IRAs and Tax Exempt Bonds

[Guest P A Weick]

I always thought it was a joke that someone would want to direct an investment into a tax exempt bond in an IRA. Now I have a customer who tells me their tax advisor says that this will make a distribution from a traditional IRA tax exempt. The contributions are pre, not after, tax. I thought all distributions from a traditional IRA made with pre-tax moneys were taxable as ordinary income. The customer's tax advisor is saying no that like a trust the character of the income is determined by the assets. Any thoughts?

[BPickerCPA]

Character of the income is NOT determined by the assets inside the IRA. ALL withdrawals are ordinary income, except for any basis recovery.

There is NO question and there really is NO discussion. That is just the way it is.

[John G]

Barry,

Didn't you tell me that Moe, Larry and Curly are no longer in the tax advisor business?

I hope this guy has a good "errors and omissions" insurance policy. He is going to need it. Time to get a new tax advisor - this guy is making a mistake about a very fundamental aspect of tax law.... we are not talking about esoteric/rare tax law issues involving private letter rulings or the boundaries set by tax courts - your advisor has made a major mistake about a basic aspect of IRA tax laws. Get a new advisor - but when you cut him loose, tell him why. This kind of bad advice can hurt a lot of people.

I completely concur with Barry, it is foolish to hold tax sheltered investments (such as muny bonds) within a tax shelter.

[mbozek]

Tax advisors occasionally mischaractize IRA trusts as a form of taxable trust which does pass through income to a beneficary with the same characteristics as the income the trustee receives, eg. cap gain, tax exempt income, etc). However, under IRC 408 all distributions from an IRA trust or custodial account with no after tax contributions are taxable income because the funds in the account have 0 basis. See pub 590, P37.