Advanced Underwriting Consultants

Question of the Day – December 21

Ask the Experts!

Here’s the question of the day.

Question:  My 45 year old client purchased her only Roth IRA three years ago with a $100,000 Roth conversion.  The Roth IRA is now worth $90,000.  If she surrenders the Roth, is she entitled to an income tax deduction?

Answer:   Perhaps, but under these circumstances it may not provide any net benefit.

Treasury Regulations Sec. 1.408A-6 says that all Roth IRAs must be aggregated for the purpose of calculating the tax treatment of distributions.  The IRS holds generally that for a loss position to be recognized, the asset must be fully surrendered.  That means that for a Roth IRA tax loss to be potentially available, all the taxpayer’s Roth IRAs must be surrendered, with a net loss being the aggregate result.

In this example, the facts are that the converted Roth is the taxpayer’s only Roth.

When the taxpayer surrenders the Roth IRA, there is a $10,000 loss.  The IRS’s position that the loss is deductible, but only if the taxpayer itemizes on the tax return.  Further, the loss is considered a miscellaneous expense, so it is only deductible to the extent the taxpayer’s total miscellaneous expenses exceed 2% of AGI.

Finally, the taxpayer must consider the tax implications of surrendering amounts associated with a conversion within five years of the conversion.  The rules say that a taxpayer younger than 59 ½ who withdraws converted amounts from a Roth IRA within five years of the conversion must pay the 10% penalty tax on the amounts withdrawn.  In this example, it would mean a $9,000 penalty tax on the $90,000 distribution.

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