Taxes | Portnoff Financial LLC- Blog



2015 IRA Contribution Reminder

It's not too late to make an IRA contribution for 2015. The deadline is the tax filing date which is Monday 4/18/2015 this year however generally it is not a good idea to wait until last minute.

Individual Retirement Accounts (IRA) are tax deferred, or in the case of a Roth IRA, tax-free savings/investment accounts. Tax deferral allows your money to grow faster without losing some of the growth annually to taxation. Having investments in an IRA also allow you greater investment flexibility to make changes without having to worry about generating any taxable capital gains transactions.

The IRA contribution limit for 2015 is $5,500 to any combination of IRAs and/or Roth IRAs as long as the total doesn't go above $5,500 unless you qualify for the catch-up contribution which is an additional $1,000 if you reached age 50 by year-end 2015.

Anyone is eligible to make an IRA contribution as long as you have earned income and you are under 70 1/2; whether you can take a deduction for a traditional IRA depends of a few factors described below. Eligibility to contribute to a Roth IRA depends on income which is also described below; there is no age limit to make Roth IRA contributions.


Phase-Out Range for IRA Deductibility: If you are considered an active participant in a company retirement plan, your deductibility for an IRA may be limited. If you are married filing jointly the phase-out for deductibility begins for adjusted gross income between $98,000- $118,000; above that there is no deduction. If you are a single or head of household filer the phase-out for deductibility begins for adjusted gross income between $61,000- $71,000; above that there is no deduction. If you are not covered by a company plan but your spouse is, the phase-out range for you is $183,000 - $193,000. If you file married-separate, your phase-out range is $0 - $10,000. If your income falls between the phase-out range, your ability to deduct your IRA contribution will be limited. There is a specific calculation to determine the amount you can deduct so if this applies to you, consult your tax advisor to determine how much you can deduct.

Even though you may not participate in the company plan, you may be considered an "active participant” so it is important to verify before attempting to take a deduction. If you and your spouse (if applicable) are not covered by a company plan, then there is no income limitation to take a deduction for an IRA contribution. SEP and SIMPLE IRAs are considered company plans for these purposes but are not included in the maximum contribution amount as they have their own limits.

Eligibility for Roth IRA Contribution: If you are married filing joint, the phase-out of eligibility to contribute to a Roth IRA is between $183,000 - $193,000 of adjusted gross income; above that you cannot make a Roth IRA contribution. For single or head of household filers, the phase-out for eligibility is $116,000- $131,000. If you file married-separate, your phase-out range is $0 - $10,000. As mentioned above, if your income falls between the phase-out range, then your ability to contribute to a Roth IRA is limited. If you are above, then you cannot contribute directly to a Roth IRA however you are still able to convert IRA funds to a Roth IRA which is discussed below.

Non-deductible IRAs: If you wish to make a deductible IRA contribution but make too much income to be eligible to take a deduction, consider a Roth IRA instead. If your income is above the threshold to make a Roth IRA contribution, you can still make a regular IRA contribution however that contribution will not be deductible. In such a case of a non-deductible IRA contribution, your money goes in after tax but still grows tax deferred and your contributions when withdrawn are not taxable however the interest/gains will be taxable upon withdrawal.

These non-deductible contributions create "basis” in your IRA which when withdrawn come out tax-free in a pro-rata distribution relative to the amount of pre-tax money in your IRA. For example, if you have $100,000 in your IRA, $10,000 of which is after-tax basis, your ratio would be 10%. If you then took a distribution/conversion of $25,000, $2,500 of that would be considered a return of your basis tax-free while the $7,500 would be taxable.

IRA to Roth Conversions: Since 2010 anyone regardless of income can convert an IRA to a Roth IRA. This means that you could make a non-deductible IRA contribution and convert it to a Roth thereby getting after-tax funds in a Roth IRA which is in essence the same as making a Roth IRA contribution. This strategy is referred to as the “Back Door Roth.” It only works if you do not have other IRA funds because if you do, the pro-rata rules described above would apply. It is unknown if this loophole will be closed by congress or if they will allow anyone regardless of income to make a Roth IRA contribution; only time will tell. For now it is still there and people who this applies to should consider taking advantage of this great tax planning opportunity.

Mega Backdoor Roth:  The “Mega Backdoor” Roth is similar to what is described above however it is related to employer plans. There are many rules and details to be aware of but the basic idea is this: if the employer plan allows for after-tax contributions, you can theoretically contribute after tax funds up to the maximum Defined Contribution plan limit which is $53,000 for 2015 and 2016 plus $6,000 catch up contribution if over 50. Then, if the plan allows, you can request a distribution of only the after-tax funds paid to you and then deposit to a Roth thereby completing a Roth conversion of after-tax funds which means getting a whole lot of money in a Roth IRA, far more than the statutory annual contribution limit which also is limited by income levels.

For example, suppose you are maxing out your 401k at $18,000 and your employer provides a $6,000 contribution for you. That means $24,000 has been contributed leaving an additional $29,000 that could be put in using after-tax funds ($35,000 if over 50). If you had the ability to, you could contribute that $29,000 from your paychecks and at some point then request a distribution of those after-tax funds and convert to your Roth IRA. That would mean getting $29,000 in a Roth IRA in one year! Well you might say, “I have bills to pay and can’t take that much out of my checks.” Well obviously if you don’t have the funds you can’t do this but suppose you do have $29,000 in a savings or taxable investment account. In that case you would increase your contributions to the plan and use your savings to pay the bills and essentially shifting those taxable savings/investments into tax-free Roth IRA accounts. That’s why this is called the “Mega” backdoor Roth. Certainly many details are left out but this is the basic idea. If you think this could apply to you be sure to give us a call to discuss.

2016 IRA Limits: For 2016, IRA contributions limits stay at $5,500 if under 50 with the additional $1,000 catch-up contribution if you reach age 50 by year end. The phase-outs for IRA deductibility and Roth IRA stayed mostly the same from 2015 with a few exceptions:

  • IRA deduction phase-out for active plan participants
    • Single $61,000-$71,000
    • Married filing jointly $98,000-$118,000
    • Married filing separately $0-$10,000
    • Spousal IRA $184,000-$194,000 (you are covered but your spouse is not)
  • Roth IRA phase-out
    • Single $117,000-$132,000
    • Married filing jointly $184,000-$194,000

If you have any questions about IRA contributions or wish to make an IRA contribution for 2015 give us a call.

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President Obama’s Retirement Account Provisions in Final Budget Proposal

As President’s Day approaches we take a look at President Obama’s final budget proposal which contains 15 provisions related to retirement accounts. All but one of the proposals are simply a repeat of those proposed last year none of which were enacted. The only new proposal would allow certain employers to pool resources to create multi-employer (defined contribution) retirement plans which would create economies of scale and encourage more small business to participate.

Below is a list of the proposals but if you would like to read a full explanation you can go to the (Ed) Slott Report at

#1 – Allow Unrelated Employers to Participate in a Single Multi-Employer Defined Contribution Plan

#2 - Eliminate the Special Tax Break for NUA

#3 - Limit Roth Conversions to Pre-Tax Dollars

#4 - “Harmonize” the RMD Rules for Roth IRAs with the RMD Rules for Other Retirement Accounts

#5 - Eliminate RMDs if Your Total Savings in Tax-Favored Retirement Accounts is $100,000 or Less

#6 - Create a 28% Maximum Tax Benefit for Contributions to Retirement Accounts

#7 - Establish a “Cap” on Retirement Savings Prohibiting Additional Contributions

#8 - Create a new “Hardship” Exception to the 10% Penalty for the Long-Term Unemployed

#9 - Mandatory 5-Year Rule for Non-Spouse Beneficiaries\

#10 - Allow Non-Spouse Beneficiaries to Complete 60-Day Rollovers for Inherited IRAs

#11 - Require Retirement Plans to Allow Participation of Long-Term Part-Time Workers

#12 - Require Form W-2 Reporting for Employer Contributions to Defined Contribution Retirement Plans

#13 - Mandatory Auto-Enrollment IRAs for Certain Small Businesses

#14 - Facilitate Annuity Portability

#15 - Eliminate Deductions for Dividends on Stock of Publicly-Traded Companies Held in ESOPs

These proposals are just that; proposals, many of which most likely will not be enacted however it does give us a sense of what lawmakers may be going after in the coming years.


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Driving Your Taxes Ever Higher

Driving Your Taxes Ever Higher

I really don’t care for Flo. She is that all-too-cheerful lady that wants to sell you a particular brand of car insurance, one that she claims will save you lots of money. She would also like you to know that you have the option to plug a small device into your vehicle. This device monitors your every move for what is called usage-based insurance. If this device shows the company that you are a safe driver, then the insurance company will offer you a discount. Sounds like a good deal, right?

Unfortunately, Flo’s little device has other, less beneficial uses. A similar device, no longer optional, may one day help the government tax you based on how, when and where you drive your vehicle. Even George Orwell would have been shocked by this level of Big Brother-ness.

The Great Recession has led to many structural changes in our economy and how we behave. One of those changes has been in how we drive.

According to a recent study from the University of Michigan, Americans’ driving habits have changed dramatically in recent decades. The average driver travels 1,200 fewer miles per year than he did in 2005. We also use less gasoline per person than we have in nearly 30 years. The decline in miles driven and fuel consumption has meant a serious loss in revenue for local, state and federal governments.

The United States Highway Trust Fund was created in 1956 and is used for the construction and maintenance of the Interstate Highway System. The Trust Fund receives its money from the federal fuel tax. The tax on a gallon of fuel has been raised over the decades and is now over 18 cents per gallon of gasoline.

But the tax is not enough. The Congressional Budget Office estimates that the Trust Fund will be insolvent this year and will continue to be so for the foreseeable future. By 2023, the Trust Fund is expected to have a shortfall of nearly $100 billion.

The current mechanisms for funding transportation services are already failing. With Americans driving less miles and consuming less fuel the situation will only get worse. This means governments must find ways to gather more tax revenue from drivers.

The most straightforward solution is to increase the fuel tax. The problem with this idea is that the tax will be chasing ever-more fuel efficient vehicles that are being driven less. As a result, a tax hike is unlikely to meet funding needs. This is where the number crunchers will start getting creative.

Luckily for them, and unluckily for us, our friend Flo’s usage-based insurance device can be converted to a usage-based tax calculator. Currently, most use-based vehicle taxes operate as a type of sales tax. With more data, governments will be able to tax our vehicle usage in a multitude of different ways that would get around decreasing vehicle usage and increasing fuel efficiency. Heavy commuters might feel the tax pinch on how many miles they drive, whether they drive in cities or what time of day they drive. On the other hand, those with short commutes will not be able to escape taxes on vehicle speed, condition of the roads used, driving in high-volume areas, driving during harsh weather, etc.

By taxing a variety of usage patterns that are independent of miles driven and fuel efficiency, governments can supplement revenue from the fuel tax. The only way to avoid these taxes will be to turn in your keys.

Our change in driving habits is emblematic of how our behavior has shifted since the economic downturn. Traditional funding pathways for government services are falling behind. This means that we can expect our government to look for more creative and intrusive ways of taking our wealth to fund their services.

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IRA Update: March 2013

With the American Taxpayer Relief Act of 2012 that was passed in 2013, there are some new tax considerations to be aware of.

NUA planning with ATRA

NUA or Net Unrealized Appreciation has to do with employer stock within a 401k plan. NUA allows the plan participant to take the employer stock out of the plan in-kind and transfer to a taxable brokerage account while only realizing ordinary income on the original cost of the shares. The gains, or NUA is taxed at long-term capital gains (LTCG) rates but only when the shares are actually sold. See more details on NUA.

Previous to 2013, the difference between the top rate of 35% and the LTCG rate of 15% meant a 20% potential tax savings when using the NUA strategy. With the new top rate of 39.6% and 20% top capital gains rate; difference is 19.6% which is close however one must consider the 3.8% surtax on net investment income. The surtax would be applied on the income generated from the sale of shares after the distribution and thus the tax would be 23.8% which is 8.8% higher than in 2012. In other words the potential tax savings is reduced to 15.8% from 19.6%.

As an aside, almost no one will actually pay 20% capital gains because if your income is high enough to be in the 20% capital gain territory, you are probably also subject to the 3.8% surtax which is why you would pay 23.8%.

It is important to look at the potential tax savings but also important to consider that any future growth of distributed stock would no longer have the protective shell of tax deferral. Once the stock is sold, the capital gain would be realized. Any future income derived from the stock such as dividends would be taxable in the year received. Also the stretch IRA for beneficiaries would no longer be applicable to distributed NUA stock.

A key consideration: Is there significant appreciation on NUA stock and when will you need the NUA funds? If the gain on NUA is not significant, the benefit is less because it may cost a lot in having realized the ordinary income to get the NUA out at ordinary rates if there is a relatively small amount of NUA that would get the LTCG treatment. However if you are going to use the funds soon after distribution, the benefit is high because some of the money that would have been taxed at ordinary rates gets the long-term capital gains treatment instead. If holding for a long time before selling the shares, you have to evaluate whether it makes sense or not.

Roth Conversion Strategies

Roth conversion strategies need to be review and revised in light of the new tax rates. Taxpayers who are subject to the return of the 39.6% bracket obviously pay more tax and need to consider whether they want to convert at this rate. Since the Bush tax cuts for most taxpayers were made "permanent," those who converted into higher tax brackets in 2012 may want to revisit and determine if they should recharacterize and begin to reconvert over a longer period to keep their marginal tax rate lower.

Even with higher rates for high income, taxable assets are still subject to the 3.8% surtax and thus Roth conversion will help to reduce taxation on those types of funds if you were to use those funds to pay the tax on conversions. There certainly is no guarantee that congress won't come back and raise tax rates even more which is already being discussed and this should be factored into your decision to what income tax bracket you will convert to.


Planning with new estate tax threshold

With the estate tax being set at $5 million with portability and inflation adjustments means only the wealthiest will pay estate taxes, that is unless and until this level is brought back down. The Generation Skipping Tax (GST) exemption is set at $5.25 million instead of going back to $1 million. The estate tax rate went up to 40% from 35% but this is only on the amounts about the exemption.

Wealthy IRA owners may want to consider naming grandchildren as beneficiaries of IRAs to take advantage of the $5.25 million GST exemption and the stretch for the younger generation. Trusts may be necessary for grandchildren so watch the wording and the type of trust used so as to not affect the stretch and force small amounts of income to trust and estate tax rates which hit the highest bracket very quickly.

If the estate is potentially large enough, strategies to reduce the estate size such as gifting, Roth conversions, and life insurance via ILITs (Irrevocable Life Insurance Trust) should be considered. You must also consider even though there is a large federal exemption amount, some states still have their own estate tax with different thresholds such as NJ which sits at a $675,000 exemption amount.

Gifts can be given to family members who may be in lower tax brackets to help them convert their own IRAs to Roth IRAs. This can also mean gifts to parents who are in lower tax brackets. Helping a parent or even a grandparent convert their IRA to Roth means that Required Minimum Distributions cease and when you inherit, you can get a tax free stretch, or if you don't need it, have the younger generation named as beneficiaries so that they get lifetime tax free distributions.

Misc Tax Planning

  • Itemized deductions begin to phase-out at $300,000 for Married filing joint ($250,000 for single filers) up to $422,500 ($372,500 for single filers).
  • AMT exemption amount has been permanently indexed to inflation. For 2013 the amount is $80,800 ($51,900 for single filers).
  • Qualified Charitable Distributions temporarily extended for 2013.
  • In-plan Roth conversion rules have expanded.
  • Top trust tax rates starts at $11,950 which means that distributions from inherited IRAs to discretionary trusts that can retain those distributions hit the 39.6% tax rate very quickly.
  • Salary deferrals for 401k, 403b, etc, can reduce the MAGI for the 3.8% surtax however cannot reduce income for purposes of the 0.9% Medicare surtax.


As always, please consult with a qualified tax professional and financial advisor to determine if these strategies are right for you.
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American Taxpayer Relief Act of 2013

Summary of key (IRA) points:

Three new income thresholds that high income taxpayers need to plan for and four different ways income is calculated to compare against the new thresholds.

  • New (return of old) 39.6% tax bracket for joint filers with taxable income over $450,000 ($400,000 for single filers) and a top long-term capital gains and dividend tax rate of 20% which actually becomes 23.8% because such a taxpayer would be subject to the 3.8% surtax on net investment income.
  • Phase-out of itemized deductions up to 80% and personal exemptions for taxpayers whose AGI (Adjusted Gross Income) exceeds $300,000 ($250,000 for single filers)
  • 3.8% surtax on net investment income for those whose MAGI (Modified Adjusted Gross Income) exceeds $250,000 ($200,000 for single filers). At the same levels, earned income in excess of these thresholds will incur an additional 0.9% surtax.

Qualified Charitable Distributions return for 2012 and 2013

New in-plan Roth 401k conversion rules

  • Since 2010 a 401k participant who had a Roth 401k available could do an in-plan Roth 401k conversion IF they were eligible to take a distribution which typically means reaching the age of 59 ½. The ARTA modified this rule to allow participants that are not eligible to take a distribution to do an in-plan Roth conversion.
  • Ability to do an in-plan Roth conversion requires that the plan offers a Roth 401k and while plans are beginning to adopt the Roth 401k in greater numbers, they are not commonplace just yet.
  • If the plan offers a Roth 401k, in order to convert, the plan must also allow for in-plan conversion and there is no requirement that a plan offer this feature.
  • If the option is available, a plan participant must still analyze their tax status to determine if it makes sense to do the conversion, determine whether a Roth IRA conversion is better, wait, or not do it at all.
  • It is critical to keep in mind one of the MAJOR differences between a Roth IRA conversion and a Roth 401k conversion is the ability to recharacterize. When you convert an IRA to Roth, you have until October 15th of the following year to change your mind and reverse the transaction however in a Roth 401k conversion, there is no mechanism for recharacterization so once you execute the transaction, there is no turning back.

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The Sequestration has Arrived!

So the dreaded "sequester” has gone into effect and we are already dealing with the consequences. If you will remember, the infamous Fiscal Cliff that was in the news last year was a combination of tax hikes and deep across-the-board spending cuts.

Well, the tax issues have been mostly ironed out. Americans will be paying more in taxes, and no one is particularly happy about it. But at least the uncertainty is out of the way, and we know what we’re facing. As the old expression goes – better the devil you know to the devil you don’t know.

Now it’s time for the second half of the Cliff, the deep spending cuts collectively called "sequestration.”

Judging by the Dow’s recent record-breaking highs, investors don’t appear to be all that worried about the cuts. For all the angst and handwringing we’ve seen over the past year and a half, they seem to have reached the conclusion that it’s not a big deal.

So what is the story? Is it a big deal?

To start, most Americans agree that the government spends too much money, a lot of which gets wasted. But slicing $1.2 trillion out of the budget sounds like a big cut. That is, until you look at the details. Only $85 billion is scheduled to take effect this year - in a budget of more than $3.5 trillion – the rest is spread out over the next 10 years. We’re talking about spending cuts of less than 2.5%, and that assumes Congress and the administration don’t weasel out of it. That’s still a real possibility.

If the cuts happen as planned, they will probably take about half a percent off of GDP growth this year. And the effects could be worse if they impact business confidence and hiring.

Still, it’s hard to get worked up about spending cuts. Even if the sequester is messy and indiscriminate, it’s better than no cuts at all.

The real issue is not the current sequestration cuts, which don’t matter in the long run, but entitlements. Social Security and Medicare are already in deficit, now, when the vast majority of Baby Boomers are still in the workforce and still paying into the system. But what happens after 2020, when those Boomers born from 1955-1961, the highest birth years, start to reach retirement age?

If you think we have a deficit problem now, take a moment to think about what’s coming.

Actually, I can tell you what’s coming - higher taxes along with lower Social Security and Medicare benefits, particularly if you are considered a "high income” retiree. And believe me, what counts as "high income” is probably much lower than you think.

The bottom line is that we cannot depend on government programs to take care of us in our old age. And this means putting the pieces of a retirement plan together today, while there is still time.

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Important IRA Rulings for 2012

In Charles Grant Beech et ux. v. Commissioner, T.C. Summ. Op. 2012-74; No. 1948-11S, 7/26/12, a non-spouse beneficiary, the decedents daughter botched an inherited IRA by not doing a trustee-to-trustee transfer and the whole inherited IRA was taxable all in one year. Remember, a non-spouse beneficiary CANNOT do a (60 day) Rollover; funds must only be moved via direct (trustee-to-trustee) transfer.

In Herring v. Campbell, Administrator of Marathon Oil Company Thrift Plan, U. S. Court of Appeals for the Fifth Circuit, 8/7/12, a $300,000 pension was not inherited by the intended beneficiaries. The decedent, John Hunter named his spouse, Joyce and the primary beneficiary of his pension plan but did not name any contingent beneficiaries. Joyce predeceased John and he never updated his beneficiary form. The plan administrator followed the rules of the plan and eventually the funds were distributed to Mr. Hunter's living siblings, not his "beloved stepsons" who inherited his estate through the Will. Unfortunately for the stepsons, a Will does not cover retirement plans, the beneficiary form does.

In Seeling, U.S. Bankruptcy Court, District of Massachusetts, Western Division, Case No. 11-30957, 5/24/12, the taxpayer received a favorable ruling protecting her inherited IRA from bankruptcy. In Clark, 2012, DC WI, 109 AFTR 2d 2012-733, 1/5/12, another bankruptcy involving an inherited IRA, the bankruptcy court ruled in favor of the creditors initially however a district court later overturned the ruling in favor of the debtor. More and more of these inherited IRA bankruptcy cases seem to be coming up and it appears a precedence is being set in many states in favor of debtors.

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IRA Tax Planning: Qualified Charitable Distribution (QCD)

A Qualified Charitable Distribution or QCD allows an IRA owner who is over the age of 70 ½ to make a charitable contribution up to $100,000 directly to a qualified charity using IRA funds and have that contribution satisfy their Required Minimum Distribution (RMD) for that year. The distribution must be made directly to the charity. If the IRA owner takes the distribution payable to him/herself, they would realize the income on their own tax return. In this case they would be allowed to take the applicable charitable deduction however in many cases, especially for higher income taxpayers, the charitable deduction may be limited as might other tax deductions due to higher thresholds. With the QCD, the funds are transferred directly to the charity so the IRA owner does not realize the income on their return thus the QCD is much more tax efficient.

There are several key points to understand about QCDs:

  • The limit is up to $100,000 per person. A married couple could affectively give $200,000.
  • Applies to IRAs, Roth IRAs, inactive SEP and SIMPLE IRAs; it does not apply to distributions from any employer plan. If a plan owner wishes to do a QCD, an IRA rollover may help accomplish that objective.
  • Roth IRAs are a poor choice to use for a QCD because they would normally be tax free and have no RMDs.
  • The distribution can (partially) satisfy the IRA owner's Required Minimum Distribution depending upon the amount.
  • The distribution must be made directly to the charity from the IRA. A check made payable to the charity from the IRA is acceptable.
  • The income from the distribution is not included on the taxpayer's return thus their AGI is less than what it would be if the distribution were included.
  • A lower AGI (adjusted gross income) means that more tax deductions and credits may be available (lower thresholds due to lower income) to meet.
  • A lower AGI may help avoid the 0.9% Medicare tax and the 3.8% surtax on net investment income.
  • No charitable deduction is allowed if the QCD is used because the distribution is not counted as income.
  • QCDs are made only from pre-tax IRA funds, not basis. If the IRA owner has after-tax basis in their IRA, the pre-tax funds are deemed to come out first leaving behind basis. This is an exception to the pro-rata (Cream-in-the-coffee) distribution rules for IRAs.
  • The charity must be a public charity; grant making foundations, donor advised funds, or charitable gift annuities to not qualify nor do split interest gifts.
  • When a QCD is made, the IRA custodian will still generate a 1099-R; the taxpayer must take appropriate steps on the tax return to avoid the inclusion of income.
  • IRA owner's may not receive anything in exchange for their donation.

QCDs have been extended retroactively to 2012 as part of the American Taxpayer Relief Act of 2013. QCD's have expired and been reinstated for several years now and most likely will continue to be a viable tax planning strategy for those who are subject to Required Minimum Distributions and are charitably inclined. With the top marginal rate now "permanently" set at 39.6% plus the 3.8% surtax on net investment income, a QCD strategy should be considered for especially for those in high tax brackets.

Check out this great article on Qualified Charitable Deductions by Robert Powell in which I was quoted:

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Inherited IRA Horror Story

In anticipation of Halloween, I thought this real client horror story from Ed Slott & Co is timely.

The beneficiary of an IRA, Casey was 17 when she inherited the IRA worth approximately $170,000 at the time. The advisor made the (unfortunately all too common) error of moving the funds into an IRA in Casey's name rather than a properly titled inherited IRA. Casey had no idea if taxes were paid or were supposed to be paid; she relied on the guidance of the advisor.

Over the last 14 years, the account was moved several times to different IRA custodians and no one ever asked how a young person had such a large IRA. Casey only took out about $20,000 in the first three years she had the account and nothing since. Fast forward to the present when she needs some money so she makes a request to the advisor for a distribution. This prompted the current advisor to ask how she had an IRA that large at such a young age which uncovered the truth; it was an inherited IRA gone wrong!

Since a non-spouse cannot do a rollover, the transfer of funds from the inherited account to her own IRA was a taxable event the value of which should have been included on her income tax return for that year. Since it has been more than 3 years, the statue of limitations for audit has passed. However in a case such as this, the funds that went into Casey's IRA was an excess contribution subject to the 6% excise penalty per year until fixed. Normally this penalty would be filed on form 5329 which is considered a separate return, and since not filed, the statue of limitations never started.

The penalty is approximately $10,200 (6% of $170,000) per year for 14 years for a total of $142,800! The excess contribution amount would actually be reduced by the net eligible IRA contribution amount for each year which would make the penalty approximately $124,620 assuming full eligibility for the maximum allowable IRA contributions going back to 1998 and assuming she never made any of her own IRA contributions during those years.

Any distribution from the IRA Casey takes will be taxable. If she takes out the excess amount of $124,620 to pay the penalty, the tax due assuming a 25% tax bracket would be $31,155 plus the 10% early distribution penalty of $12,462 for a total of $43,617. Add these up and we have a total amount due of $168,237. All is not lost however because earning on the excess contributions are not distributed and if we assume a reasonable growth rate of 5% (which is below the 6% penalty amount), then her IRA would be worth approximately $336,588 minus the $168,237 penalty leaves her with $168,351 in her IRA. There would be the other penalties such as failure to file form 5329, accuracy related penalties, and interest due on those penalties for 14 years which would further reduce her IRA.

Note that had a distribution occurred when inherited, she would have paid the tax then presumably at lower rates because she was 17 and single, avoided the 6% annual penalty, and the 10% early distribution penalty which does not apply to beneficiaries of IRAs. More importantly if the original advisor was competent and set up a properly titled inherited IRA for Casey, she could have done the stretch and would still have the IRA today and paid much less tax along the way.

Don't let this happen to you or anyone you love. If you are not already, work with an Ed Slott Trained Master Elite IRA Advisor to make sure you and your beneficiaries don't have a scary story like Casey's to tell!

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More 60-Day IRA Rollover Rulings

When you take funds from an IRA (or other retirement plan) payable directly to you, you have 60 days to get the entire amount into an IRA (or other plan) to avoid the distribution being taxable as income. There are many reasons why some IRA owner's are unable to complete the rollover in the 60 day period. IRS has the authority to grant waivers and give the IRA owner's additional time to complete the rollover however the IRA owner must have a valid reason. In many cases, IRS denies these requests. The following are new PLR requests that have come out:

  • PLR 201146024: Denied- IRA owner used funds for an assisted living facility. The IRA owner's daughter who had power of attorney for her mother took the IRA distribution to get her into the assisted living facility and intended to put the money back within 60 days when her mother's home was sold. Unfortunately the sale of the home took longer than expected and she was not able to get the funds back to the IRA with 60 days. IRS denied the request because she used the funds.
  • PLR 201206023: Denied- IRA owner thought he had 90 days to complete the rollover. In many PLRs, the IRS has granted extensions of the 60 day period to allow a taxpayer the additional time to complete a rollover when in the case of advisor/bank/broker/institution error. In this case, the IRA owner claimed that the employee of the bank told him he had 90 days however he did not have any documentation to prove this claim and presumably the bank/bank employee was unwilling to admit error (assuming the IRA owner was telling the truth and received bad advice) and thus IRS denied his request. 
These PLR requests are expensive and in many cases unnecessary. PLR requests for 60 day rollovers begin at $500 and go up to $3,000 just for the request, not including the professional fee to properly draft the request. First many of the mistakes can be avoided, and when some of these mistakes occur, often the rules are clear and relief is unlikely to be granted. If you plan to do a 60 day rollover, make sure that you get the funds back into the IRA within the 60 days and avoid using the money for anything while out of the IRA. Better strategy to work with an advisor who knows the rules and can help you avoid these mistakes in the first place.
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