Tax Torpedoes: How the Tax Man Can Getcha

Tax Torpedoes
Written By Larry Hall

Written by Larry Hall
August 11, 2025

🧨 What Is a Tax Torpedo? 

The term “tax torpedo” was popularized by retirement researchers William Reichenstein and William Meyer. Their work focused on how Social Security benefits are taxed, and how the phase-in of taxes can accelerate faster than income. They also explored how retirees with higher incomes can be blindsided by Medicare surcharges.  

Here’s a particularly painful example of a tax torpedo. 

Imagine a retired couple, both of whom are on Medicare. The year is 2023. Their joint Modified Adjusted Gross Income (MAGI) is $212,000—just below the threshold for Medicare Part B and D surcharges. They decide to give their granddaughter a $1,000 gift. They have money sitting in an IRA account, so without thinking, they take a $1,000 distribution and send the gift. She’s thrilled. It’s well below the $17,000 gift tax exclusion, so they assume all is well.  

That $1,000 IRA withdrawal pushes their MAGI to $213,000.  

📅 Fast forward to 2025: 

The additional $1,000 of income pushed them across a threshold, triggering monthly surcharges on both Part B and Part D Medicare premiums. The following increases applied: 

  • Part B surcharge: $74.00/month per person 

  • Part D surcharge: $13.70/month per person 

  • Total annual cost: $2,104.80 (For both spouses in 2025) 

That $1,000 IRA distribution triggered $2,104.80 in extra Medicare premiums, a stealth tax increase. By the time the surcharge hits, they may not even remember the gift. Had they taken the money from their savings account instead, they would have avoided the torpedo entirely.  

These surcharges are called Income-Related Monthly Adjustment Amounts or IRMAA. If you’ve heard people talking about IRMAA and wondered who she is, consider yourself acquainted. 

Tax torpedoes don’t just target high-income households. You don’t need a six-figure income to trigger one. They can strike anyone—retirees, workers, small business owners—especially those navigating complex benefit programs.

This is the essence of a tax torpedo: a small income bump triggers a disproportionately large tax hit. Many of these traps lurk in the tax code. The goal of this series is to help you spot them before they strike.  

Alternatively, you can hire a good tax professional to keep their eyes open for you. 

📋 Tax Torpedoes to Watch For 

Here’s a preview of topics I’ll cover in this series: 

🧾 IRMAA: The Stealth Surcharge 

As described above, Medicare premiums can sharply jump if your income crosses certain thresholds. These surcharges—known as Income-Related Monthly Adjustment Amounts (IRMAA)—are based on income from two years prior, and they often catch retirees off guard. 

Unlike salaried workers, retirees often have considerable latitude in how much taxable income they take and when they take it. That flexibility is a double-edged sword. 

  • Large one-time IRA distributions, such as Roth conversions, can trigger IRMAA surcharges. 

  • Capital gains from selling investments or property—like a vacation home—can push income over the line. 

  • Even tax-exempt interest from municipal bonds is included in the MAGI calculation for IRMAA. 

Tax-exempt doesn’t necessarily mean tax ignored. 

Any tax decision must be considered for all its consequences—not just the immediate ones. IRMAA is a prime example of how timing, source, and structure matter as much as the dollar amount. 

🧮 Taxation of Social Security Benefits  

Anywhere from 0% to 85% of your Social Security benefits are taxable. The portion depends on your total income and its composition—not just the benefit itself. 

The IRS phase-in formula creates a steep marginal tax rate spike for many retirees. This “tax torpedo” effect means a modest increase in income can lead to disproportionately higher taxes. 

Decisions about when to begin receiving benefits are complex. Taxation is just one piece of the puzzle—but it’s a piece that’s often overlooked. 

Taxpayers between the ages of 62 and 75 have a particularly rich window for tax planning—especially those with significant IRA balances. The decision of when to claim Social Security and whether to tap IRA funds before Required Minimum Distributions (RMDs) deserves careful attention.

It’s not just about minimizing taxes this year. It’s about understanding how today’s decision affects the lifetime tax burden—both for IRA owners and their beneficiaries. In some cases, taking distributions earlier may reduce long-term exposure to tax torpedoes, even if it means paying a little more now. 

Coordination—not just optimization—is key.  

🔍 Roth Conversion Torpedoes: Beyond the Brackets 

While Roth conversions can be a smart long-term strategy, they can also push you into higher brackets or trigger IRMAA and Social Security taxation if not timed carefully. The resulting increase in Adjusted Gross Income (AGI) can disrupt other parts of your tax picture. 

Here are a few hidden torpedoes to look for? 

  • Capital Gains Rate Disruptions—If you have long-term capital gains in the same year you decide to take a Roth conversion, be cautious. You may qualify for the 0% long-term capital gains tax rate, but a Roth conversion may bump your AGI enough to push you into the 15% to 20% bracket.  

  • Loss of Itemized Deductions—If you’re among the few who still itemize, a higher AGI can erode deductions. For example, medical expenses are only deductible to the extent they exceed 7.5% of AGI. A Roth conversion may push your income to the level that eliminates that deduction.  

  • Affordable Care Act (ACA) Premium Tax Credit Cliff—2025 is the final year for Enhanced Premium Tax Credits under the ACA. These credits currently extend beyond the old 400% of federal poverty level (FPL) cap. If you’re receiving ACA subsidies now, be especially careful. A Roth conversion could push your income just over the threshold—eliminating your credit entirely.

📈 Long-Term Capital Gains Rate Disruption 

Long-term capital gains are taxed at 0%, 15%, or 20%, depending on your taxable income. Gains are stacked on top of ordinary income, which means a Roth conversion or large IRA withdrawal can push your gains into a higher bracket. 

  • In 2025, the 0% rate applies to taxable income up to $96,700 (MFJ). 

  • If a Roth conversion bumps you above that, your gains may be taxed at 15% or even 20%. 

🧗 Tax Credit Cliffs

Credits like the Premium Tax Credit can vanish instantly if your income crosses a threshold. One dollar too far, and the benefit disappears. 

Tax credits are particularly valuable. Unlike deductions—which reduce the amount of income subject to tax—credits reduce your tax bill dollar for dollar. If they’re refundable, they can even generate a refund beyond what you paid in, functioning like a direct payment. 

  • The Premium Tax Credit (for ACA health plans) can disappear entirely if your income exceeds the eligibility threshold—especially once the temporary expansion sunsets. 

  • Sometimes tax law changes will disqualify you for a tax credit you’ve previously enjoyed. While the Child Tax Credit was increased in the latest tax bill this year, it’s more difficult to qualify. It’s estimated millions of families will no longer qualify. 

  • ACA enhanced subsidies are set to expire this year, unless Congress acts, and millions may see their subsidies sharply decline or disappear completely.

These cliffs can turn routine decisions—like a Roth conversion, asset sale, or side income—into costly surprises. Timing and income awareness matter, especially for retirees, freelancers, and anyone managing variable income.  

💣 Net Investment Income Tax (NIIT) 

If your Modified Adjusted Gross Income (MAGI) exceeds $250,000 (MFJ) or $200,000 (Single), you may owe an additional 3.8% NIIT on investment income—including capital gains, dividends, and rental income. 

This tax, although it’s been around for years, is often overlooked until it hits. Roth conversions or asset sales can push MAGI over the line and subject you to this tax. 

🧾 Alternative Minimum Tax (AMT) 

Still relevant for some taxpayers—especially those with incentive stock options (ISOs) or large deductions. The AMT is a parallel tax system that comes into effect if certain thresholds are crossed. 

The AMT requires you to calculate your taxes twice: 

  • Once under the regular tax system, with its deductions and credits 

  • Once under the AMT rules, which disallow many of those benefits 

You pay whichever tax is higher (of course). 

The AMT is especially relevant for taxpayers with: 

  • Large ISO exercises 

  • High state taxes 

  • Significant miscellaneous deductions 

  • Accelerated depreciation or passive activity losses 

It’s not about income alone—it’s about how your income is structured. Planning around AMT exposure can help avoid surprise tax bills, especially in years with unusual income events.

🧭 Why This Series Matters 

You don’t need to become a tax expert. But you do need to know where the danger lies. These articles are designed to help you spot trouble before it strikes—and to show how smart planning can keep your tax bill in check. 

Stay tuned as we explore one torpedo at a time. 

Because when it comes to taxes, what you don’t know can getcha. 

Are you concerned about tax torpedoes?

Schedule a consultation or reach out through my Contact page—I’m happy to discuss your situation.

This article is for informational purposes only and does not constitute professional tax advice. For guidance on your specific situation, consult a qualified tax professional.

📚 Sources & Further Reading

by by William Reichenstein, Ph.D., CFA; and William Meyer

Part A, Part B, and Part D Medicare Costs

Larry Hall

Lawrence (Larry) Hall, CPA, is a Grantham, New Hampshire based tax professional. He holds MS in Accounting and MBA degrees from Plymouth State University, where he taught accounting for several years. He thinks a lot about tax matters so you don’t have to.

https://HallTaxPro.com
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