2010 Roth IRA Conversions: Why this Year is Special

Roth IRA conversions in 2010 are of special significance due to some unique tax circumstances and rule changes. If you’ve considered making a Roth IRA conversion from a traditional IRA and have worried about the tax implications, or haven’t been able to contribute to a Roth in year’s past due to high income levels, you’ll want to pay close attention.

There is one big tax rule related to conversions that only takes place in 2010 and others that are new this year that make it a special year for a conversion. Before getting into why 2010 is so significant, let’s first cover what a Roth IRA conversion is and why you might want to consider it in the first place.

What is a Roth IRA Conversion?

A Roth IRA conversion is actually a rollover from a Traditional IRA to a post-tax Roth IRA. Roth IRA’s are an attractive investment vehicle because all earnings are tax-free upon withdrawal in retirement. Many big proponents of Roth IRA’s advocate for them because they think tax rates will increase in future years and if you expect your tax bracket in retirement will be higher than it is now it might also make good sense to convert, because you don’t have to pay future taxes in retirement on Roth IRA’s.

The Drawback: Tax Liability Now

The drawback to converting from a Traditional IRA to a Roth IRA is that you must pay taxes on the conversion amount, when you make the conversion. You’re taxed at whatever your tax rate is for that year. Because you didn’t pay taxes up front with the Traditional IRA, you pay taxes on the amount going to your Roth (which you would have done in the first place had you originally contributed to your Roth).

If you don’t have significant savings on hand immediately, this can be a huge impeding factor that might cause you to shy away from a conversion altogether. It’s usually wise to save ahead of time so that you have enough cash on hand to pay for the conversion taxes. Now, let’s get in to why 2010 is a big year for Roth conversions.

The Three Big Roth IRA Conversion Changes in 2010

1. Roth IRA Conversion Income Limit Restrictions Removed

Prior to 2010, you could not convert from a traditional IRA to a Roth IRA if your modified gross adjusted income (magi) exceeded $100,000. In 2010 (and beyond), that rule has been eliminated.

2. High Income Earners Can Now Avoid the Roth IRA Income Limits

Roth IRA contributions have income phaseout limits. This prevents high wage earners from being able to contribute to Roth IRA’s. However, those same high earners with traditional IRA’s can now get into Roth IRA’s through the backdoor via the aforementioned $100,000 conversion income limit restriction being removed.

These converters, however, will not be able to contribute new funds directly to a Roth IRA. They’ll have to move funds over via a conversion in any year that they want to put funds into a Roth IRA.

3. Spread Out your Tax Liability Over 2011 and 2012

Unique only to 2010 conversions, you are able to choose between paying taxes on your converted dollars on your 2010 tax return, or spread out the payment in 2011 and 2012 (50% on each year’s tax return). This way, if you don’t have the savings immediately at hand or don’t want to deplete  your emergency savings, you can spread out the tax liability to 2011 and 2012. In other years (including starting again in 2011), you have to claim the conversion amount as ordinary income for that tax year.

Note that it is recommended that you pay the tax liability with saved non-retirement dollars versus pulling funds from your IRA, which kind of defeats the point of the conversion in the first place.

Things to Note on IRA Conversions:

• Carefully consider this move before you make it. If you’re thinking about making a conversion, it is one of those times that it might pay off to speak with a CPA, CFP, or other certified professional. There may be a number of situations where making a conversion does not make good financial sense.
• The conversion rules also apply to employer plans such as 401k’s.
• The conversion itself shouldn’t cost anything, minus a few trading or account closing fees. Excluding the taxes, of course. Any discount broker, such as TradeKing or Zecco could help you do it (note: I have my Roth IRA in TradeKing because they don’t charge annual fees).

Roth Conversion Discussion:

• Have you (or will you) make the Roth IRA conversion this year? Why or why not?
• If you are making the conversion, are you spreading it out over 2011 and 2012?

Related Posts:

2010 IRA Maximum Contributions

Once a year, when tax time comes around, you get the terms gross income, adjusted gross income (AGI), and modified adjusted gross income (MAGI) shoved in your face… a lot. And since you’re only faced with having to know what these somewhat ambiguous tax terms mean once a year, they are very easy to forget. Heck, I already did.

So, what I’m going to do in this post is highlight what each of these terms mean, where you will encounter them, and why they are important to know so that you can refer back to this post in the future when the ambiguity returns.

Gross Income (aka Gross Earnings)

We’ll start with the easy one. Gross income is simply the total money, or income, that you receive per year before any deductions and taxes are taken out. Gross income is also referred to as ‘gross earnings’, ‘total income’, or simply ‘gross’. At first, you might just think, OK, it’s my salary, simple enough. Not quite. The IRS factors all of the following income sources into your gross income, and it runs from line 7 to line 21 of your 1040. Gross income is the net sum of the following:

• wages
• salaries
• tips
• taxable interest
• ordinary dividends
• taxable refunds, credits, or offsets of state and local income taxes
• alimony received
• business income or loss
• capital gains or losses
• other gains or losses
• taxable IRA distributions
• taxable pensions and annuities
• rental real estate
• royalties
• farm income or losses
• unemployment compensation
• taxable social security benefits
• and other income

All of these income sources add up to the ‘total income’ amount on line 22 of your W4.

Adjusted Gross Income (AGI)

Thankfully, we aren’t taxed on gross income. We get to subtract a number of deductions. Your gross income minus all of these deductions is what becomes your adjusted gross income (AGI) or Net Income. What deductions do you get to subtract? Why, thank you for asking. The following deductions make up lines 23-35 of the first page of your 1040:

• educator expenses
• individual business expenses
• health savings account (HSA)
• moving expenses
• one-half of self employment tax
• self-employed SEP, SIMPLE, and qualified plans
• self-employed health insurance deduction
• penalty on early withdrawal of savings
• alimony paid
• the IRA deduction
• student loan interest deduction
• tuition and fees deduction
• domestic production activities deduction
• Archer MSA deduction

The sum of these deductions adds up to line 36 of your 1040. To get your adjusted gross income, you subtract line 36 from line 22. Your adjusted gross income is what’s left, and it goes in line 37. If you use Turbotax or HR Block, it probably didn’t occur to you how these actual terms related to your 1040. Neither the standard deduction or itemized deductions are factored into your adjusted gross income.

Modified Adjusted Gross Income (MAGI)

Modified adjusted gross income (MAGI) are important because they are used to calculate income phaseout limits that indicate what your Roth IRA, SEP IRA, and traditional IRA maximum contribution limits are. And doing things to reduce your income such as increasing to the maximum 401k contribution, might actually lower your overall MAGI and allow you to contribute more to your IRA’s.

The IRS defines MAGI as:

AGI without:

• Any passive loss or passive income, or
• Any rental losses (whether or not allowed by IRC § 469(c)(7)),  or
• IRA, taxable social security or
• One-half of self-employment tax (IRC § 469(i)(3)(E)) or
• Exclusion under 137 for adoption expenses or
• Student loan interest.
• Exclusion for income from US savings bonds (to pay higher education tuition and fees)
• Qualified tuition expenses (tax years 2002 and later)
• Tuition and fees deduction
• Any overall loss from a PTP (publicly traded partnership)

Also, in order to qualify for the retirement savings contribution credit,  you must have an adjusted gross income under these limits:

• $55,500 (married filing jointly),
• $41,625 (head of household), or
• $27,750 (single, married filing separately, or qualifying widower)

There you have it – gross income, adjusted gross income, and modified gross income in a nutshell. I’ll be referencing these terms in some upcoming posts. No quizzes at the moment.

I recently covered situations in which you’d have to pay real estate capital gains taxes, which prompted a few people to ask me about real estate capital losses.

The basic question is “If you have to pay taxes on capital gains from the sale of property in certain situations, are there also situations in which you can claim real estate losses as a tax deduction?”. To answer that question, let’s first look at equity investments versus real estate.

Real Estate Gains vs. Capital Losses: The Same as Investments?

A capital gain on the sale of a home is essentially selling your home for more than you bought it for. A real estate capital loss is selling your home for less than what you originally bought it for.

With equity investments (stocks, mutual funds, etc.) you are able to deduct your capital losses from your taxable income and you must pay capital gains taxes when you make gains on your sale. However, the same rules do not apply to gains and losses on the sale of primary or secondary residences.

Are Losses on a Home Sale Tax Deductible?

According to the IRS Publication 523, “A loss on the sale of a home is not tax deductible”. Check out page 5 of the publication for more specifics. Unfortunately, for anyone who was seeking a silver lining when selling their home for a loss over the past few years, it won’t come in the form of a tax deduction.

Losses on Investment Properties

There is an exception. If you sell an investment property for a loss, your loss may be deductible against your income. Investment properties are treated very similar to equity investments in this regard. You will need to fill out IRS form 4797 in order to claim your losses.

Related Posts:

• Buying Vs. Renting a Home
• Tiny Home Movement
• First-Time Homebuyer Tax Credit Extension Date Moved

The homebuyer tax credit extension approved last fall by Congress was given another 3-month extension this week. However, it might not be the type of extension you were hoping for if you recently joined the housing market.

This time the tax credit extension was voted as a 3 month relief to homebuyers who were tardy on closing their purchases. In order to take advantage of the homebuyer tax credit, you still must have had a signed purchase agreement by the original tax credit extension date of April 30, 2010.

With this new extension, you now have until September 30, 2010 (vs. June 30) to close on the purchase of the home. This legislation was forced, and overwhelmingly approved because it is estimated that as many as 180,000 homebuyers would not have qualified for the tax credit even though they had a signed purchase agreement by April 30, because lenders were inundated with buyers rushing to close their sale and qualify for the tax credit.

Related Posts:

• You May be Ready to Buy your First Home if…
• Real Estate Capital Gains Taxes on a Home Sale
• Buy or Rent a Home?

When you are about to sell your home, one of the first things that you should consider is if you will have to pay capital gains taxes on the sale. This is a topic that hasn’t come up much in recent years with property values declining, nevertheless, it should be on the radar of those joining the world of home ownership.

Capital Gains on the Sale of a Home: A Good Problem to Have

If you have to pay capital gains on the sale of a home, it’s really not a bad problem to have. It means your house has appreciated in value since you have purchased it. You’re luckier than just about anyone who has bought a home in the last 10 years! That being said, there are certain rules and exceptions that can exclude you from paying capital gains on the sale of property that should be at the top of your mind.

Real Estate Capital Gains Principal Residence Exclusion

There is a huge real estate capital gains tax exclusion that allows you to exclude $250,000 in profit (individual) or $500,000 in profit (married). In order to be eligible for exclusion from having to pay capital gains, you must have lived in the home as your principal residence for 24 months out of the last 5 years.

Why should you pay attention to this? Well, if you are considering when to sell your home and you know that you will make profit on it, but you’re not quite to that 24 month mark, you may want to consider holding until the two year mark.

Exceptions to the 24 Month Rule

If you lived in your home less than 24 months, you still may be able to exclude a portion of the exclusion amount.

According to the IRS, principal residence exclusions are allowed for certain “unforeseen circumstances“, including:

Capital Gains Partial Exclusions

The maximum partial exclusion that one can use if they meet one of the previously mentioned exclusions is limited to the percentage of the 24 months that the person fulfilled the requirements. As an example, if you owned and occupied a home for one year (half of two years) – you may exclude half the regular maximum amount, or up to $125,000 of gain ($250,000 for most joint returns). The proportion may be figured in days or months.

How do you Report Capital Gains on Real Estate in your Tax Return?

You must use IRS Form – Schedule D to report gains. When you have owned your home for less than a year, it is considered a short-term capital gain. Over a year is considered a long-term capital gain.

Can you Deduct Capital Losses on a Home Sale from Taxes?

Sorry, no. Real estate capital gains (and capital losses) are treated completely differently than other investments. Capital losses cannot be treated as tax deductions.

What About Exemptions on Capital Gains for Investment Property?

Sorry, you are not excluded from paying capital gains. In fact, capital gains on real estate were primarily created to take a cut of investment property gains. This goes back to the home needing to be your principal residence for two years rule.

More IRS Real Estate Capital Gains Tax Help

If this is a topic that hits ‘close to home’ (pun intended), you may also want to check out these IRS articles:

• IRS Topic 701: Sale of a Home
• IRS Publication 523: Selling your Home
• IRS Publication 530: Tax Information for Homeowners

Home Sale Taxes Discussion:

• Have you had to pay capital gains on a home sale?
• Have you been eligible for the exclusion on a previous sale?
• Did you wait to hit two years before selling to be eligible for the exclusion?

Related Posts:

• How to Sell your Home For Sale By Owner (FSBO)
• Buying Vs. Renting a Home: What to Look At

2010 Federal Tax Brackets

Since the best tax planning usually comes throughout the year prior to the IRS tax deadline, right now might be a good time to revisit what your overall AGI might be this year and adjust your tax allowances so that you don’t get penalized or reduce your take home pay in other ways such as building up to the 2010 maximum 401K contribution.

You will want to avoid jumping up to the next tax bracket, if possible to prevent getting taxed at a higher level on that income. Here is another look at the 2010 federal tax brackets.

Tax Brackets for Singles:

10% – $0-$8,375
15% – $8,375-$34,000
25% – $34,000-$82,400
28% – $82,400-$171,850
33% – $171,850-$373,650
35% – $373,650+

Tax Brackets for Married Filing Jointly:

10% – $0-$16,750
15% – $16,750-$68,000
25% – $68,000-$137,300
28% – $137,300-$209,250
33% – $209,250-$373,650
35% – $373,650+

Tax Brackets for Married Filing Separately:

10% – $0-$8,375
15% – $8,375-$34,000
25% – $34,000-$68,650
28% – $68,650-$104,625
33% – $104,625-$186,825
35% – $186,825+

Tax Brackets for Head Of Household:

10% Tax Bracket – $0-$11,950
15% Tax Bracket – $11,950-$45,550
25% Tax Bracket – $45,550-$117,650
28% Tax Bracket – $117,650-$190,550
33% Tax Bracket – $190,550-$373,650
35% Tax Bracket – $373,650+

Keeping IRS Tax Rates Lower on All Income

Here’s the part of the equation that is a common misconception. Your overall tax rate is not at whatever bracket you fall in. Only the income that falls into that tax bracket is taxed at that rate. As an example, if you are filing single, your tax rate on your first $8,375 of income is at 10%, all income between $8,375 and $34,000 is at 15%, and so on.

So my point in addressing this at the halfway point of the year is this – if you calculate that you might have income that would be considered part of a higher bracket, you may want to take action to keep your income lower and avoid the higher taxes on the income that would fall into the higher bracket.

Don’t Forget the Standard Deduction!

Also, keep in mind that there are standard tax deductions that will lower your income, if you don’t decide to itemize taxes. The standard deductions amounts are as follows:

• $5,700 for single filers
• $11,400 for married filers
• $8,400 for head of household
• $950 for dependents

Other Income Lowering Tax Deductions & Tax Credits:

• You can donate to a 501(c)(3).
• You could donate a car to charity.
• Get a home energy tax credit.
• You could contribute to a traditional IRA.

Tax Bracket Discussion:

• What have you done to stay in a lower tax bracket this year?
• Which tax bracket did you max out in last year? Which are you predicting this year?

Monday was the deadline for non-profits that make under $25,000 per year to file a tax return. And apparently, many (around 365,000) missed the memo, which went out 4 years ago. Here’s the unfortunate chain of events that could lead to your favorite local non-profit losing tax exempt status.

1. The 2006 Pension Protection Act had provisions that required all non-profits to file an annual tax return.
2. Non-profits making less than $25,000 annually were previously excluded from having to file a return (those over $25K had to previously).
3. Non-profits that don’t file a return for three consecutive years lose tax exempt status.

Why Should You Care that Your Local Non-Profit is no Longer Tax Exempt?

For starters, they may be hit with a user fee of $850 and have to reapply for tax exempt status. That means that less of your donation is going towards the cause that you intended it to (and towards this fee) and if the non-profit does not receive exempt status again, they might have a hard time surviving at all.

Additionally, your donations may no longer be tax deductible. However, it sounds as though you may be off the hook until the IRS posts a revocation notice that lists the charity as no longer tax exempt. According to Sarah Hall Ingram, IRS commissioner for tax exempt and government entities. When a non-profit loses its tax exemption, the IRS is required to issue a public notice. Until the notice is published, she says, donations to the organization are still deductible. The IRS doesn’t plan to publish the names of non-profits that lose their exemption until January, Ingram says, “So if somebody gives between now and when the name gets on the public list, the donor is protected.”

What Non-Profits Will be Affected?

Want to find out if your charity is impacted? The Urban Institute has published a list of charities at risk of losing tax exempt status. If yours is on the list, give them a heads up. They might not even know what’s at stake for them.

Non Profit Tax Forms

Non-profit’s need to file IRS form 990, and those under $25K in annual revenue can fill out the shortened version: IRS form 990N.

Non-Profit Tax Exempt Discussion

• Is one of your favorite charities on the list?
• Would you still donate to them if your donation was no longer tax deductible?

Related Posts:

• How to Donate your Car to Charity
• Energy Tax Credit Guide
• Best & Cheapest Ways to EFile

Donating A Car is Not as Easy as it Sounds

When donating your car to charity, there are two things that you want to ensure happens:

1. The charity gets the full benefit of your vehicle donation.
2. You get full taxable value for your donation from the IRS.

And in order to do so, it’s not as simple as driving up to your favorite local charity, handing them the keys, and having them hand you the receipt with a tax deductible $ amount on it. Here are the steps you will need to take to ensure that both of the above happens. Note that the same rules apply to boat donations and airplane donations as well (although it might be a lot harder to ‘drop the plane off’ at the local charity).

1. Avoid the Rif-Raf

There are hundreds, maybe thousands of for-profit companies who will gladly take your donated vehicle and keep most of the proceeds for themselves. Avoid the middleman in order to benefit a true charity, not a for-profit business. Step 1 is really that simple.

2. Find the Right Charity to Donate your Vehicle to

The charity that you donate your car to must be a 501(c)(3). If you’re unsure whether or not the charity is a 501(c)(3), you can check out Charity Navigator or view a complete list of approved IRS charitable organizations, or Publication 78. You should also take a look at the Better Business Bureau Charity guide if you’re looking for ideas on who to donate to.

Then contact your charity of choice and see if they take vehicle donations and what they do with the vehicles.

3. Drop your Vehicle Off

If possible, tow or drive the vehicle to the charity or the auction site for the charity. It may cost you some money to get it there, but it’s simply the right thing to do. Maximizing your own benefit jeopardizes the good will behind the donation in the first place.

4. Get a Receipt when the Charitable Organization Sells your Donated Vehicle

To avoid an IRS audit or cover yourself in the event of one, you’ll need more than a good faith estimate. When your donor recipient sells the vehicle (usually at auction), then you will need to gather a receipt of how much they made in the sale. This is how much you can deduct in your taxes. Keep the receipt in case you get audited by the IRS.

5. Use Fair Market Value (FMV) for your Car Donation when Possible

There are certain cases when you can used Fair Market Value, or FMV, for your donation. This is usually a higher value than you will be able to get elsewhere. To find fair market value, use Kelly Blue Book (KBB) or NADA. Here is when you can use fair market value:

• when the charity keeps and uses the vehicle, versus selling it.
• when the charity makes improvements to the car prior to selling it.
• when the car is sold at a discounted price to a person with a low income.
• if the car is worth less than $500.

Whether the car is sold at auction, used by the charity, or less than $500, you should always get a receipt and hold onto it.

6. Tax Forms for Car Donations

Making the IRS happy goes beyond just getting a receipt and deducting your donation. You have to include the right forms. And according to form 8283, if the value of your vehicle donation is over $5,000, you’ll need an appraisal. Here are the forms you’ll need to include with your tax return: IRS noncash charitable donation form 8283, form 1098C, and form 8453.

7. Feel Good About your Deed

Donating a vehicle can result in a huge benefit for a worthwhile charity and for your taxes as you lower your taxable income (which could potentially push you into a lower tax bracket). This is one of those cases where everyone wins if you do things the right way to maximize the benefits for both parties. Car donation FTW!

Car Donation Discussion:

• Have you ever donated a vehicle?
• Was it easier/more difficult than expected? Any lessons learned?
• Did you have to tow it in?

I’ve had a few readers come to me with this question in the last few weeks. With taxes due this Thursday, it’s cram time for a lot of people. As you rush to complete your taxes this year, you still want to ensure that you are diligent in your preparation efforts so that you are not holding up any red flags for the IRS to find.

First off, realize that you are not alone. 1 in 5 taxpayers don’t file their taxes until the final week ahead of the April 15 deadline. Last year, 27 million taxpayers waited until the final minute before the tax deadline. Take a deep breath. Here are some details on the tax filing deadline and what to do if you aren’t going to be able to meet it.

When is the 2009 Tax Filing Deadline?

For the 2009 tax year, the tax filing deadline is April 15, 2010. But what exactly does that mean?

Tax Filing Postmark & E-File Deadline

The April 15 tax deadline does not refer to when the IRS receives your tax return. It actually refers to the date that the tax return is postmarked. So if you mail out your tax return on April 15 by U.S. mail and the IRS receives your tax return after that date, your return won’t be considered late. The same rule applies for e-filing your taxes. If you e-file your taxes, you must do so by April 15th as well.

When is the Tax Deadline if I’m Out of the Country?

You are off the hook for now. You have an additional two months to file your taxes. Your tax filing deadline for 2009 taxes if out of country is June 15, 2010.

• You live outside the United States and Puerto Rico and your main place of work is outside the United States and Puerto Rico, or
• You are in military or naval service outside the United States and Puerto Rico.

If you qualify as being out of the country, you will still be eligible for the extension even if you are physically present in the United States.

Tax Extension Filing Deadline

If, for one reason or another, you are unable to file your tax return by the April 15 tax deadline, you can file for an IRS tax extension. Note that the extension must be postmarked by the April 15 deadline also.

How to File a Tax Extension

In order to file a tax extension, you will need to fill out IRS form 4868. Turbotax also offers a tax extension service. Note that filing the extension does not get you off of the hook, you still need to pay any estimated taxes by the April 15 deadline. If you don’t you will owe interest and possibly a penalty on your taxes owed.

The tax extension will allow simply to push back the deadline for sending in your 1040, 1040A, 1040EZ, 1040NR, or 1040NR-EZ six months (4 month if you are out of the country). If you’re in country, the tax filing extension deadline is October 15, 2010.

Tax Filing Help

If you still haven’t purchased your tax software and aim to e-file by April 15, Turbotax and H&R Block are the two tax software prep programs that I would recommend. I used Turbotax last year and H&R Block this year and neither has disappointed.

Tax Deadline Discussion

• Have you still not filed your taxes?
• Did you apply for the tax extension?
• How are you preparing your taxes this year?

Related Posts:

• Best & Cheapest Way to Efile
• Federal Tax Brackets 2010
• How to Check your Tax Refund Status
• How to Change your Tax Allowances
• 2010 IRS Maximum Allowed 401K Contribution
• 2010 IRS Maximum Allowed IRA Contribution

Worried that your income tax refund hasn’t hit your mailbox or bank account yet? Or do you just have a lack of patience like I do?

Checking on your income tax return’s status is actually pretty simple to do. Just go to the IRS Refund Status site and enter the necessary information.

To Check your Refund Status you will Need:

1. Your Social Security number
2. Your filing status (single, married filing jointly, etc.)
3. The refund amount that you determined

What will the Refund Status Site Tell me?

When you enter the above information correctly, you’ll be able to find out:

• If your return was received
• If your return was processed
• When your refund is estimated to be mailed or deposited into your bank account (if you selected the direct deposit option)

Watch Out for Refund Status Scams

The IRS never initiates email, so beware of emails offering to check your tax return status for you. In fact, I wouldn’t necessarily trust any websites that supposedly link to an IRS refund status site (ironic, since I did just that in this post, I realize). You’d be better off just typing irs.gov in your browser and clicking ‘check on your refund’, and then ‘where’s my refund?’.

Tax Refund Discussion:

• How long did it take for you to receive your refund?
• How did you file this year? Paper or efile?
• Did you request direct deposit or check?

Related Posts:

• Best & Cheapest Way to Efile
• How to Change your Tax Allowances
• 2010 IRS Maximum Allowed 401K Contribution
• 2010 IRS Maximum Allowed IRA Contribution