Advanced Underwriting Consultants

Question of the Day – March 28

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question:  My client intends to make a Roth IRA contribution for 2012.  Where does she report that contribution on her tax return?

Answer:  Nowhere.  Roth IRA contributions are not reported on the individual’s tax return.  The IRA custodian does report a taxpayer’s Roth IRA contributions as part of its Form 5498 reporting obligation.

Form 5498 is filed with the Internal Revenue Service and a copy is also sent to the person who owns the account. Form 5498 provides confirmation to the IRS of the amounts the taxpayer contribution to traditional and Roth IRAs.

The taxpayer is obligated to keep records of Roth IRA contributions on her own, to substantiate that her contributions were proper, and also to prepare for proper tax treatment of future distributions from the Roth.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – February 22

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question:  What is the special first time home-buyer rule with regard to Roth IRA distributions?

Answer:  Qualifying distributions from a Roth are income tax-free.

A qualifying distribution occurs when an individual takes a distribution following a five year period beginning with the taxable year in which that individual first made a contribution to any Roth IRA in the taxpayer’s own name and one of the following is met:

(1) the distribution is on or after the owner attains age 59-1/2,

(2) the distribution is made to a beneficiary after the death of the owner,

(3) the distribution is on account of the owner’s disability, or

(4) the distribution is a qualified first-time home-buyer distribution.

All other Roth IRA distributions are non-qualifying.  Non-qualifying Roth IRA withdrawals are made according to the following ordering sequence: (1) aggregate annual contributions, (2) conversion amounts, (3) earnings on annual contributions and conversion amounts.

Distributions of annual contributions are always income tax-free and are never subject to the 10% early withdrawal penalty.  A distribution of conversion amounts is also income tax-free, but these amounts may be subject to the 10% early withdrawal penalty if made within five years of the conversion and while the owner is under age 59-1/2.

Earnings distributed prior to age 59-1/2 are also generally subject to the 10% early withdrawal penalty.

The taxpayer can take a qualifying distribution from a Roth IRA if she meets the five year test AND she qualifies for the first time home-buyer test.

The home-buyer can be the taxpayer or a close member of the taxpayer’s family.  To qualify for the exception, the money must be used within 120 days after distribution from the IRA for home purchase expenses.

A taxpayer can only claim use the first time home-buyer rule to shelter up to $10,000 of Roth IRA distributions from income tax during the taxpayer’s lifetime.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – December 21

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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.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – November 26

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Here’s the question of the day.

Question:  My 72 year old client would like to contribute $6,000 each to a Roth IRA for himself and his spouse.  Can he do so?

Answer:   Yes, so long as he has earned income at least of at least $12,000, but the couple’s adjusted gross income is not in excess of $173,000 (for 2012).

Unlike a traditional IRA where the ability to make contributions ends once the taxpayer reaches age 70 ½, an older taxpayer with earned income is eligible to make Roth IRA contributions for himself and his spouse based on normal Roth IRA rules.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – November 5

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question:  My unmarried client has earned income which is tax-exempt by a special federal rule.  If he has no other earnings, is he eligible to make a traditional IRA or Roth IRA contribution?

Answer:  No.

A taxpayer must have earned income to be eligible to contribute to his own IRA or Roth IRA.  Code Sections 408, 179 and 1402, read together, make the point that the earned income must be included in the gross income of the taxpayer to count as eligible for an IRA or Roth contribution.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – November 2

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Here’s the question of the day.

Question: My client has an IRA with both after-tax contributions, and pre-tax contributions.  The IRA also has untaxed earnings.  Is there any way the client can separate the after-tax contributions and convert that to a Roth IRA?

Answer: For most people, the answer is no.

The problem is that many of these clients already have other IRAs with significant pre-tax contributions in them.  When a conversion of an IRA is accomplished, the conversion amount is considered taxable and non-taxable in the same proportion as the total account balance in the IRA immediately before conversion.

Here’s an example.  Suppose the IRA has a total account balance of $100,000 of which $10,000 represents after-tax contributions and $90,000 is the amount of pre-tax contributions and earnings in the account.  If $10,000 is converted, the conversion will be considered to be $1,000 tax-free as conversion of after-tax contributions, and $9,000 will be the taxable amount representing pre-tax contributions and/or earnings.

Why not just segregate the IRA money into two or more IRAs with all the pre-tax money in one and all the after-tax money in another?  The answer is it can’t be done!  For purposes of determining the taxable portion of a Roth conversion, all IRAs owned by the taxpayer are aggregated together.

For clients with access to an employer plan such as a 403(b) or 401(k) that accepts IRA rollovers, there may be a solution to the dilemma.  The client may

  1. roll the pre-tax IRA contributions and earnings into the employer plan, leaving only after-tax money in the IRA, and then
  1. perform the Roth conversion.

When an IRA is rolled over to a pension plan, the rules provide that only the pre-tax money can be moved.  In fact, employer plans are not allowed to accept rollovers of after-tax contributions at all.  There are special rules that say rollovers of IRAs to pension plans drain the pre-tax part of the IRA first.  Rolling over that portion effectively strips out all the untaxed money and puts it in the pension plan, leaving only after-tax money in the traditional IRA.

On the subsequent Roth conversion, only after-tax money is converted from the traditional IRA.  While all the client’s IRAs must be aggregated for purposes of determining the taxable and non-taxable portion of the conversion, employer-sponsored retirement plans are not included in the aggregation.

For clients lucky enough to have employer plan accounts that accept rollovers, it’s possible to roll all the pre-tax contributions and earnings from an IRA into the employer plan, leaving only after-tax contributions in the IRA, and then accomplish a tax-free conversion to a Roth IRA.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – September 1


 

Question: My client did a conversion of a traditional IRA to a Roth IRA in 2010.  The client intended to do a two year deferral of the income tax into 2011 and 2012, but he recently passed away.  Can his beneficiaries still take advantage of the tax deferral on the conversion?

Answer: No.

The Instructions for IRS Form 8606 for 2010 state

If the taxpayer died during 2010 after making a conversion, the taxable amount of the conversion may not be spread over 2 years (2011 and 2012). The tax return of the deceased taxpayer must show (a) the entire taxable amount in 2010 or (b) a re-characterization (see page 3) of the conversion.

Likewise, if the taxpayer does a conversion in 2010, elects to defer, and dies in 2011, the entire previously unreported amount is taxable in the year of death.

 

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – August 31

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Here’s the question of the day.

 

Question: My client intends to make a contribution to a Roth IRA for 2011 in April of 2012.  If it turns out the client earned too much in 2011, can the contribution be applied to calendar year 2012?

Answer: Yes, assuming the client qualifies to make a Roth IRA contribution for 2012.

 

In the case of a traditional IRA, contributions made between April 16 and December 31 of a calendar year are assumed to be contributions made for that calendar year. On the other hand, traditional IRA contributions made between January 1 and April 15 may be a contribution for either that calendar year or the prior calendar year. The taxpayer must indicate on the form submitted to the IRA custodian to which year the contribution applies.

 

Here’s an example. On December 1, 2010, Sally made a traditional IRA contribution of $3,000. On January 5, 2011, Sally made an additional contribution of $3,000 and reported to the IRA custodian that this was a 2010 contribution.

On April 15, 2011, Sally filed her 2010 Federal Income Tax Return and took a deduction of $6,000 for an IRA contribution.  Some time later (but in no case later than May 31) the IRA custodian issued a Form 5498 with copies to both the taxpayer and the IRS indicating Sally made $6,000 in 2010 traditional IRA contributions.

 

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.