My thanks for Natalie Choate for analyzing and pointing out the following information.  Ms. Choate is truly a rock star in the world of IRA law, and much gratitude is owed to her by those of us in the financial community for her thorough analysis and commentary that she provides on such matters as this.

If you live long enough, you’re liable to see just about anything… the following is an example of the most extreme example I’ve ever heard of for using the tax law to your own advantage, deliberately flaunting the law for purposes of evading tax.

The Facts

If you intentionally over-fund your Roth IRA, above the amount that you’re allowed to contribute for the tax year.  The tax law allows you to remove the excess contribution by October 15 of the year following the year of contribution.  If you do not remove the excess contribution (and the gains associated with it) by that point, you will be subject to a 6% excise tax on the excess contribution until the situation is rectified.

The situation can be rectified by either crediting the excess contribution to a future years’ contribution, or by withdrawing the excess amount prior to the deadline for the following year.  Each year that you do not rectify the over-contribution you will be subject to the excise tax.

The Anomaly

If you do not remove the excess contribution and the growth associated with it by October 15 of the year following the year of contribution, once you’ve been assessed the excise tax, your rectification is only required to the extent of the excess contribution – not the growth associated with it.  The growth is no longer considered (under present tax law).  In other words, you can rectify the excess contribution at that point by simply removing the excess, but the growth doesn’t have to be removed.

If you’re following the way this is working, you’ve probably figured out the gist of the “idea” we’re talking about here.

The Terrible, Terrible Idea

Here’s an example of the bad idea in play:

Let’s say you have no Roth IRA at all, but you have $20,000 that you’d like to invest.  Furthermore, you don’t have compensation that would make you eligible to contribute anything to a Roth in the first place.  Ignoring all convention, you open an IRA and contribute the $20,000, investing it in the latest hot stock.  October 15 the following year rolls around, and your hot stock has doubled in value.  (It should be noted that if your hot stock didn’t do so well, such as losing money, you could pull it out now and walk away with no consequence.)

Under the normal conventions, you could withdraw the entire $40,000 (your contribution plus your gain), but you’d have to pay ordinary income tax on the gain of $20,000.  Doing this, you’d avoid the excess contribution 6% excise tax, $1,200.

However, in this terrible, terrible idea, you decide to wait until after October 15, and pay the excise tax on the over-contribution.  Now you have three choices:

• If you’re otherwise eligible for contributions to the Roth in the current year, part of the excess contribution can be used (credited) as a regular contribution.  You would then be subject to the excess contribution tax on the remainder of the over-contribution until it’s been used up by future credits (this is one of the right things you could do).
• If you’re not eligible for the contributions, you could withdraw the excess contribution at this point, along with the growth in the account, paying ordinary income tax on the growth.  This is the other right thing you could do.
• If you’re up for a challenge (and possibly jail time), you could withdraw only the excess contribution and leave the growth in the account to grow tax free for the rest of your life.  It probably won’t do you a lot of good in Alcatraz, though.

The Reason This is a Terrible Idea

The IRS is never in favor of kooky tricks like this that don’t work as the law intended.  So what might happen?  Well, the IRS could review your IRA account and disqualify it completely, on the basis that the custodian should never have allowed the excess contributions in the first place.  In this manner, you’d be subject to tax on the growth in the account and the whole account would be null and void.  Your IRA custodian is likely to be in hot water as well, as this would be a violation of the basic rules of IRAs.

Since the entire concept of the ability to withdraw the excess contribution is designed to help taxpayers resolve an honest mistake, abusing this provision is likely to be soundly disallowed.  If the facts were known, (which they would be discovered eventually), the IRA is likely to be disallowed completely, and the abuse is likely to carry with it severe penalties.

The IRS doesn’t presently have remedy for the situation – and in the case where you honestly make a mistake and elect to leave the funds in the account (crediting against the current year, as in the first bullet point above) – it wouldn’t be too much of a leap for the IRS to disqualify distributions from the gains.  This would become especially so if the activity I’ve described becomes a rampant abuse.

It’s best to follow the rules as intended and leave well enough alone.

Photo by CarbonNYC

Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

Six Tax Benefits for Job Seekers

Many taxpayers spend time during the summer months updating their resume and attending career fairs.  If you are searching for a job this summer, you may be able to deduct some of your expenses on your tax return.  Here are six things the IRS wants you to know about deducting costs related to your job search.

1. To qualify for a deduction, the expenses must be spent on a job search in your current occupation.  You may not deduct expenses incurred while looking for a job in a new occupation.
2. You can deduct employment and outplacement agency fees you pay while looking for a job in your present occupation.  If your employer pays you back in a later year for employment agency fees, you must include the amount you receive in your gross income up to the amount of your tax benefit in the earlier year.
3. You can deduct amounts you spend for preparing and mailing copies of your resume to prospective employers as long as you are looking for a new job in your present occupation.
4. If you travel to an area to look for a new job in your present occupation, you may be able to deduct travel expenses if the trip is primarily to look for a new job.  The amount of time you spend on personal activity compared to the amount of time you spend looking for work is important in determining whether the trip is primarily personal or is primarily to look for a new job.
5. You cannot deduct job search expenses if there was a substantial break between the end of your last job and the time you begin looking for a new one.
6. You cannot deduct job search expenses if you are looking for a job for the first time, or if you are looking for a job in an entirely new occupation or career.

In addition to all that…

It’s important to know that you have some other job-related tax breaks which you can take advantage of…

Moving Expenses – if you move to a new home for your employment, either a new job or just being transferred in your current job, you might be able to deduct your moving expenses if:

• the move is closely related to your start of work in the new location
• your new work location is more than 50 miles farther away from your old home than the distance from your old home to the old work location.  In other words, if your old workplace was 7 miles away from your old home, your new workplace must be at least 57 miles away from your old home.
• you must continue to work in the new location for at least 39 weeks during the 12 months after the move.  If you’re self-employed you must also work in the new job for 78 weeks during the 24 months following the move. (There are exceptions for disability, layoff, transfers, and other situations.)

You may include the cost of transportation and storage of your household goods for up to 30 days, as well as travel and lodging from the old home to the new home (only one trip per person).

Unreimbursed Employee Business Expenses – certain expenses related to your job that are not reimbursed by your employer can be deducted.  Some examples are:

• Dues to professional associations and chambers of commerce if work related and entertainment is not one of the main purposes of the organization.  Any part of the dues that is related to lobbying or political activities is not deductible.
• Educational expenses related to your work.  These expenses must be required to maintain your current job, serving a business purpose of your employer, and not part of a program that will qualify the taxpayer for a new trade or business.
• Licenses and regulatory fees.
• Malpractice insurance premiums.
• Office-in-home expenses (subject to quite a few qualifications)
• Phone charges for business use (but not the cost of basic service for the first phone in a home)
• Physical exams required by the employer
• Protective clothing and safety equipment required for work, as well as tools and supplies required for your job
• Uniforms required by your employer that are not suitable for ordinary wear
• Union dues and expenses

This is not an exhaustive list – you can find more information by going to the IRS website at www.IRS.gov.

Photo by Richard Croft

Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

One source of funds that you may not have considered is within your non-IRA investment accounts – especially if you have inherent capital gains and losses (even moreso if you have carried-over capital losses that wouldn’t otherwise be utilized readily).

Offsetting Gains With Losses To Produce Cash

Here’s how it works: You sell your “loss” positions, establishing a capital loss for tax purposes.  Then you can sell your “gain” positions in like amounts, giving yourself a tax-free source of cash, since the loss will offset the gain for taxation purposes.

For example – imagine that you have a $100,000 IRA that you’d like to convert.  Running the numbers, you’ve come to realize that the conversion will cost $25,000 to complete.  In addition to the IRA, you also hold some non-IRA money, in the form of two investments.  One of these investments has an inherent loss of $20,000, and the other has an inherent gain of $30,000.

By selling out of the “loss” position completely and selling just enough of the “gain” position to offset the tax loss you’ve realized, you have effectively created a tax-free source of income in the amount of $20,000.  This still leaves $5,000 if you’re planning to convert the entire amount.

After you’ve finished with your conversion activities (and after 30 days has passed so that you don’t run afoul of the wash sale rules), you can re-invest the leftover money in those same investments, keeping your allocation at least similar to what it was before.

At this stage you have three choices, assuming you don’t have an extra $5,000 laying around:

1. You can choose to only convert a portion of your IRA – the amount that you can generate tax-free money to pay tax upon.  In our example, this would be $80,000.
2. You can use more of the cash that you freed up from the sales of your non-IRA gain and loss holdings.
3. You can convert the entire amount and take distribution of the additional $5,000 to pay the extra tax.  Actually you’d need to pull out $5,500 in order to pay the penalty on that amount that you’re distributing.

Of these three, I’d recommend option 2, which is the outcome where you complete the conversion of the entire amount without having to pay additional tax or penalty on the money that you’re using to pay the tax on the conversion.  Yeah, that last sentence belongs in a museum.  Happy converting!

Photo by NOAA Photo Library

Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

As you know (if you’re read the article about Penalties for Changing SOSEPP) it can be costly to you if you make a change to your SOSEPP once you’ve set it up.  The good news is that a Roth Conversion is NOT considered a “distribution for purposes of determining whether a modification”, and therefore in itself will not trigger a loss of the penalty-exempt status of the SOSEPP.

What does happen then, in such a circumstance?  Well, that’s when things go into the “it depends” category, followed closely by a whole lotta “no guidance from the IRS”.

If you have converted the entire balance of your IRA that is subject to the SOSEPP to a Roth IRA, you will be required to continue taking your series of payments from the new Roth IRA just the same as if they were still coming from the traditional IRA.  If you don’t, you will most likely be subjected to recapture of the penalties on the earlier SOSEPP distributions, unless you’ve reached the end of the distribution requirement period – five years or age 59½, whichever is later.

On the other hand, if you’ve only converted a portion of the traditional IRA to a Roth IRA, this is where it gets murky.  The IRS has not provided definitive guidelines on exactly how you handle the SOSEPP from here… it is abundantly clear that you must continue your series of periodic payments until the end of the distribution period.  What’s not clear is if you must continue taking the payments from the remainder of the traditional IRA, or from the Roth IRA, or proportionately from both accounts, or in any amounts you choose from either account, as long as the amount is proper to fit the bounds of your SOSEPP.

The best way to deal with this situation would be to convert the entire account if that’s feasible.  If it’s just not feasible, then you should ask for a Private Letter Ruling from the IRS – especially if we’re talking about sizeable amounts (you be the judge).  If the possible tax and penalty is relatively minor, I’d suggest taking proportionate amounts from the trad and Roth IRAs until the SOSEPP distribution requirement period ends.  Make sure that you keep documentation on all of these transactions – you’ll need it if the IRS comes a-callin’.

Photo by aldenjewell

Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

10 Facts About Capital Gains and Losses

1. Almost everything you own and use for personal purposes, pleasure or investment is a capital asset.
2. When you sell a capital asset, the difference between the amount you sell it for and your basis – which is usually what you paid for it – is a capital gain or a capital loss.
3. You must report all capital gains on your income tax return.
4. You may deduct capital losses only on investment property, not on property held for personal use.
5. Capital gains and losses are classified as long-term or short term, depending on how long you hold the property before you sell it.  If you hold it more than one year, your capital gain or loss is long-term.  If you hold it one year or less, your capital gain or loss is short-term.
6. If you have long-term gains in excess of your long-term losses, you have a net capital gain to the extent your net long-term capital gain is more than your net short-term capital loss, if any.
7. The tax rates that apply to net long-term capital gains are generally lower than the tax rates that apply to other income.  For 2010, the maximum long-term capital gains rate for most people is 15%.  For lower-income individuals, the rate may be 0% on some or all of the net capital gain.  Special types of net capital gain can be taxed at 25% or 28%.
8. If your capital losses exceed your capital gains, the excess loss can be deducted on your tax return and used to reduce other income, such as wages, up to an annual limit of $3,000, or $1,500 if you are married filing separately.
9. If your total net capital loss is more than the yearly limit on capital loss deductions, you can carry over the unused part to the next year and treat it as if you incurred it in that year.
10. Capital gains and losses are reported on Schedule D, Capital Gains and Losses, and then transferred to line 13 of Form 1040.

Calculations

To determine tax treatment, your short-term capital gains (STCG) and short-term capital losses (STCL) are “netted”, and the same is done with your long-term capital gains (LTCG) and long-term capital losses (LTCL), as in the following equations:

STCG – STCL = Net STCG(or L)

LTCG – LTCL = Net LTCG(or L)

If the amount of loss (in either equation) is greater than then amount of gain, you have a net capital loss (either short or long).  Likewise if the amount of gain is greater than the amount of loss, you have a net capital gain.  These amounts are then netted against each other, as follows:

Net Capital Gains = Net STCG(or L) + Net LTCG(or L)

Tax Treatment Situations

If you have only short-term gains and losses, any net gain will be taxed at your ordinary income tax rate – that is, it is added to your other income from wages and the like, taxed just the same as income.  A net loss can be deducted from your income to the extent of the $3,000 annual limit discussed previously.  Any remaining net loss can be carried over to future years and deducted against net capital gains first, and then at the $3,000-per-year rate against your ordinary income until the net loss is exhausted.

Likewise, if you have both short-term and long-term gains and losses and the net short-term gains are greater than any net long-term losses, the remaining difference is taxed and treated as ordinary income.

If you have only long-term gains and losses, any net gain will be taxed at the applicable long-term capital gains rates (typically 0% or 15% for 2010).  Any net loss is treated the same as the net short-term capital loss described above.

If you have net long-term gains and net short-term losses that are less than or equal to the net long-term gains, in the “netting” discussed above, your net long-term gains will be reduced to the extent of your net short-term losses.

If the nettings result in net capital gains for both long-term and short-term, your net short-term gains will again be taxed at your ordinary income tax rate, but the net long-term gains will be taxed at the applicable long-term capital gains rate (typically either 0% or 15% for 2010).

And lastly, if the nettings result in net capital losses for both holding periods, this net loss is (as you might expect) allowed to be deducted from ordinary income at the $3,000-per-year rate.  Any amount of loss that remains is carried over to future years (as described previously).

Photo by Wikimedia

Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

The trick to all of this is to know how much to have in each kind of account… of course there are no hard and fast rules to determine what’s the best percentage to have in each kind of plan, but below is a discussion of some of the factors that you should consider as you balance out your tax treatment.

Early in life…

Early in your investing career it probably makes the most sense to load as much of your savings into your 401(k) or other tax-deferred savings vehicle as possible, in order to maximize the benefit from tax savings up front.  The biggest reason for this (beyond the tax savings) is so that you take advantage of your employer’s matching benefit, along with deferring taxes on your income as it increases over time.

Later in your career when your income is higher, maximizing contributions to tax-deferred accounts will have a greater benefit to you from a tax savings standpoint – and this is assuming that you expect for the taxes you’ll pay later (during retirement) will be lower due to your diversification of tax treatment.

Also early in your investing career, as your income supports it you should begin making contributions to your Roth IRA as soon as possible.  This is partly due to the restrictions on income around investing in Roth IRAs – but mostly because you are paying tax at lower rates (in your lower-earning days) than you might later on in your career when your income increases.

And then on top of it all, when your income has grown to a point that you can maximize the other options (401(k) and Roth), you should begin investing in an account that is treated by capital gains tax (primarily).  This will give you the third leg of the tax-diversification stool.  Since capital gains are (presently) taxed at a much lower rate than ordinary income – which is what your IRA or 401(k) distributions are taxed at – it makes a great deal of sense to have some of your money invested in these accounts as well.

Later in life…

Later on in your life, as you reach that point where you will have to begin taking Required Minimum Distributions (RMDs) from your IRA and 401(k) accounts, it might make sense to take significant portions of those accounts and either convert them to Roth accounts or capital gains taxed accounts.  The preference would be to place the funds distributed into a Roth IRA, especially if you are in a position where you will not need access to the funds for some time and therefore can benefit from the tax-free growth of the account.  But you may also want to balance those conversions to Roth with some non-tax-deferred investments as well – because you never know what may happen with the tax code.

It’s (very!) possible, given the government’s need to increase tax revenues to pay for things like the health care initiative, that there could be changes in the works for how tax-deferred plans are taxed.  Just a few options that have been put forth in recent memory include:

• extra taxes on IRA assets (this was in place back in the mid-80’s)
• changes to the minimum distribution rules to require faster distribution or to eliminate “stretch” capabilities
• adding investment restrictions, such as requiring a portion of IRAs to be invested in “socially responsible” investments
• nationalization of retirement accounts – e.g., governmental takeover of all IRA and 401(k) plans in exchange for a superannuization plan like some socialized countries use

Yet another option, especially if you have very few assets outside your IRAs and 401(k) plans, you can reduce your taxable estate (when we have an estate tax again, that is) by taking extra distributions from your IRA or 401(k) and making gifts to your children and grandchildren.  You could place the assets in a trust that represents a completed gift, or give the money directly to your future heirs – this way you are able to see your children and grandchildren enjoying the fruits of your labors while you’re still living.

Photo by alancleaver_2000

Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

Actions for Dealing With an Over-Contribution

You have three options for dealing with the over-contribution situation:  you can pull the over-contribution out; you could also re-characterize the contribution; or you could do nothing.

Pull the over-contribution out. This is known as a corrective distribution.  Essentially this is exactly as it sounds:  you pull out the money that represents the over-contribution, plus (here’s the wrinkle) any growth or income attributed to the over-contribution.  You need to do this by the due date (including extensions) of the tax return for the year of the contribution… In this case “due date” has a special meaning:  if you filed your return on time (including extensions) this means October 15 of the year following the year of the contribution, even if you did not use an extension; however, if you did not file your return on time, the deadline is (was) April 15 of the year following the contribution year.

So if you contributed a total of $1,000 more than you were eligible for to your IRA, and there was growth and income of $200 attributable to the over-contribution, you need to withdraw $1,200 before October 15 of the year after your contribution year.  And, you’ll need to pay ordinary income tax on the $200 of earnings – plus 10% in early distributions penalty.  Of course if you didn’t file your tax return on time, (actually if you plan to not file your tax return on time) you need to pull out your over-contribution by April 15.

Recharacterize. This method resolves an over-contribution to a Roth IRA, by changing the character of the contribution to a traditional IRA instead of a Roth IRA.  This can only be done if you’re eligible to make a contribution (either deductible or non-deductible) to a traditional IRA (you meet the income, other plan coverage, and age limits).  To do this you submit Form 8606 to the IRS indicating a change to the over-contribution amount, plus or minus any earnings or losses that have occurred attributed to the over-contribution, from Roth to traditional.  This has the same deadlines mentioned above for the corrective distribution.

Do nothing. In essence you’re not exactly doing nothing – you’re accepting the fact that the over-contribution occurred, and you’ve chosen to accept the consequences.  The consequences are that for any amount you’ve over-contributed, you are subject to a 6% penalty for excess contribution.  This may be the best course of action if the over-contribution can be absorbed as a contribution in the following year.

As an example, maybe you made a contribution to your Roth IRA of $5,000 for the year, and it turns out that your income level only allows a contribution of $4,800 – something you didn’t discover until it was too late.  The consequence is that you’ll owe a penalty of 6% – $12 total – on the over-contribution of $200.  As long as you are eligible to contribute at least $200 to your Roth IRA in the following year (and you don’t over-contribute again), you can pay the penalty and leave the money where it is.

Unfortunately, if the over-contribution amount in question is large, this method doesn’t really help much.  This can be the case if you’ve mistakenly rolled over an inherited IRA into your own IRA instead of an inherited IRA – and you’re a nonspouse beneficiary.  If you don’t catch it in time, you will be subject to the 6% penalty for the year of the rollover and every subsequent year thereafter until you distribute the IRA.  When you finally catch the mistake (or rather, the IRS catches your mistake, more than likely), you’ll be subject to ordinary income tax (and retroactive penalties and interest) on the entire distribution as well, since you effectively treated the IRA as your own money from the very start.

Photo by Darwin Bell

Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

This is a follow-up to the article Open a Roth IRA for Your Child, where we talked about how beneficial it can be to set up one of these accounts for your child. One of the points we talked about in that article was how the account can only be funded with of the lesser of $5,000 (for 2010) or total taxable compensation.  It’s very important to know what exactly can be considered “taxable compensation” for this purpose.

Taxable Compensation

Of course, any wages reported in Box 1 of a W-2 form from the employer is considered taxable compensation.  In addition, any tips, professional fees, or other amounts you receive for providing personal services are compensation as well.  If your scholarship or grant is included in Box 1 of a form W-2, this is also considered taxable compensation.  Commissions, self-employment income, alimony, military differential and non-taxable combat pay (even though it’s non-taxed!) are also included in determining the total amount of taxable compensation for the purpose of determining IRA contribution limits.

But most of these sources of income are not common for children, especially younger children – unless they happen to make money as a model, actor, or other sort of entertainer.  Usually for younger children the paper routes, lawn mowing, and babysitting jobs are just a bit beyond their reach.  So, well-intentioned parents often get the idea to “invent” income.

Invented Income

In general, if the activity isn’t something that you would normally have to pay someone to do (like taking out the trash, making your bed, doing the dishes, etc.) then it’s probably not taxable compensation you’ve paid the child.  If the child is doing the activity for your neighbor for a reasonable compensation then that’s a different story – just use your head and make sure that it’s really compensation and not an allowance.  You’re doing this to help the child get started with a Roth IRA – not to establish a criminal record as a minor!  (Okay, not exactly a criminal record, but definitely afoul of the IRS – just as bad at any age!)

Photo by Jef Poskanzer

Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

Facts About Your Appeal Rights

The IRS has put together a list of seven facts that they want you to be aware of with regard to your appeal rights (Tax Tip 2010-65):

1. When the IRS makes an adjustment to your tax return, you will receive a report or letter explaining the proposed adjustments.  This letter will also explain how to request a conference with an Appeals Office should you not agree with the IRS finding on your tax return.
2. In addition to tax return examinations, many other tax obligations can be appealed.  You may also appeal penalties, interest, trust fund recovery penalties, offers in compromise, liens, and levies.
3. You are urged to be prepared with appropriate records and documentation to support your position if you request a conference with an IRS Appeals employee.
4. Appeals conferences are informal meetings.  You may represent yourself or have someone else represent you (such as an Enrolled Agent, an attorney, or a CPA).
5. The IRS Appeals Office is separate from – and independent of – the IRS office taking the action you may disagree with.  The Appeals Office is the only level of administrative appeal within the agency.
6. If you do not reach agreement with IRS Appeals or if you do not wish to appeal within the IRS, you may appeal certain actions through the courts.
7. For further information on the appeals process, refer to IRS Publication 5, Your Appeal Rights and How to Prepare a Protest If You Don’t Agree.

Additional Publications

In addition to Publication 5, there are several other IRS Publications that may help you in your appeal process.  For example, Publication 556, Examination of Returns, Appeal Rights and Claims for Refund. You can also refer to Publication 1660 (PDF), Collection Appeal Rights, which discusses how you can appeal collection actions and Publication 3605, Fast Track Mediation–A Process for Prompt Resolution of Tax Issues.

Photo by David Pickersgill

Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

Hold on there, cowboy!  There’s a problem with your kooky little scheme – the IRS has planned for just such an eventuality.  Effectively, any amount that you withdraw from your Roth IRA that is not previous contributions or conversions, will be subject to tax in the year that you withdraw it, until you’ve paid the tax on the conversion.  This is in addition to the amounts that you owe tax on during that year due to your election to spread the tax.  Gobbledygook, right?  Right – howza bout an example?

An Example

You have an IRA worth $100,000, and in 2010 you decide you’d like to convert it to a Roth IRA.  You have an existing, five-year-old Roth IRA, with $20,000 in it.  In 2011, you withdraw $30,000 from the Roth IRA.  At the end of the year, instead of owing tax on $50,000 (half of the conversion amount of $100,000), you actually owe tax on $60,000.

This is calculated as:  your withdrawal was $20,000 from earlier contributions, and $10,000 from the conversion.  That $10,000 must be added to the previously-agreed-upon $50,000 amount that you knew you’d owe tax on for 2011.  And then in 2012, you will owe tax on the remaining $40,000 from the conversion.

So, in other words, the IRS has determined that this two-year tax deferral is not going to be used as a tax-free method for achieving tax-free withdrawals from your IRA – once the amounts have remained in the account until 2012, any amount can be withdrawn without tax.  But of course, you’ve already paid the tax on the conversion by that point (or rather, you will by tax day in 2013).

So what happens if you withdraw the funds in 2010 after converting earlier in the year?  Effectively this is treated as a distribution from your original IRA (actually recharacterized from the Roth conversion), so you’d owe tax on that amount in 2010, and the remaining amount would be split between 2011 and 2012.

The “Hole”

I suppose that technically there is a time period where you could have access to 100% of the funds having paid zero tax:  between January 1, 2012 and April 15, 2012, when the tax bill is due for the first half of your conversion amount.  So you have three and a half months to unleash your devilish scheme on the world… not sure what you’ll do with this information, but perhaps there is some advantage that you might receive by leveraging the amount.  I doubt there’s much advantage to be had, especially given the loss of deferral if you withdraw the funds, but maybe you have a plan.  Go to town!

Photo by marya

Post from: Getting Your Financial Ducks In A Row

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).