September, 2007

Traditional/Roth IRA conversions

I got a question last month about converting a traditional IRA to a Roth IRA. It’s somewhat complex, but it can be done. If you want to do it, it’s better if your income is “low” to avoid paying a 10% penalty on top of the tax. I like the Roth, but it isn’t for everyone.

The difference between the traditional and Roth has two parts, the timing of the tax paid on the original principal, and the tax on the gain on the principal.

All your income is taxed, but the traditional IRA allows the deferral of that tax on the principal amount contributed to the IRA until you take the money out at 65. (The withdrawal date is really 59 1/2, but let’s just say 65). The idea is that the un-taxed money can grow tax deferred, and that you’re expecting to make less money at retirement, putting you in a lower tax bracket. You pay tax on the money plus any gain you withdraw. I, of course, would like to believe that my income bracket will be higher at retirement (whatever that might be!) than it is now, plus I have my suspicions about how Medicare and Social Security will be funded in the future.

The Roth IRA offers no current tax deduction, but the growth is tax-free—you’ve already paid tax on the “principal” and the gain is tax-free. Did I mention that the gain is not taxed?

The limit on new contributions for either IRA for 2007 will be $4,000 or $5,000 if you are 50 or older. There are some additional limitations on contributions, particularly if you’re participating in another retirement plan, like a 401(k). For the Roth only, if your MFJ modified AGI income is $156k or more ($99k single), you contribution will be limited; it will not be allowed at all if your income was over $166k ($114k single).

If you withdraw money from either IRA before it’s time, you’ll pay tax on whatever income you deferred, plus a hefty penalty. You’ve got to really need this money to justify withdrawing from an IRA before its time. ‘Once in a lifetime’ you can avoid the penalty on $10,000 if you purchase a home with the money. You still have to pay tax on the withdrawal (remember you deferred paying tax when the money went in), you just avoid the 10% penalty if this applies to you.

There is one other common case where you can avoid the 10% penalty for “early withdrawal” of funds: if you withdraw the money from a traditional IRA and put it into a Roth IRA. The restrictions on this include:

  1. Your “modified Adjusted Gross Income must be $100,000 or less (until 2010 when this limitation is removed).
  2. If you’re married, you have to file a joint return (also removed for 2010), and the amount must meet the definition of a “qualified rollover contribution.
  3. If the IRA is inherited, you can’t roll it over.

For more info, see IRS Code Section 96.4 and Section 408

The income limit to convert is the year the money comes out, not the year the money goes into the Roth. The income limit does not include the money out of the traditional IRA (only for purposes of determining the AGI limit—you still have to pay the tax on the distribution from the traditional IRA!). If you’re married filing jointly, it is your combined income. If you’re already 70 1/2, you can’t do the conversion. It is very messy if you have traditional IRA’s which had deductible and non-deductible contributions. Expect that you’ll pay me the 10% penalty instead of paying the IRS if I have to figure this out!

You can’t keep the money out more than 60 days in between funds. I had a lawyer client who had won his case, but needed funds until he collected. He cashed in his IRA, hoping the settlement would arrive before 60 days so he could call it a “rollover.” It was 65 days until the settlement showed up, so he paid the 10% penalty.

I tell my clients to send the money directly from institution to institution so they never receive the money in the first place. In 2010 you’ll be able to report the income on the funds withdrawn over 2 years (2010 and 2011) instead of being required to report all the rollover income in the year of withdrawal.

If you know your income will be low this year, or perhaps even a loss, it might be a “planning opportunity” to take the income from a conversion now, using up your loss against the income you would have had to report otherwise! If you’re in real estate and ‘having a bad year’ in 2007, the income limits shouldn’t bother you and you should not delay ‘till 2010 if you want to make this conversion.

Once you make a conversion, you must leave the money in the Roth for 5 years, or pay the 10% penalty as if you took it out early from the traditional IRA.

If you have a loss on your Roth IRA, you can take it once all the money comes out as a Schedule A, subject to 2% deduction. So keep track of what you put into a Roth—basically forever or until you use it up.

For more information, take a look at IRS Publication 590 or

Classes – Schedule C, Basic Payroll, How to Prepare the 1120S and The 'S' Corporation

Andy’s Preparing your own Schedule C class will be presented September 21st 6-8 pm at:
Women’s Initiative, Oakland Office 519 17th Street, Suite 110. Accessible via BART 19th St. Station. To register, please contact at (415) 641-3470.

The C class will also run at the Small Business Administration in SF on October 10th at 6. to sign up. It will be at 455 Market Street, 6th Floor, and I usually use the Montgomery St BART station.

Here’s the blurb:
Prepare your business taxes for ’06 and get ready for ‘07. Review what the IRS wants to know from you and how to report it on the Schedule C for your business. This is a class for business owners who need a basic understanding of their 1040 Schedule C tax forms. We’ll also talk about what to do with the numbers once you have them. We don’t guarantee you won’t get audited, but this class will make it less likely.

Also, in conjunction with the IRS and EDD, Andy's going to be doing some Basic Payroll seminars coming up in the near future. The next seminar will be October 24th in San Rafael at 120 North Redwood Drive, 2nd floor, Redwood Room October 24, 9 am – 3 pm. Reservations may be made at 866 873-6083 for the Federal/State Basic Payroll Tax Seminar, or on line at

Andy will be back in Oakland November 7th downtown, and December 5th in Oakland again. These seminars have proven to be very popular.

How to Prepare the 1120S: Getting In and Staying In is a seminar for tax preparers on the nuts and bolts of preparing the annual tax return for “S” corporations. This will be a four hour presentation for a fee on November 3rd in Lafayette. We’re still working on a CPE sponsor, but please pencil in the date if you’re interested in learning how to prepare these returns or just want to review before the next tax season.

Andy will be doing a presentation on Why I love the “S” Corporation for the Solano/Napa EA Society Tuesday, January 22nd 2008 at 6 pm. More details will follow.

September 15th - October 15th Tax Deadlines—We need 2 weeks

Corporate deadline for returns on extension, is September 15th for calendar year entities. The deadline for personal tax returns on extension from 2006 is October 15th. The deadline is NOT the same for personal and corporate returns. Please don’t wait until the last minute. If you don’t have your materials to us two weeks before deadline, we will not be able to prepare your return on time—you’ll be filing late, which results in an additional penalty, plus it makes us frown. If we haven’t been contacting you to annoy you, we’re not worried about you, so you need to contact us. We try not to worry.

Additions to the Practice

My wife Kimberley and I have a new future Employee, Max Foster Rogers. He arrived via C-Section last Wednesday August 22 at 12:10 pm and was 8 lbs, 2.6 oz. Mother and baby are doing well, most of us are sleep deprived.

Your Questions in Future Newsletters

Feel free to e-mail questions you’d like answered. If we think it is a topic of general interest, we’ll include the answer in upcoming newsletters!