Would this be a valid Roth IRA?

[Guest Grahame]

I am trying to determine if a Roth IRA would be a suitable vehicle for my retirement funds.

I have received conflicting advice as to whether or not I am eligible to establish a valid Roth IRA.

Because my income is above the maximum allowable, and the fact that it is entirely capital gains I appear to be ineligible on two counts. However it would not be too difficult to arrange for a small amount of earned income to be generated and placed in a Roth IRA. I would of course have to pay a 6% annual penalty on those funds which I am willing to do in order to gain the tax benefits of a Roth IRA. If the contribution was not more than $4000 per annum for myself and my wife, and the penalty was paid annually, would this constitute a valid Roth IRA?

[John G]

Bad idea - on both counts, lack of earned income and total income. Flagerent disregard of the tax code, IMO, could open your returns up for a more thorough examination.

Other options: You can look for some tax loses (in a year like this, surely you have something that went down) and sell it to offset some of the cap gains to bring income under ceiling. You can talk with your accountant about structuring a business with payroll for yourself and your spouse, either one working is sufficient. Talk to your accountant about other options for tax year shifting of income. Do not try to end run the IRS to create a Roth. If your accountant sees no way for you to qualify, accept his/her advice.

[Guest Grahame]

John,

Thank you for taking the time to reply to my post. I assure you I do not have a "flagrant disregard of the tax code". I have read the relevant sections of the code very carefully and understand that my "punishment" is a 6% penalty. The IRS is welcome to go through my past tax returns with a fine toothcomb there is nothing for them to find. I want all my future tax returns to be similarly audit proof, which is why I am researching this particular point. Given the above, can you or anyone else point out other sections of the code that I may have overlooked?

Of course anything that I discover will be presented to my professional advisers. However long experience has taught me that it is better to have a pretty good idea what the answer is before asking an adviser.

[Michael Devault]

I can find nothing in the Income Tax Regulations that would cause distributions from the Roth IRA to be affected by the fact that excess contributions have been made.

However, I believe that the 6% excise tax paid annually on aggregate excess contributions. In other words, if you make an excess contribution of $2,000 in 2001 (and no other contributions are ever made), you pay the tax in 2001 if the excess contribution is not withdrawn. But, you also pay the 6% tax in 2002, 2003, 2004 and so on. This annual penalty on the same contribution may make the idea less palatable.

Hope this helps. Good luck!

[John G]

My take on this end-run goes beyond the annual 6% penalty. Since the Roth was artificially created and not based upon meeting the income limitation or earned income requirement, I would expect a court ruling that the assets are therefore not a Roth and do not receive the tax shelter benefits. You may also find that your accountant will not knowingly participate in this strategy. Mine would politely ask me to find another accountant.

[Guest Grahame]

Michael,

Thank you for your reply. Your reading of the tax code seems to be the same as mine and I thank you for your input.

[Guest Grahame]

John,

You raise some interesting points. A careful reading of my original post will reveal that I have no intention of creating a Roth IRA without earned income. I agree with you that it would be an artificially created IRA and would be disallowed.

It seems that are two categories of rules to be taken into account: rules that specifically prohibit certain actions, and rules that conditionally allow certain actions. In the first category is the requirement for earned income, and a contribution of not more than $2000 in any one year. In the second category is the imposition of a 6% penalty if one exceeds a certain contribution. If the intent of the law was to limit a contribution absolutely and finally to the figure calculated under the rules, the provision for a 6% penalty would not exist. Would it? In fact that there is no income limitation on a Roth IRA provided one pays the financial cost. There is just an income limitation on penalty free contributions. Whether or not the 6% penalty is an insurmountable barrier to an adequate return is up to the person creating the IRA.