IRAThe Roth IRA is widely considered one of the greatest gifts the U.S. Congress has ever given to taxpayers. With a Roth IRA, contributions are made with after-tax dollars and, therefore, we do not receive an upfront tax deduction for the contribution. In return for not getting a tax deduction, the taxpayer gets something more significant – qualified distributions can be withdrawn tax free. Qualified distributions are distributions that occur after a five-year waiting period has elapsed and a triggering event has occurred. The triggering events are either the attainment of age 59½, death, disability, or a first time home purchase. Not only are your initial contributed amounts withdrawn tax free but all of the future appreciation in the Roth IRA account value escapes taxation as well.      
 
One problem that has frustrated many taxpayers is the relatively low income limits which prohibit many of us from being able to contribute to a Roth IRA. For 2015, a married couple filing a joint return will be unable to contribute to a Roth IRA if their modified adjusted gross income (MAGI) exceeds $193K. For a single person, the ability to contribute to a Roth IRA account disappears when MAGI exceeds $131K. 
 
We have been advising our clients for some time now about the strategy of contributing to a Roth IRA even when your income exceeds the above income limits. Many practitioners call this strategy a Backdoor Roth IRA Conversion. Let me explain how this works. 
 
First, you will need to contribute funds to a traditional IRA with your IRA custodian. In order to do this, you will need to have earned income and you must not have reached 70½ years of age. You do not need to inform your custodian whether this is a deductible or nondeductible contribution – just that it is a contribution to your IRA. 
 
For example, let’s assume you have the necessary earned income and you have not reached 70½ years of age. You contribute a maximum of $5,500 to your IRA account ($6,500 if you reached 50 years of age during the year). Once the IRA contribution posts to your account, you inform your custodian that you wish to convert these funds to a Roth IRA. Some practitioners suggest that you can do this conversion the very next day whereas others suggest you wait a short period of time. I recommend you wait until at least the next month (e.g., you fund the IRA on April 15 and call your custodian with the conversion order on May 1). 
 
There is one big caveat. This strategy only works well for taxpayers who do not already have money in traditional IRA accounts because the IRS pro-rata rule will apply. The pro-rata rule dictates that all owned IRAs, including SEP and SIMPLE IRAs, are included in the required pro-rata calculation. For example, let’s assume you already had a traditional IRA with a value of $95K (from deductible prior year contributions plus appreciation). If you attempted this strategy with a $5,000 current year contribution, the pro-rata rule would result in a fraction of $5,000/$100,000 so that only 5% ($250) would be a tax-free conversion. The other $4,750 would be taxable income from the conversion that would be reported on your income tax return. Obviously, this is not a great result for all this work. 
 
A better result plays out for the taxpayer who has no other IRA accounts. In this case, the entire $5,000 nondeductible contribution could be converted to a Roth IRA free of income tax. The only income that would be taxable for this taxpayer would be any appreciation on the $5,000 investment from the date of contribution to the date of conversion.
     
As you can see from the above examples, determining the best strategy depends on a number of factors. We would be happy to assist you in exploring this strategy if you wish to contribute money into a Roth IRA and your income exceeds the Roth IRA contribution limits.                   
Businessmen working on computersThere is a little known provision in the Internal Revenue Code that can provide a huge income tax advantage for certain taxpayers in the right circumstances. Although conventional wisdom tells us to roll over our retirement account assets to a rollover IRA account when we leave an employer or retire, the availability of the Net Unrealized Appreciation (NUA) tax strategy requires very careful consideration before we roll over these assets. 
 
If you own highly appreciated employer stock in your company’s 401(k) or other retirement plan, you may be quite a bit better off withdrawing the employer stock personally and rolling over only the other plan assets into a rollover IRA. If you follow the letter of the law, you will pay no current income tax on the employer stock’s prior appreciation or on the other assets rolled over to the rollover IRA. The only income tax you pay in the year of distribution would be on the cost basis of the employer stock held inside the retirement account. 
 
The greater the amount of appreciation in the employer stock held in your retirement account, the more advantageous this tax break becomes. The mechanics of this strategy are somewhat complicated but an example should help clarify how this works. Let’s assume you are nearing retirement and have a 401(k) with your employer valued at $1 million. Let’s further assume that the largest asset in your 401(k) is employer stock valued at $750K with a cost basis of $100K. Therefore, the employer stock has appreciated $650K (this is the NUA).
 
You direct your employer to distribute the $750K in employer stock, in kind, directly to you and you roll the other $250K in plan assets to a rollover IRA. You sell the employer stock the next day for $750K and you pay long-term capital gain on the $650K in appreciation you built up over the years. Under our current capital gain tax rate structure, this $650K would be taxed at 20%. Importantly, the IRS has made clear that the sale of NUA stock is exempt from the 3.8% net investment income tax that is generally added when we recognize a large capital gain event. As noted previously, you will also pay ordinary income tax on the $100K of cost basis in the employer stock that was distributed to you.                                            
 
If instead, you rolled the entire $1 million in plan assets into a rollover IRA, the NUA tax break is forever lost. An IRA rollover permanently kills any possibility of getting NUA tax treatment for the employer stock and is irrevocable. Once rolled over, any future distributions out of your rollover IRA will be taxed at your prevailing ordinary income tax rate which could be as high as 39.6%, depending on your particular situation.
 
To qualify for the NUA tax break, you must take a distribution of 100% of the retirement account during the year (the retirement account balance must be zero by the end of that tax year). The 100% distribution must also occur after any one of these four triggering events:
 
1) Death
2) Reaching age 59½ 
3) Separation from service
4) Disability
 
The favorable NUA tax treatment also applies when employer stock is distributed to the employee’s beneficiaries after the participant’s death. 
 
For most retiring employees, rolling over a lump sum distribution received from their employer plan is generally the best tax deferral and financial planning strategy. The opportunity for continued tax-deferred growth of retirement assets inside an IRA is extremely valuable for most retirees. That said, the possibility of NUA tax treatment for certain retirees holding highly appreciated employer stock should force us all to slow down and analyze our particular situation before we make an irreversible rollover decision.
 
If you are holding highly appreciated employer stock in your employer-sponsored retirement account, we would love the opportunity to discuss the NUA strategy with you.     

With contributions from Penny Sayre, CPA, Tax Manager

Substantiation requirements must be met for charitable donations to be allowed

Gift Money200The federal government encourages your generosity by allowing you to deduct your gifts to charities on your income tax return if you itemize deductions. However, you must follow the IRS’s reporting and substantiation rules to assure your charitable deduction is allowed. While all contributions must be substantiated, there are numerous and overlapping requirements.

General Rules

For a contribution of cash, check, or other monetary gift, regardless of amount, you must maintain a bank record or a written communication from the donee organization showing its name, plus the date and amount of the contribution. Any other type of written record, such as a log of contributions, is insufficient.

For a contribution of property other than money, you generally must maintain a receipt from the donee organization that shows the organization's name, the date and location of the contribution, and a detailed description (but not the value) of the property. If circumstances make obtaining a receipt impracticable, you must maintain a reliable written record of the contribution. The information required in such a record depends on factors such as the type and value of property contributed.

Contributions Over $250

If the contribution is worth $250 or more, stricter substantiation requirements apply. No charitable deduction is allowed for any contribution of $250 or more unless you substantiate the contribution with a written receipt from the donee organization. You must have the receipt in hand when you file your return (or by the due date, if earlier) or you won't be able to claim the deduction. If you make separate contributions of less than $250, you won't be subject to the written receipt requirement, even if the sum of the contributions to the same charity total $250 or more in a year.

The receipt must set forth the amount of cash and a description (but not the value) of any property other than cash contributed. It must also state whether the donee provided any goods or services in return for the contribution, and if so, must give a good faith estimate of the value of the goods or services. If you received only “intangible religious benefits,” such as attending religious services, in return for your contribution, the receipt must say so. This type of benefit is considered to have no commercial value and so doesn't reduce the charitable deduction available.

Contributions Over $500

In general, if the total charitable deduction you claim for non-cash property is more than $500, you must attach a completed Form 8283 (Noncash Charitable Contributions) to your return or the deduction is not allowed. In general, you are required to obtain a qualified appraisal for donated property with a value of more than $5,000, and to attach an appraisal summary to the tax return. However, a qualified appraisal isn't required for publicly-traded securities for which market quotations are readily available. A partially completed appraisal summary and the maintenance of certain records are required for (1) nonpublicly-traded stock for which the claimed deduction is greater than $5,000 and no more than $10,000, and (2) certain publicly-traded securities for which market quotations are not readily available. A qualified appraisal is required for gifts of art valued at $20,000 or more. IRS may also request that you provide a photograph.

Recent Case Provides a Note of Caution to Taxpayers Related to Documentation of Noncash Charitable Contributions

As we begin the new tax year of 2015, a review of a 2014 Tax Court Memorandum Decision (TC Memo 2014-203, Thad D. Smith v. Commissioner) provides a reminder that the IRS and the courts take the charitable contribution rules seriously and that good tax documentation is required to support a deduction for noncash charitable contributions. Here’s a summary of the take-away lessons from the Smith case regarding documentation of noncash charitable contributions:

Recordkeeping for Contributions for which You Receive Goods or Services

If you receive goods or services, such as a dinner or theater tickets, in return for your contribution, your deduction is limited to the excess of what you gave over the value of what you received. For example, if you gave $100 and in return received a dinner worth $30, you can deduct $70. But your contribution is fully deductible if:

If you made a contribution of more than $75 for which you received goods or services, the charity must give you a written statement, either when it asks for the donation or when it receives it, that tells you the value of those goods or services. Be sure to keep these statements.

Cash Contribution Made through Payroll Deductions

You can substantiate a contribution that you make by withholding from your wages with a pay stub, Form W-2, or other document from your employer that shows the amount withheld for payment to the charity. You can substantiate a single contribution of $250 or more with a pledge card or other document prepared by the charity that includes a statement that it doesn't provide goods or services in return for contributions made by payroll deduction.

The deduction from each wage payment is treated as a separate contribution for purposes of the $250 threshold.

Substantiating Contributions of Services

Although you can't deduct the value of services you perform for a charitable organization, some deductions are permitted for out-of-pocket costs you incur while performing the services. You should keep track of your expenses, the services you performed and when you performed them, and the organization for which you performed the services. Keep receipts, canceled checks, and other reliable written records relating to the services and expenses.

As discussed earlier, a written receipt is required for contributions of $250 or more. This presents a problem for out-of-pocket expenses incurred in the course of providing charitable services, since the charity doesn't know how much those expenses were. However, you can satisfy the written receipt requirement if you have adequate records to substantiate the amount of your expenditures, and get a statement from the charity that contains a description of the services you provided, the date the services were provided, a statement of whether the organization provided any goods or services in return, and a description and good-faith estimate of the value of those goods or services.

Please call us if you have any questions about these rules. Together we can make sure that you'll get all the deductions to which you are entitled when we prepare your 2014 tax returns.

Overview

A recent U.S. Tax Court decision has challenged a long-accepted understanding of how the 60-day IRA rollover rules work. In Bobrow v. Commissioner, the court ruled that the once-per-year rollover rule applies in aggregate to all of a taxpayer’s IRA accounts and not on an account by account basis. This position is inconsistent with the IRS’ own Publication 590 and proposed regulations written better than 30 years ago. Due to the significance of this decision, we felt it important to highlight the key points you need to know to steer clear of problem areas with IRA rollovers going forward.

Background

Withdrawals from IRA accounts are normally taxable but the standard rollover rule of IRC Sec. 408(d)(3)(A) stipulates that as long as the funds are rolled over within 60 days, the distribution will not be taxable. To prevent abuse, IRC Sec. 408(d)(3)(B) applies a limitation whereby the 60-day rollover rule cannot be utilized more than once in a one-year period (measured as 365 days from the date that the first distribution occurred).

Historically, this rollover rule has been applied on an account-by-account basis. For example, if an individual has two IRA accounts and takes a distribution from IRA # 1 that is rolled over into a new IRA account (IRA # 3), then no further rollovers can occur from IRA # 1 or IRA # 3 during the next year since both accounts have already participated in one rollover in a one-year period. The rollover from IRA # 1 into IRA # 3, however, has never prevented a taxpayer from making a tax-free rollover from IRA # 2 into any other traditional IRA, during this same one-year period – at least until the Bobrow decision.

New Interpretation

The IRS issues Publication 590 annually to assist taxpayers in preparing their individual income tax returns. The example cited above has been in Publication 590 for better than 20 years and is based on language in IRS proposed regulations introduced in 1981. Soon after the court’s decision, the IRS issued Announcement 2014-15 which adopted this less taxpayer-friendly interpretation of the IRA rollover rules. The IRS also announced that they plan to revise Publication 590 in the near future.

The IRS has acknowledged that because this was a significant departure from the standard view on the IRC Sec. 408(d)(3)(B) rollover limitation – including the IRS’ own position – no new regulations will take effect before January 1, 2015.  In addition, the IRS has declared that it will not pursue the Bobrow interpretation for any rollover that involves an IRA distribution occurring before January 1, 2015.

Why did the tax court decide the Bobrow case the way it did?  Most likely, it was to prevent taxpayers from using IRA funds as a form of temporary loan – one that could be chained together through a sequence of IRA rollovers. The prior interpretation of the IRA rollover rules could have provided taxpayers with several different IRA accounts the ability to stretch their IRA loans out over extended periods of time. Tax-free use of a taxpayer’s IRA funds was certainly not the original intent of Congress when IRA accounts were first introduced back in 1974. It is likely the IRS felt the rollover limitation rule of IRC Sec. 408(d)(3)(B) was being abused by the taxpayers in the Bobrow case enabling them to use their various IRA accounts for multiple short-term loans. The taxpayers were, in essence, attempting to “game” the system.

What this means for you

The bottom line for taxpayers is that beginning on January 1, 2015 the IRA rollover rule will now apply aggregated across all IRA accounts of the taxpayer. This means the once-per-year rollover limitation is not just a per-IRA limitation but a per-taxpayer limitation (i.e., a taxpayer can only do one rollover across any/all of his IRA accounts during a 365-day period).

If a taxpayer attempts to make more that one IRA-to-IRA rollover within a 365-day period, the consequences could be severe.  The second (third, fourth, etc.) rollover within the 365-day period will be considered a distribution which, for traditional IRAs, will generally be subject to income tax and, if the IRA owner is under 59 ½ years of age, the 10% penalty. For Roth IRAs, the distribution may be subject to income tax and/or the 10% penalty. And if that’s not bad enough, subsequent distributions erroneously “rolled over” during the 365-day period could result in excess contributions in the receiving account, subject to the 6% excess contribution penalty for each year they remain in the account.

What doesn’t count toward the once-per-year IRA rollover rule 

a)      Trustee-to-Trustee IRA Transfers – This is the best way for IRA money to be moved from one IRA to another. The funds go directly from one custodian to another without the account owner having an opportunity to use the funds while they are outside the IRA. When IRA funds are moved this way, there is no 60-day deadline and the once-per-year rule does not apply. IRA owners may make as many trustee-to-trustee transfers as they desire, and at any time.

b)      Plan-to-IRA Rollovers – The once-per-year rollover rule is an IRA-to-IRA and Roth IRA-to-Roth IRA rule. So, if a taxpayer makes a rollover that is not between two IRAs or two Roth IRAs, it does not count as a rollover for purposes of the once-per-year rule. For example, if a taxpayer rolls over money from their 401(k) to an IRA on January 25th of year 1 and then rolls that money via a 60-day rollover to another IRA on March 10th of the same year, the once-per-year rule has not been violated.

c)       IRA-to-Qualified Plan Rollovers – Similar to the Plan-to-IRA rollover exclusion outlined above, IRA-to-Qualified Plan rollovers also do not count as rollovers for purposes of the once-per-year rollover rule.

d)      Roth IRA Conversions – If money is converted from an IRA or employer plan to a Roth IRA, the conversion – which is technically a rollover – does not count as a rollover for purposes of the once-per-year rule.

 

If you are considering an IRA rollover,  make sure it will meet the applicable rules and survive IRS scrutiny. We are here to assist you in determining the best course of action and to answer any questions. Contact us at (719) 630-1186.

The federal government encourages your generosity by allowing you to deduct your gifts to charities on your income tax return if you itemize deductions. However, you must follow the IRS’s reporting and substantiation rules to assure your charitable deduction is allowed. While all contributions must be substantiated, there are numerous and overlapping requirements.

General Rules

For a contribution of cash, check, or other monetary gift, regardless of amount, you must maintain a bank record or a written communication from the donee organization showing its name, plus the date and amount of the contribution. Any other type of written record, such as a log of contributions, is insufficient.

For a contribution of property other than money, you generally must maintain a receipt from the donee organization that shows the organization’s name, the date and location of the contribution, and a detailed description (but not the value) of the property. If circumstances make obtaining a receipt impracticable, you must maintain a reliable written record of the contribution. The information required in such a record depends on factors such as the type and value of property contributed.

Contributions Over $250

If the contribution is worth $250 or more, stricter substantiation requirements apply. No charitable deduction is allowed for any contribution of $250 or more unless you substantiate the contribution with a written receipt from the donee organization. You must have the receipt in hand when you file your return (or by the due date, if earlier) or you won’t be able to claim the deduction. If you make separate contributions of less than $250, you won’t be subject to the written receipt requirement, even if the sum of the contributions to the same charity total $250 or more in a year.

The receipt must set forth the amount of cash and a description (but not the value) of any property other than cash contributed. It must also state whether the donee provided any goods or services in return for the contribution, and if so, must give a good faith estimate of the value of the goods or services. If you received only “intangible religious benefits,” such as attending religious services, in return for your contribution, the receipt must say so. This type of benefit is considered to have no commercial value and so doesn’t reduce the charitable deduction available.

Contributions Over $500

In general, if the total charitable deduction you claim for non-cash property is more than $500, you must attach a completed Form 8283 (Noncash Charitable Contributions) to your return or the deduction is not allowed. In general, you are required to obtain a qualified appraisal for donated property with a value of more than $5,000, and to attach an appraisal summary to the tax return. However, a qualified appraisal isn’t required for publicly-traded securities for which market quotations are readily available. A partially completed appraisal summary and the maintenance of certain records are required for (1) nonpublicly-traded stock for which the claimed deduction is greater than $5,000 and no more than $10,000, and (2) certain publicly-traded securities for which market quotations are not readily available. A qualified appraisal is required for gifts of art valued at $20,000 or more. IRS may also request that you provide a photograph.

Recordkeeping for Contributions for which You Receive Goods or Services

If you receive goods or services, such as a dinner or theater tickets, in return for your contribution, your deduction is limited to the excess of what you gave over the value of what you received. For example, if you gave $100 and in return received a dinner worth $30, you can deduct $70. But your contribution is fully deductible if:

  • you received free, unordered items from the charity that cost no more than $10.20 in 2013 ($9.90 in 2012) in total;
  • you gave at least $51 in 2013 ($49 in 2012) and received only token items (bookmarks, key chains, calendars, etc.) that bear the charity’s name or logo and cost no more than $10.20 in 2013 ($9.90 in 2012) in total; or
  • the benefits that you received are worth no more than 2% of your contribution and no more than $102 in 2013 ($99 in 2012).

If you made a contribution of more than $75 for which you received goods or services, the charity must give you a written statement, either when it asks for the donation or when it receives it, that tells you the value of those goods or services. Be sure to keep these statements.

Cash Contribution Made through Payroll Deductions

You can substantiate a contribution that you make by withholding from your wages with a pay stub, Form W-2, or other document from your employer that shows the amount withheld for payment to the charity. You can substantiate a single contribution of $250 or more with a pledge card or other document prepared by the charity that includes a statement that it doesn’t provide goods or services in return for contributions made by payroll deduction.

The deduction from each wage payment is treated as a separate contribution for purposes of the $250 threshold.

Substantiating Contributions of Services

Although you can’t deduct the value of services you perform for a charitable organization, some deductions are permitted for out-of-pocket costs you incur while performing the services. You should keep track of your expenses, the services you performed and when you performed them, and the organization for which you performed the services. Keep receipts, canceled checks, and other reliable written records relating to the services and expenses.

As discussed earlier, a written receipt is required for contributions of $250 or more. This presents a problem for out-of-pocket expenses incurred in the course of providing charitable services, since the charity doesn’t know how much those expenses were. However, you can satisfy the written receipt requirement if you have adequate records to substantiate the amount of your expenditures, and get a statement from the charity that contains a description of the services you provided, the date the services were provided, a statement of whether the organization provided any goods or services in return, and a description and good-faith estimate of the value of those goods or services.

Please call us if you have any questions about these rules. Together we can make sure that you’ll get all the deductions to which you are entitled when we prepare your 2013 tax returns..