Remember you can find past episodes at http://www.financialinsiderweekly.com under “past episodes”.

Remember you can find past episodes at http://www.financialinsiderweekly.com under “past episodes”.

The opportunity was to accumulate additional value during 2010 while deferring the tax to 2011 and 2012.

Here is a link to an article I wrote about Roth conversions during 2010. http://www.taxtrimmers.com/rothconversion.shtml

During the last few months, there has been a significant decline in the stock market. Some taxpayers may find that they are paying income taxes for a value that no longer exists.

For example, if the value of the Roth account converted from a regular IRA during 2010 declined from $200,000 to $100,000 and the taxpayer is subject to the maximum 35% federal income tax rate, the federal income tax attributable to the Roth conversion could be reduced from $70,000 to $35,000 by “undoing” the 2010 Roth conversion and then making the conversion in 2011.

The Internal Revenue Code permits this reversal to be done. It is called a “recharacterization”. The Roth account trustee must be notified of the intention to recharacterize the Roth conversion to a transfer to a regular IRA account. The plan assets must also be transferred from the Roth IRA account to a regular IRA account in a trustee-to-trustee transfer. According to questions and answers posted to the IRS web site (www.irs.gov), the final date for the notice and transfer to be done for a 2010 Roth conversion is October 17, 2011.

When a recharacterization for 2010 is done, a Roth conversion can’t be done for 2011 until more than 30 days after the date of the recharacteriation.

There is some inconvenience involved in doing a recharacterization, including filing an amended 2010 income tax return if your has already been filed. The amended return can be done after October 17, 2011. If the decline in value has been small, I would leave the Roth conversion alone.

If you are wondering if you should “undo” a Roth conversion, I recommend that you consult with your investment advisor/financial planner and your tax advisor.

IRS Circular 230 Disclosure:

As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

Remember you can find past episodes at www.financialinsiderweekly.com under “past episodes”.

The Bush tax cuts, which were extended to 2011 and 2012 are scheduled to expire after next year. If Congress does nothing, the maximum long-term capital gains rate will increase to 20%. In addition, the 3.8% Medicare tax on investment income when adjusted gross income exceeds $200,000 for singles and $250,000 for married filing joint returns enacted as part of the Health Care Reform legislation will also become effective after 2012, so the maximum long-term capital gains rate for high-income taxpayers is scheduled to be 23.8%, or an increase of more than one-third!

The National Commission on Fiscal Responsibility and Reform issued its report, “The Moment of Truth”, during December 2010. The report includes proposals for tax reform. Among its proposals is to eliminate preferential tax rates for long-term capital gains and qualified dividends, and taxing these items of income at ordinary income tax rates.

The proposal is to broaden the tax base and reduce federal income tax rates. Although the proposal is stated to repeal the alternative minimum tax, it’s closer to repealing the regular tax and replacing it with the alternative minimum tax. The proposal is strikingly similar to the Tax Reform Act of 1986 that was passed when Ronald Reagan was president. If history repeats itself, the “new” system will probably gradually erode under future Congresses with new higher tax rates and restored preferences for long-term capital gains.

Meanwhile, we need to think about the next few years. It seems likely that we will not see a 15% maximum tax rate for long-term capital gains for some time after 2012.

In order to qualify for the long-term capital gains rate, you have to hold capital gains property for more than one year. That means you will have to acquire the property before December 31, 2011 in order to qualify for long-term capital gains rates before they expire after 2012.

Some employees who are holding employee stock options should consider exercising them this year.
In addition, some taxpayers should consider taking capital gains during 2012. The “wash sale” rules do not (currently) apply to capital gains, so you can sell stock to qualify for the long-term capital gains rate and repurchase the stock immediately after the sale.

These statements are oversimplified. Please don’t take actions with significant tax and financial results without consulting with your tax and financial advisors.

IRS Circular 230 Disclosure:

As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.