term capital gains? Well, the reason why is because you have $65,000 in ordinary income and that's above the threshold of $44,625 to pay 0% long-term capital gains tax.

So you had $65,000 in ordinary income and then you had another $10,000 in long-term capital gains. So you're at $75,000. So $65,000, you pay taxes based on the various marginal federal income tax bracket rates. And then since you're up over that threshold of $44,625, you are then going to pay a 15% long-term capital gains tax rate on the $10,000.

So $1,500. So how are you ever going to pay 0% long-term capital gains tax rate? Well, here's another example. Financial Samurai reader Jeff earns $40,000 in ordinary income. He pays 10% on the first 11,000 in income and 12% on the income he earns beyond that up to $44,725. So his total tax liability is $4,580.

If Jeff sells an asset that produced a short-term capital gain of 2000, then his tax liability rises by another $240 because that 2000 you multiply that by 12%. This is short-term capital gains, you hold it for less than a year. So it's ordinary, it's taxed as ordinary income. But if Jeff waits one year and a day to sell, then he pays 0% on the capital gains.

Why? Because total income is $40,000 from his day job plus $2,000 in capital gains. So that's $42,000, which is below the $44,625 threshold for single people to pay 0% long-term capital gains tax. So I hope this is clear, because it was confusing to me in the past. And many readers have been confused before, and you might be confused right now.

But listen to it again, or click over to the post to read the examples. It's very important to figure out what is the ideal amount of money you want to make. Alright, so let's say you want to make more than $44,625 for singles and $89,250 for married couples. Again, these are the two long-term capital gains tax thresholds where you pay 0% capital gains tax rate.

So let's say you want to make more. Well, for 2023, the standard deduction increases by $900 to $13,850 for singles and by $1,800 to $27,700 for married couples. So you would simply find a job or do some freelance work, whatever, where your adjusted gross income is less than those standard deduction amounts.

Because if it's equal to or less, you don't pay any ordinary federal income tax on those amounts because they're deductions, right? And then you can earn long-term capital gains or long-term passive income investments, qualified dividends, and so forth, up to the threshold of $44,625 for singles and $89,250 for married couples.

So if you combine the standard deduction amounts with these 0% long-term capital gains tax thresholds, you get $58,475 for singles and $116,950 for married couples. Can you all live off that type of income? I sure as heck can. If I was single or if I was a married couple with no mortgage debt, no consumer debt, simple lifestyle, decent lifestyle if I don't live in San Francisco or any coastal city, not bad.

Even with a couple kids, yeah, $116,950 for a married couple with two kids and no income taxes. Again, zero, right? That's great because that adjusted for, let's say, a 30% tax rate is kind of like making, I don't know, $160,000. So how much capital is required to generate the thresholds for single and married couple where you pay 0% tax, right?

The $44,625 and $89,250. Well, at a 4% rate of return, you need about $1.1 million to $2.2 million. $1.1 million for individuals, $2.2 million for couples. And I hope when you hear $1.1 million and $2.2 million, you feel that it's doable. You're inspired to get there. You don't feel like it's such an outlandish number to get to in your working career that you just give up.

Because I admit, I've talked in the past about needing $300,000 to live a middle-class lifestyle in an expensive coastal city with kids. I've talked about, yeah, $5 million. That's kind of like the ideal net worth figure that y'all have voted on over 10,000 votes that said that's the ideal net worth figure to have before retirement.

And I've even talked about $10 million, right? So the higher these numbers go, I'm afraid some of you might be demotivated. You might think, why bother? Why care? But as we have just discussed, you can get to $1.1 to $2.2 million and live an amazingly comfortable lifestyle without having to pay any capital gains tax.

And let's say you're making these amounts. You then have the ability to go do work, take active income on things you really care about, that are meaningful to you, that you just enjoy. You can make $5,000, $10,000, $20,000, $30,000, whatever. It doesn't have to be about the money. It's actually not about the money.

It's about doing the things that you enjoy that are meaningful to you. And if you do that, you're going to feel a tremendous amount of purpose. Your heart will be filled with joy, or at least more joy. And you'll have a better time overall in your life. I remember when I first started working, I was feeling overwhelmed because I was working with people who had windfalls of tens of millions.

And you read the news, just like now, social media, you hear about people making a billion dollars, they have a hundred billion. It's just, it's so daunting and crazy. So I want to dial this kind of investing FOMO, this anxiety back a little and say, look, 1.1 to 2.2 million, if you're married, is good enough to lead a very comfortable and happy life.

And yes, some of you will say, well, it's still 1.1 to 2.2 million. Yes, I know. But it's much more digestible than thinking about all these other crazy numbers out there on the internet and in the news. I firmly believe the majority of you, maybe it's 51%, or maybe it's 80%.

The majority of you financial samurai readers and listeners will become millionaires in your lifetime. And this is a book and topic I want to write about for my next book. So thanks so much for listening. I hope you're more inspired by this podcast. And I hope it helps you think about ways to earn and spend your time in a different manner, in a more efficient manner.

And if you enjoyed this episode, I'd love a positive five star review with some commentary. And if you want to support my work, please check out Buy This, Not That, my Wall Street Journal bestselling book at financialsamurai.com/buythisnotthat. And please sign up for my newsletter so you never miss a thing at financialsamurai.com/news.

Take care.