Roth IRA

 

 

Joe,

One of my friends just asked me if I planned on converting my IRA to a Roth IRA. He was excited because of a rule change that now made him eligible. He asked me if I were going to do the same thing. I lied and said I was. To be honest, I don’t even know the difference. Should I convert my IRA? What is the rule change he is talking about?

Walter, Stillwater

 Walter,

You are not alone in not knowing the difference between a traditional IRA and a Roth IRA. The basic difference rests when the taxes come out. With a traditional IRA you put money in tax free, but are then taxed when you withdraw. With a Roth IRA, you pay an upfront tax on the investment, but then the money is tax-free to withdraw.

My guess is the change he is talking about is the dropping of the income limit for those who can open or convert a Roth IRA. In the past, only investors with a yearly income under S100,000 could access a Roth IRA. A recent study by Fidelity Investments found that 83% of those surveyed knew nothing about the removal of income limits on IRAs. Understandable given that most investors face other financial issues to worry about. Which is a shame because investor ignorance clouds a significant economic opportunity.

So should you convert your traditional IRA to a Roth IRA? Probably. The most obvious reason is the tax-free income stream. With a Roth IRA, an investor pays the upfront tax, based on his income tax percentage, on the contribution. This strategy works especially well for those who plan on being in a higher income bracket upon retirement than they are now. Not just those starting out, but those who are out of work right now.

But even if you are doing well financially a Roth conversion is advisable. In a one time offer, the government will allow investors to defer the tax hit over two years. If you convert your traditional IRA to a Roth IRA in 2010, you can spread the tax liability evenly over 2011 and 2012. This helps to lessen the shock of a one time large tax hit.

 Another reason to convert now is to take advantage of a shrunken portfolio. Yes, there is an upside to the freefall of your IRA. When you convert to a Roth IRA, you are taxed on the amount converted. If your IRA has a value reduction of 30%, that means 30% less in taxes. When the account grows, you will not be taxed on the additional growth.

Finally, a conversion to a Roth IRA provides you more control over your estate planning. There are no mandatory deductions at 70.5, meaning a Roth IRA is preferable if you plan to pass on the account to beneficiaries.

All of these factors contribute to the proverbial perfect storm for you to convert your traditional IRAs to a Roth IRA. Don’t let your ignorance or a lack of press contribute to a missed financial opportunity.

Hope this information helps. Maybe you can even give your friend some advice. As always, check with a money manager whom you trust before making any conversions. There are many subtle rules that impact your conversion. Best of luck, Walter.

photo credit: scottwills

Certified Financial Planner Review

Office news – Joe Rapacki

As to better serve our clients I’ve undertaken a commitment to become a Certified Financial Planner.  So, last week I attended a CFP exam review program in downtown Minneapolis at the Westin hotel.   The facility was great and the classmates were great.  The attendees included Kristin from Nebraska, Jeremy from Edina, and Erin from Anchorage, Alaska!  All sharp advisors who, I’m sure will be passing the exam.

Four 8 hour days of review and motivation has been a good beginning preparation for the exam.  Next will be the needed study time before the Nov. 21 exam.   Wish me luck!
Joe

photo credit: Steve Wampler.

Your primary residence in a divorce

photo credit: steakpinball

Joe,

My wife of seven years and I have been talking about divorce. While nothing is finalized yet, I am curious what we can do with our family home. Should we sell it now and split? Wait? Will the selling hurt us coming tax time?

Roland, White Bear Lake

Roland,         

First, let me say I am sorry to hear you are going through such a difficult time. Divorce is not easy—not emotionally and not financially. While I hope you don’t need this advice, it is good you are preparing now.

I am not sure of the exact particulars of the situation—for instance having kids, time lived in home, and current marital status all play a role in determining the best course of action. That said, here is a hypothetical example I give many of my clients:

Let’s say Jack and Jill, a couple who has been married for five years, decide to separate. In the past, in a housing market long, long ago, it would have been easy for the couple to sell the home and divide the profit. If they divorced and filed as “single”, Under IRC §121 Jack and Jill could exclude up to $250,000 of gain on the sale of a principal residence if the ownership and use tests are met. To meet these tests, both Jack and Jill would need to  1) own and  2) use the home as their primary residence for two of the five years preceding the sale. However, if one of the spouses did not meet the test, they might be best off staying married until  year end and file jointly.  This way Jack and Jill could claim $500,000 so long as they both meet the use test and one of the two meets the ownership test.

Additionally, reduced exclusions are available to those couples who fail the two out of five year test due to health, employment, or marital changes—think divorce or lay off.

However, the plummeting real estate market has turned many homes into toxic assets. Many couples cannot afford to sell their homes at their current value. In that situation, Jack and Jill may decide to have Jill continue to live in the house, and pay Jack his portion when she sells or refinances the house. However, this is problematic in a couple respects.

First, with the current real estate market, it may be a considerable time before the home is sold at a favorable price, leaving Jack waiting for his potential payout. Second, Jill would need to sell the house within three years of the divorce for Jack to be eligible for the exclusion.  This time frame can be extended to six years if the former spouse is granted use of the home by a divorce “instrument.”

Also, Roland, make sure you keep the lines of communication open with your former spouse. This will provide a chance to communicate a strategy that is most advantageous to both of you. Then make sure you find a tax professional to handle the situation should the divorce proceeding continue. Not only will they provide you the best strategy to minimize your taxes, they will also protect you so you don’t unwillingly underpay your taxes and be liable for penalties years from now. The rules governing divorce and deductions are complex and nuianced.  Also, it may sound ideal to use the family CPA—they  have done the family taxes for years afterall. However, in divorce proceedings it is best for each party to have his and her own accountants, as some of the decisions that could be advantageous to one client, might be disadvantageous to the other. You want to make sure your CPA goes to bat for you.

Hope this information helps. As always, contact me should you need further advice. Best of luck reaching an amicable solution.

Late 2009 Tax Planning – Equipment Purchases

Joe,
Are there some tax rules my small business could take advantage of before the end of 2009?

Brad, Bloomington, MN

Dear Brad, 

That’s a good question. There are two favorable items due to expire on December 31, 2009.

1. Bonus depreciation. The 50 percent first-year bonus depreciation (for new equipment) is due to expire at the end of 2009. What this means is that 50% the cost of the new asset may be depreciated in addition to using the standard depreciation tables. Also, the $8,000 additional first-year depreciation allowed for new vehicles placed in service ends in 2009. For bonus depreciation to apply, the equipment must be placed in service by the end of 2009.
2. Code Section 179 expensing. Although this does not affect many clients, the limit for Code Section 179 expensing drops from $250,000 in 2009 to a maximum of $125,000 in 2010.

The rules are somewhat complex and you should review the specifics with your tax professional. 

For more information, visit:  http://www.irs.gov/businesses/small/article/0,,id=213666,00.html

Joe

Homeowner Tax Relief

photo credit: mhartford

We recently had a short sale on our home. We were surprised to learn we’d be getting a form 1099 for the amount of debt that the bank discharged.  And that we would be required to put the amount of the debt discharged as INCOME on our tax return. Is this true?

Frankie, Hopkins, MN

 

Yes, the Internal Revenue Code requires debtors to report all the forgiven debts on their Form 1040. Normally this is taxed as ordinary income unless one can use the bankruptcy or insolvency exemption.

However, there’s a rule in place that should help you out this year. Congress passed a law that allows homeowners special relief for the years 2007-2012. In order to qualify, the debt that was forgiven must be from one’s principal residence. Secondly, you must have incurred the debt to buy, build or substantially improve the residence. There’s no relief if you refinanced your mortgage in 2006 and used the equity that was cashed out to buy a Lincoln Navigator.

The rules for determining qualified principal residence indebtedness (QPRI) can be complex if the homeowner obtained a home equity loan and/or refinanced and used the loan proceeds for multiple reasons. So review the specific details with your tax professional.

Joe

Estate Taxes

Hello, Joe,

What are you hearing about the estate taxes for 2010?

Barb, Edina, MN

Hello, Barb;

There’s a fair amount of speculation about what will happen with the estate taxes.  The current federal estate tax law allows a $3.5 million dollar exclusion.  However, the estate tax is due to be completely eliminated in 2010 (This is a sunset provision written years ago into law).  However, a number of sources view such an event as unlikely to happen.

There are two reasons that this is unlikely.  First, the current federal budget deficit will require tax revenues to be at least be at the 2009 level for the foreseeable future.  Secondly, if the estate tax expires, the step up of basis in assets passing through an estate would expire as well.  Beneficiaries have limited knowledge about the cost basis of assets that are held by decedents.  The potential complexity of unknown or incomplete cost records would cause both the beneficiaries and the IRS overwhelming problems.

The most likely legislation will be simply an extension of the existing estate tax laws and exemption, for another year.  This will allow a busy Congress to visit the issue next year.  The majority of clients still believe that “I’m going to get taxed some how, some way, and I’m not going to like it”,

Estate planning is still important.

Joe
photo credit: simonsimages

Financial Planner Questions

Working from home

Joe,
I want to work from home, but not sure if my employer would go for it. What’s in it for the company? And, if they do let me work from home, what can I deduct on my taxes?
-Patrick, Minnetonka

Thanks, Patrick.  Those are two great questions that I hear a lot.

To answer your first question, there are many benefits to your employer to let you work from home. You would be happier—and more likely to stay on the job—for one. And, believe it or not, more productive. Studies show that employees who work from home show a jump in productivity. Also, your working from home will help a company work on their, to use a fancy buzz-term, corporate contingency plan. That is just a fancy way of saying their plan if a situation or disaster occurs. Say everyone gets swine flu or a hurricane hits.

While it many not apply to you, companies are also interested in allowing employees to telecommute because it expands their pool of available talent.
But before you get too excited about working from home, let me answer your second question. As all things government, the rules for tax deductions are complicated and intimidating.

In order to make any deductions as a telecommuting employee, you must first prove that your working from home is for the convenience of your employer, not simply for you. The above stated advantages provide good ways to show the convenience (profit!) of you working from home.
Next, you need to make sure you are deducting valid expenses.  There are direct expenses, relating to the home office such as painting the office or buying furniture for the office, and indirect expenses, items on the periphery such as electricity, taxes, or interest. You can deduct direct expenses, and the business-use part of indirect expenses for one of two reasons:

1) The part of the home where you work is used exclusively for work
2) You use the space to meet with customers or clients

Of course, the expenses you deduct can’t add up to more than you made in the course of business.

Finally, if you work both at home and a central office, you still may deduct expenses if the majority of your work is done from home. For instance, if a journalist does most of his writing from home, but goes to the office for meetings, he may deduct his expenses incurred at home and his traveling to the office.
Hope that clears up your question, Patrick. If you have any more questions don’t hesitate to ask.

photo credit: Yasuhiko Ito

Temporary Work Location (in Different State)

photo credit: Shenghung Lin

Hello Tax Advisor!

I’ve been offered a month-to-month contracting job in Iowa.  Looks like I’ll need to rent an apartment for the time I’m down there.  What’s the IRS say about being able to deduct these living expenses?? Herb B.  (in wonderful) St. Paul

Hello Herb:

In general, taxpayers may deduct ordinary and necessary expenses paid or incurred in connection with the operation of a trade or business.

In contrast, the IRS disallows deductions for personal, living, or family expenses, including meals and travel costs.  Transportation between a taxpayer’s residence and principal place of business are normally considered nondeductible personal expenses.

An exception applies, however, if the taxpayer is working away from home and the employment is temporary, as opposed to indefinite, in duration.

In that event, the taxpayer may deduct meals and travel expenses associated with the temporary position. Furthermore, a taxpayer is not treated as being temporarily away from home while pursuing employment that lasts longer than one year.

If the employment is initially expected to last for a year or less, but subsequently continues for longer than a year, the employment is treated as temporary until the sooner of when the taxpayer’s reasonable expectations change or one year elapses. Indefinite employment carries the prospect that the work will continue for an indeterminate and a substantially long period.

Regards Joe Rapacki

Reasonable Compensation for S Corporation Shareholders

photo credit: 16 Miles of String

“Reasonable Compensation” in regard to S Corporation shareholders has been a hot topic with the IRS.  Recently there have been several court cases that support the position of the IRS that:

S Corporations must pay reasonable wages to a shareholder-employee who performs services to the corporation, before non-wage distributions may be made to the shareholder-employee.  What this means is that S Corporation shareholders are required to pay payroll taxes on what should be considered as “reasonable compensation” for services.

What factors should be considered to determine ”reasonable compensation”?

A.  Training and expertise

B.  Duties and responsibilities

C.  Payments to non-shareholder employees.

D.  Time and effort devoted to the business.

E.   What comparable businesses pay for similar services.

Please contact us for further guidance on this issue.

Next Page →

• Search for:

• Social Sidebar

  Facebook
• 

• About

  Joe Rapacki is a CPA in the Twin Cities who helps keep more money in your pocket!

  Call the office to schedule an appointment 952-945-5011 or send an email

• Sign up for Joe’s Tax Blog

  by Email by RSS Reader

• Recent Posts

  • Roth IRA
  • Certified Financial Planner Review
  • Your primary residence in a divorce
  • Late 2009 Tax Planning – Equipment Purchases
  • Homeowner Tax Relief

• New York Times Tax News

  • Oh, That Account
  • The Private Sector’s Tramping in Iraq
  • Show Us the Money
  • Taxes in the Global Economy
  • The Light-Touch Tax Audit
  • No Taxes Until After the Election
  • Strange Priorities
  • Making Your Own Luck
  • Another Black Eye for H&R Block
  • Taxing an Unfriendly Church

• ShoeBox Finance

  • Shoeboxed App Available Through the New Google Apps Marketplace
  • Party With the Small Business Web at SXSW!
  • Shoeboxed to Revolutionize Receipt Management for Accounting Professionals
  • How to File Your 1099s This Tax Season (Plus a Special Offer!)
  • Shoeboxed as a Web Resource for Entrepreneurs
  • Shoeboxed New Headquarters and Change of Address!
  • Give the Gift of Time This Holiday Season!
  • Shoeboxed and the Small Business Web: Connecting Apps to Help Your Business
  • Shoeboxed iPhone App Named New York Times App of the Week
  • Shoeboxed iPhone App Tutorial

• Categories

  • 1099
  • Around the Office
  • audit
  • children
  • deduction
  • depreciation
  • Estimated taxes
  • filing
  • Financial Planning
  • Forclosure
  • Freetime
  • Health care taxes
  • Individual Retirement Accounts
  • IRA
  • irs
  • medical deductible
  • meetings
  • S Corporation
  • Sales and use tax
  • self employment
  • Social Security
  • taxes
  • Uncategorized
  • Vacation Home
  • Your Questions Answered

• IRS REQUIRED DISCLOSURE

  Any advice contained in this blog is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.