Convertin Your IRA to a Roth

A lot of clients have asked about converting regular IRAs to Roth IRAs. This is a complicated question.

Let’s start with the basics. You usually get to deduct the money you contribute to your regular IRA while there is no deduction for contributions to a Roth IRA. You pay taxes on the money you take out of your regular IRA. There may be some adjustments but the distributions are a taxable event. If you meet the requirements for a Roth IRA you do not pay tax on money you take out of it. So Roth distributions generally are tax-free.

You are allowed to convert a regular IRA to a Roth IRA. Here is the problem: you pay taxes on the amount you move from your regular IRA to a Roth IRA. You need to pay these taxes out of money that is not in the IRA. So if you have a $10,000 tax liability for making one of these conversions, it must come out of other investments or savings account. If you use the IRA money to pay the taxes you might end up paying some penalties and taxes.

Why do a conversion? You do not have to pay taxes on future earnings in the Roth IRA assuming you meet the requirements of having it in the account for five years and being over 59-1/2. There are some exceptions to these rules.

You are paying current taxes to save future taxes. If you left the money in the regular IRA you would eventually pay taxes on all the earnings when you withdrew it from the account. You do not pay these taxes on the Roth.

Here is the big problem. You can pay as much as 40% in taxes on the value of the IRA that you convert to a Roth. This happens if you are in a high tax bracket. Even if your income were about $100,000 you would pay about 33% in taxes on the conversion. That’s a lot of money.

I have analyzed this conversion for several clients. The results have consistently come in that doing the conversion does not result in significant savings for the client. After taxes were considered the clients would end up with the same amount of money whether or not they did the conversion.

The one kicker that investment advisors keep throwing on the table is that tax rates are probably going up so pay the taxes now. I have a problem with paying a lot of taxes now based on what Congress might do in the future.

A conversion like this could benefit a low-income taxpayer, perhaps someone who lost a job and had very low income this year but expects to re-enter the workforce soon. This could result in some future benefit. Analyze your situation carefully if you are thinking about doing this type of transaction.

If your business is organized as an S-Corporation and it pays for your health insurance you could have a problem.

A corporation that has elected to have its profits or losses passed through to its shareholders, rather than paying its taxes directly, is an S-Corporation. If your corporation pays for your health insurance, you are required to add the value of any company paid premiums to the gross wages on your W-2 form.

For example, if your wages are $100,000 and you pay health insurance premiums for yourself of $12,000 (you wish they were that low) your gross wages on the W-2 form should be $112,000. These premiums are not subject to Social Security or Medicare Taxes.

There is some good news. After going through these gyrations you are allowed to deduct the health insurance premiums on the face of your personal federal tax return and Massachusetts tax return. In effect, it does not cost any additional taxes when you follow these rules.

If it has no effect, why do it? First, it’s the law. Second, if you do not put the premiums on your W-2, you are not allowed to deduct them on your corporate tax return. Third, they become an itemized deduction on your personal return that is subject to a floor of 7.5% of your gross income. So you would not get the full benefit of deducting the health insurance premiums.

Please note that this applies only to 2% or more shareholders. It does not apply to any employee who is not an owner.

Please pay attention to this problem. The IRS is getting more and more active in reviewing these transactions and assessing penalties if you fail to follow them.

Question of the Day

A client called to ask if the State of Massachusetts was willing to forgive penalties on sales taxes that were paid late.

Here is one of the unfortunate facts about sales taxes. No matter what the business structure, the owner of the business is personally liable for sales taxes plus the penalties and interest on them. So the corporate structure will not shield the owner from paying these taxes out of personal funds.

There is a possibility that the state will abate penalties if it is the first time they have been imposed and the person can give a good reason for not paying them on time. This abatement is requested using form CA-6. Here is a website where you can find the forms. http://bit.ly/MassForms

It will take the state a minimum of two months to process the request, they will continue to bill you, and you will still accrue the penalties and interest on the balance due.

The best policy is to pay your taxes on time.

More Time to File Your Tax Return

Floods can be a good thing. The IRS and Massachusetts have extended the deadline to file and pay your 2009 income taxes to May 11. They also have extended the time to pay some of your payroll taxes. Here is a link to get all the details. That is still due on April 15th. However, they may change this as well. I will keep you posted.

Correction 9:30Am 4-2-10 Estimates also are extended

Click on the title to see the IRS notice.

Whistle Blower Policy

We had some big business scandals in the early part of the new millennium. Accounting fraud at companies like Enron and Worldcom, and theft from companies like Tyco were in the headlines almost daily. Business executives were treated to the “perp walk” on a regular basis, partly to prove that the government was doing something about them. The end result was a lot of people lost a lot of money because of a few arrogant #$%^&*.

Non-profits were directly affected by these scandals. There is now more scrutiny of how non-profits do their work, and concern when any individual at the non-profit gets a salary over $150,000. (Maybe the big banks should get some of this scrutiny. But that’s off topic.) There has always been a concern when a non-profit spends more than 20% of its revenue on administration and fund raising.

The law passed to deal with business ethics, Sarbanes-Oxley, now requires that non-profits have a Whistle Blower Policy. A Whistle Blower Policy details the organization’s response to someone who reports alleged inappropriate activity within the organization. It protects the Whistle Blower from retaliation and gives a process for reporting the questionable activity. Many organizations do not know that this requirement exists, but the new IRS Form 990 now has a question about this.

What’s a non-profit to do? They can spend thousands of dollars with an attorney to create a customized policy. This is appropriate for large organizations like colleges and the United Way. There even are companies that enable an organization to outsource their response to people who report inappropriate activity.

Smaller organizations have an alternative. They can use a template to establish a policy. Here is a good site where you can get such a template.

http://www.blueavocado.org/content/model-whistleblower-policy-nonprofits

Take a look and try it out.

Charity for Haiti

Who says the government cannot move quickly?

Congress passed a new law that allows you to deduct the charitable contributions you make to Haiti relief in 2010 on your 2009 tax return. President Obama has signed the bill into law.

This means write the check now and get the tax benefit on the return you will file shortly.

File Free With the IRS

This is a repeat blog from a year ago. The only thing that changed was the dollar limitation.

Do you have a simple federal tax return to file? You can do it on-line free through the IRS. You qualify if you receive a W-2 from your employer, and have some interest and dividend income. You even can own a home and qualify. The major restriction is that all of your income must be below $57,000.

You can file your return through an IRS partner, or you can complete the tax forms found on the IRS Web site at http://www.irs.gov/app/picklist/list/formsInstructions.html This is a fast, easy, and free way to file your return. Would you like to have your refund in less than 3 weeks? You can have it deposited directly into your checking account. Have a personal check in front of you when you file your return so you have the numbers they require to take advantage of direct deposit. This system is appropriate only for uncomplicated returns.

This link to the IRS Web site can help you file your return.

http://www.irs.gov/efile/article/0,,id=118986,00.html?portlet=4

Massachusetts also offers a webfile alternative. Access it here

https://wfb.dor.state.ma.us/income/Default.aspx

If the link does not work. Please copy and paste it into your browser