Mary Kay Foss

You start with the Schedule C profit and reduce it by the deduction claimed for one-half of self employment tax. The amount is shown on Line 27 page one of the return and is calculated on Schedule SE. The self-employment tax is calculated on 92.35% of Schedule C profit and is affected by the social security wage base and whether the individual has any social security wages. Even inexpensive tax-planning software is able to calculate the correct amount but it isn't at all intuitive.

There have been a number of private rulings recently on this issue. In addition to the one cited, check 200052039 and 200116056. As long as the transfer to the spouse meets the 408(d)(6) requirements, they've allowed payments to continue just on the reduced amount. Of course, you're not supposed to use a private ruling as a precedent but if we didn't have them we'd have almost no information on what is considered a modification for Sec. 72(t) purposes.

Unfortunately you cannot choose which IRA funds are treated as being contributed to the Roth. Even if you had isolated that $28,000 separately, the calculation requires that all IRA funds be considered when determining how much of the Roth conversion is taxable. The calculation is made on Form 8606. The conversion may still be a good idea, you just can't manage the timing of the tax consequences.

There is a good article on this issue in the October 1 edition of Spidell's California Taxletter. The chair of the Assembly Revenue and Taxation Committee and the Senate Committee on Revenue and Taxation are sponsoring a meeting with interested parites January 17 from 1 to 4 p.m. at the State Capitol. The two chairs had solicited comments for "partial conformity" that were to have been submitted by Dec. 17. We're hoping that this is resolved soon. We've heard that some of the larger employers are not implementing the EGTRRA changes until the matter is clarified. In a radio interview in LA yesterday, the assembly speaker supposedly said that CA should use its limited resources on education rather than conformity. I don't think our reps in Sacramento really understand the problem. If they thought there was an exodus of business out of California in the 90s, this could cause a greater one.

When funds are withdrawn from a Roth, contributions come out first, then taxable amounts from conversions from a traditional IRA, then nontaxable amounts from conversins from a traditional IRA (basis from nondeductible contributions) and finally earnings. The earnings would be taxable, but if you contribute $2,000 per year for 18 years it will take a while before you get to a taxpaying point. I hope your kids will be out of college before you're 59.5. Mine were and I thought they'd never finish.

There is an exception to the 10% penalty for up to $10,000 used for the purchase of a new home for distributions from an IRA; it doesn't work with a 401k so any distribution would have to be rolled to an IRA first. Purchase of a new home is one of the items mentioned in the regulations for a hardship distribution. Generally 401k plans do not allow distributions to employees under age 59.5; that's why there are hardship distributions. The hardship distribution would be subject to the 10% penalty and adversely affects the employee's ability to make additional deferrals to the plan.

The question seems to be combining a couple of issues. Amounts transferred directly to an educational institution are not treated as gifts for gift tax purposes. This allows grandparents, for example, to pay tuition and also give annual exclusion gifts. One of the exceptions to the 10% penalty for early withdrawal from retirement accounts is for higher education. The exception does not necessarily require that the amounts be transferred directly to an educational institution to avoid the 10% penalty but there is no limit on the amount of funds that can be used this way. The funds can be applied to tuition, books, supplies and even dorm fees. There could be some income tax consequences if the Roth hasn't been around long five years and has successful investment performance but since we're talking about college for a newborn or retirement of the parents of a newborn, I'm assuming that's not an issue here.

Mandatory withholding applies to amounts that are eligible for roll over that are not rolled over. The MRD is not eligible for rollover so you don't have to withhold at the higher rate. The 10% voluntary withholding would generally be used unless the payee doesn't want any withholding. If the payments are being made as an annuity, voluntary withholding is detemined like regular payroll withholding using marital status and exemptions.

There are penalties for not filing Form 8606 and penalties for overstating basis in an IRA so it's important that you deal with this. Form 8606 is one that can be filed separately. Obtain copies of the form for every year that you made a nondeductible contribution. After completing the forms, send them all in together with a note asking that any penalties be waived because you just became aware of the requirement. If you do this within a month or so, the basis for the nondeductible IRAs will be on file with the IRS. The calculation that Barry mentioned treats all IRAs as coming out of one pot. Part of the amount converted to Roth will be from the deductible IRAs and part from the nondeductible. There isn't any way to designate that the conversion come from just once source or another. Good luck!

I'm not so sure that IRAs inherited from the same person cannot be combined, although I can't find a definitive source. Sec 408(d)© denies rollover treatment for an inherited IRA. Private letter rulings have allowed transfers from the decedent's custodian to a custodian named by the beneficiary but the rulings generally deal with one specific IRA. The 2001 proposed regs. at 1.408-8, Q&A 9 say that amounts in IRAs that an individual holds as a beneficiary of the same decedent can be aggregated for RMD purposes. This doesn't go a step further and endorse combining them but it doesn't prohibit it either. Your suggested titling is in line with what my clients have used.

Before the stock market went down an individual started taking substantially equal periodic payments from an IRA of about $200,000 for 2000 and the same amount for 2001. He turns 59.5 next year and the IRA can no longer support the large withdrawals. I understand that he will owe the 10% penalty plus interest on the two payments that he has taken but I have some questions about procedure: 1. The modification to the payments occurs in 2002, by not taking the large payment. Is Form 5329 filed with the 2002 Form 1040? 2. Since Form 5329 is a form that can be filed separately from the Form 1040, can it be filed earlier? 3. What period does the interest cover? My first thought was from April 15, 2001 to April 15, 2003 on the first withdrawal BUT if we can file Form 5329 early the interest term should be shortened. 4. Our state (CA) has a similar penalty but no interest (that I'm aware of). The penalty might as well be included with the 2002 return if there's no interest. Agree? 5. Does anyone have experience with this?

I have never seen any authority for calculating a required distribution by netting out the amounts they should have taken in prior years. Proposed reg. 54.4974-2 governs the situation. In 1995, Examination Guidelines for Distributions from Qualified Plans were issued as Announcement 95-99 (1995-48 I.R.B.). In those guidelines, Example 25 gives the situation where RMDs have been missed. There are not enough facts given in the example to determine how the RMDs were figured, but it looks like no adjustment was made for prior missed distributions.

You cannot transfer funds directly from a 401(k) Plan to a Roth IRA. First you must roll the funds to a traditional IRA. There is no minimum amount to convert from a traditional IRA to a Roth. The limitations are based on your adjusted gross income in the year of the conversion.

The current year RMD is supposed to be removed from the account before the funds are placed in a beneficiary account. The custodian should do this if you ask for a movement of funds, but these rules sometimes are missed.

A RMD due 4/1/02 seems to be the only distribution where some controversy exists. The January 2001 proposed regulations are applicable to distributions for years beginning on or after January 1, 2002. The 1987 proposed regulations will be gone at that point. Most distribution schemes rely on the regulations in effect under 401(a)(9). It seems to me that the model amendment is only relevent for plans that want to use the new proposed regs before 1/1/02. I suppose if a plan specifically referenced the 1987 proposed regulations it would need an amendment even in 2002. A distribution due 4/1/02 would be for the calendar year 2001 and would come under the old rules without a plan amendment.

I think that you should ask that a switch be made to a fractional formula, the risk of triggering all of that income is too great.

Kathleen-- I'm answering your question as if you're looking at an RMD from an IRA rather than a qualified plan. With an IRA, the IRS cannot force you to go back and payout the missed RMDs. However, the 50% penalty would apply for each year that no RMD was taken. My understanding is that the statute of limitations for the 50% penalty does not begin to run until Form 5329 is filed. I guess the IRS could go back any number of years to assess penalties in that case. Good luck!

The answer you're concerned about comes from the Internal Revenue Code and is not changed by the regulations. A beneficiary can still not name a new beneficiary to extend distributions past their life expectancy. Only a surviving spouse can do that through a rollover. With the new regs. a nonspouse beneficiary takes payments over their life expectancy whether the death occurs before or after the RBD.

Most Qtip Trusts are drafted so that they do qualify. Check with the attorney to be sure. When you use the 5-year rule, everything is paid out by the end of the fifth year. You don't remove 1/5 each year but the question of income vs principal on any IRA payments to a Trust depends either on (a) provisions of the trust agreement or (B) the state law. In California currently 90% of each payment is treated as principal. The good thing is it builds up the Qtip Trust, the bad thing is there are higher income taxes to pay. Regarding your last point. Rev Rul 2000-2 changed the rules about the drafting of Qtips and how much has to be available to the survivor.

Notice 89-29 (1989-1 C.B. 662) Q&A 7 indicates that a loss is possible from an IRA. At a liaison meeting between the CalCPA Taxation Committee and the IRS on 11/24/98, the IRS cited the notice and indicated that the loss would be deducted from gross income. Pub 590 for 2000 at Page 29 says such a loss is an itemized deduction. We're meeting with the IRS next month again and we've asked for clarification but they don't always answer the tough questions.

Barry is absolutely correct, as usual. There is nothing in the Code to direct you to because all of these changes are in the proposed regulations for Sec. 401(a)(9). The initial proposed regulations came out in 1987 and were never finalize. The current set was issued in January of this year and the WSJ reports that they will be finalized by year end.

When Roth IRAs were first enacted, it was recommended that conversions and contributions be kept in separate accounts. After the technical corrections that were made early on, there is no reason to keep them separate. Go ahead and make your contribution into the Roth conversion account.

The death of the participant (Joe in your example) does not put him on an accrual basis. Therefore Joe's 2001 RMD is not taxable on his final tax return. The RMD for the year of death is the amount Joe would have received if living and it is paid to the plan beneficiary. If the spouse is the beneficiary, the proposed regs indicate that the amount Mrs. Joe could treat as her own or roll over is the amount in excess of the RMD. With a spouse beneficary filing a joint return with Joe, it could be on the final return but as Mrs. Joe's income.

I'd be concerned in your ruling fact pattern that the Trust B designation would be a pecuniary bequest. If that were the case, all IRD would be taxable upon funding and the life expectancies would be unimportant. I suppose you could have gotten around this by designating a fraction equal to the exemption amount. I'm also very interested in how the ruling comes out. If you decide to withdraw it, please let us know that as well.

I wanted to comment on the last line of the original post. The unpaid RMD for 2001 IS and estate asset because it is included in the IRA balance as of the date of death. However, I agree completely with everything Barry has said about the income tax treatment of it. I only bring it up because someone called me today with the same question. They were thinking that the unpaid RMD for the year of death was an additional estate asset to be shown on the 706.