Roth IRA, to convert or not to convert?

The answer depends on your tax rate now and expected tax rate when you plan to take withdrawals. Also, you should consider this only if you can cover the taxes with funds from outside of your IRAs, otherwise you are forfeiting the tax deferral on those funds.

For example, someone with a low tax rate now, from large losses, large deductions or low income, may have less in taxes to pay now so that the rate of tax is less than what it could be in the future, making converting a wise financial move.

As a separate matter, the taxes can be paid over two years, however, if you expect a higher rate for 2011, the interest you earn will not make it worth waiting.

Someone with high taxes now, or in the AMT, would be a bad candidate for converting.

If you are considering this and want more analysis, we created a tool for that purpose so let us know.

Tax planning: 2009 tips and traps, and 2010 changes

Tax law changes for 2009 will require you to submit more information to your tax preparer to ensure that you get the most of tax credits and deductions. If the person working on your tax returns does not have all the proper information, you could pay too much or your return could be rejected.

Here is an overview of tax changes to consider when gathering your information:

* Making Work Pay Credit (“MWPC”), is a $400 credit to offset a reduction in withholdings enacted early in 2009. It is phased out for higher income and offset by the Economic Recovery Payment, described below. You could end up owing taxes if the credit does fully offset the reduction in withholdings (affects 2009 and 2010).
* Economic Recovery Payment (“ERP”) is a payment received as part of your social security benefits (for 2009 only), and affects the MWPC so that failing to report it could result in your tax return being rejected. The payment itself is not taxable.
* Government Retiree Credit (“GRC”) is for those not receiving social security, but affects the MWPC (2009 only). The new Schedule M reconciles the MWPC, ERP and GRC so you need all the information.
* First Time Home Buyer’s Credit is a $8,000 credit that applies to first time buyers purchasing between certain dates and requires a paper filing (electronic filings will not get the credit). If you buy the home in 2010, you have the option of amending your 2009 taxes for the credit. Note that this credit gets repaid over time on future tax returns beginning in 2010.
* Tax credit for long term home owners buying a new home, between certain dates, also requires a paper filing to avoid being rejected.
* American Opportunity Tax Credit (an expanded Hope Credit) allows use of the credit for two year more years than the Hope Credit, covering junior and senior years of college when the Hope Credit was not available.
* New Vehicle Purchase sales tax deduction (2009 only) is an additional Schedule A item, so long as your are not taking the general sales tax deduction.
* Energy Credit for solar power, fuel cells and certain energy efficient improvements are Schedule A deductions. There are two types of credit depending on what improvements were made to your home and taking the deductions requires you to have documentation.
* The Cash for Clunkers voucher is not considered income (2009 only).
* A tax refund can be used to buy U.S. Series I bonds.
* There is an AMT patch which helps for 2009, but falls back for 2010.
* There is an increased casualty and theft loss limit that helps for 2009.
* Note that a dependent child’s income is taxed when it exceeds $1,900.
* The Tuition and Fees Deduction applies to 2009.
* Unemployment Compensation has $2,400 excluded from taxable income (2009 only).
* Educator’s Expense enhanced for 2009.

Note that not all states accept the IRS changes, so the information and outcome could be different.

For 2010, some old provisions return and some new changes require action now:

* 2010 conversion to a Roth IRA has no income limit and two years to pay the taxes (please see To convert or not traditional IRA to Roth IRA).
* Certain changes lost for 2010 worth repeating (see What to watch out for in 2010 – investing, taxes and more):
* AMT patch falls back;
* Casualty and theft loss limits fall back;
* Educator and tuition and fees deductions against adjusted gross income are not available;
* Deduction of state and local sales taxes ends;
* Exclusion of $2,400 of unemployment income ends; and
* Exclusion of income from qualified distributions from IRAs to charities ends.
* The estate tax still has not been enacted retroactively, as expected (see Estate Planning – will we have a new tax law in time).

As we said before, tax planning involves a multi-year view to optimize what you end up paying (please see More Strategies – Three Year Planning…., Tax Credits and all Continued, and What to watch out for in 2010 – investing, taxes and more)

Let us know if you have questions or comments. Thanks,

Steven

Estate Planning – will we have a new tax law in time?

Many people have argued that Congress will freeze the federal estate tax exemption at $3.5 million and the estate tax rate at 45%

The House passed such a law and sent it to the Senate early this month.

However, as described in the article below, passage of this change to current law is not certain as there are political and procedural obstacles in the Senate. (Please see a more recent comment at What to watch out for in 2010)

If no action is taken, then there will be no estate tax in 2010 and only a $1 million exemption in 2011. In the second artilce below, Kiplinger’s Tax Letter projects a 1 year extension of the 2009 law.

We will continue to watch this to see if a law does pass…. and let me know if you have questions or comments. Contact Us

Estate Tax Reform Bill Passes House, Moves to Senate

Posted on December 8, 2009

On Dec. 3, the House passed the Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Act of 2009 (H.R. 4154). With time running short, the bill now moves to the Senate, where straight passage of it is uncertain, and passage of any estate tax legislation is anything but assured.

Introduced by Rep. Earl Pomeroy (D-ND), the legislation permanently extends current estate tax law, which taxes the heirs of a deceased individual whose estate is valued above $3.5 million ($7 million for couples) at a 45 percent tax rate. The Pomeroy bill passed the House by a narrow margin – just 225 to 200 – and mainly along partisan lines, though 26 Democrats did join a united Republican caucus in opposition to the measure. The bill essentially mirrors what the president asked for in his FY 2010 budget request. Most importantly, the Pomeroy bill would extend current law and prevent the estate tax from expiring in 2010 and then coming back in 2011 under its pre-Bush tax cut levels.

According to an estimate released by the Congressional Joint Committee on Taxation, the Pomeroy bill would bring in $468 million in 2010, when the government would otherwise collect no estate taxes, but then cost the government $533 billion over the next nine years because of higher exemptions and lower tax rates than would have been in place if current law was left unchanged.

Passage of the Pomeroy bill in the Senate is unlikely because several important senators have misgivings about certain provisions. Sens. Max Baucus (D-MT) and Kent Conrad (D-ND), chairs of the Senate Finance and Budget Committees, respectively, argue that Congress should index the tax for inflation, something the Pomeroy bill does not do. Moreover, the Pomeroy bill includes the Statutory Pay-As-You-Go Act of 2009 (H.R. 2920) that would give PAYGO budget rules the force of law in Congress. The House passed the PAYGO bill in July, but the Senate has yet to take action on it because, according to a recent Congress Daily (sorry, subscription required to view), top Democratic senators are opposed to enacting the provisions.

Estate tax legislation is therefore likely to go down one of two paths in the Senate. One alternative is for the Senate to bring up legislation similar to the Pomeroy bill, debate it, and pass it. The other option is for the Democratic leadership to tack a one-year estate tax extension onto a likely omnibus appropriations bill that insiders say Congress will pass before the end of 2009. Depending on how congressional events play out, either option is possible.

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Without action by Congress before the end of this year, the estate tax will disappear in 2010, but only for one year. The tax will then reappear in 2011 with just a $1-million exemption and a 55% maximum rate. In addition, many heirs of folks who die in 2010 will have to use the decedent’s tax basis for inherited assets.

The House has OK’d a permanent extension of the law in effect for 2009… a $3.5-million exemption with a 45% rate. Its bill repeals the carryover basis rule.

But the Senate has its own ideas. Finance Com. head Max Baucus (D-MT) favors continuing the $3.5-million exemption and indexing it to inflation each year, while maintaining the 45% rate. A coalition of Republicans and moderate Democrats is pushing for broader relief…a $5-million exemption and a 35% maximum tax rate. They have enough support to demand a vote for their proposal on any estate tax bill, and are likely to keep the Senate from voting on a permanent extension this year.

So a simple one-year extension of 2009 law is the likely result. This way, lawmakers can revisit the estate tax next year, after the health care debate ends. The bill will also kill carryover basis. To speed passage, the Senate may even add it to a fast moving appropriations bill that will be approved in the next week or so.

Two easings that could’ve passed in 2009 must wait because of the delay: Portable estate tax exemptions. Under current law, if a spouse passes away without having fully used up his or her exemption, the balance is wasted. Taxwriters want to ensure that any unused exemption goes to the surviving spouse. That way, taxpayers needn’t set up complicated trusts in their wills solely to save estate taxes.

And reintegrating the gift and estate taxes. The lifetime gift tax exemption is $1 million, less than a third of the estate tax exemption. Combining the two again would let taxpayers make larger lifetime gifts tax free to their heirs. Both changes must wait till 2010, when Congress will have more time on its calendar for debate.

Let us know if you have questions or comments. Thanks,

Steven