Subject: BL-Newsletter: Roth IRA Regs Are Online Date: Tue, 1 Sep 1998 08:28:40 -0500 =========================================================== BenefitsLink Newsletter Free, useful information about U.S. tax and labor laws and new Internet resources, for employee benefit plan sponsors, service-providers and participants. =========================================================== WHAT HATH ROTH WROUGHT? _______________________________________________________________ Proposed regulations for Roth IRAs have been issued by the Treasury Department (the IRS). They appear in full text on BenefitsLink (tm) at http://www.benefitslink.com/taxregs/1.408A.shtml (There is no charge for accessing that page or any other page on BenefitsLink.) Here is the official summary and explanation of the new regs: GENERAL PROVISIONS AND ESTABLISHMENT OF ROTH IRAs Proposed section 1.408A-1 contains general provisions regarding Roth IRAs, and proposed section 1.408A-1 contains provisions regarding the establishment of Roth IRAs. As described in proposed section 1.408A-1, a Roth IRA is treated for Federal tax purposes in the same manner as an individual retirement plan except as otherwise provided in section 408A and the proposed regulations. Thus, all the rules of section 408 and the regulations under section 408 apply to Roth IRAs to the extent they are not inconsistent with section 408A or these proposed regulations. Section 408A(b) defines a Roth IRA as an individual retirement plan which is designated at the time of its establishment as a Roth IRA. That section also grants the Secretary of the Treasury authority to prescribe the manner for designating an individual retirement plan as a Roth IRA. Proposed section 1.408A-2 provides that a Roth IRA instrument must clearly designate the IRA as a Roth IRA, and that designation cannot later be changed. Thus, a taxpayer may not designate an IRA as a Roth IRA and later redesignate the Roth IRA as a traditional IRA or otherwise treat the Roth IRA as though it were a traditional IRA for Federal tax purposes. REGULAR CONTRIBUTIONS Proposed section 1.408A-3 sets forth rules regarding regular (i.e., non-conversion) contributions to a Roth IRA. Unlike contributions to traditional IRAs, contributions to Roth IRAs are not deductible under any circumstances. A taxpayer's regular contributions to all his or her Roth IRAs for a year are limited to the lesser of $2,000 or the taxpayer's compensation for that year. As with traditional IRAs, a special rule for married taxpayers permits one spouse to treat the other spouse's compensation as his or her own for purposes of the limit on regular contributions. The limit is reduced by any amounts that the taxpayer contributes for that year to an individual retirement plan other than a Roth IRA (although employer contributions, including elective contributions, to a SEP or SIMPLE IRA Plan do not reduce the contribution limit). Additionally, the contribution limit (determined without regard to any reduction for traditional IRA contributions) is phased out for modified adjusted gross income between $95,000 and $110,000 for single taxpayers, between $150,000 and $160,000 for married taxpayers filing joint returns, and between $0 and $10,000 for married taxpayers filing separate returns. Any contribution in excess of the contribution limit is subject to the 6-percent excise tax under section 4973 unless it is distributed to the taxpayer (with allocable net income) under section 408(d)(4) by the Federal income tax return due date (with extensions) for the year of the contribution. The proposed regulations define the terms compensation and modified adjusted gross income. The definition of compensation is the same as that applicable under section 219(f)(1) for determining the amount, if any, that a taxpayer may contribute to a traditional IRA. This definition does not include amounts transferred from one individual to another by gift (for example, a gift from a parent to a child). The definition of modified adjusted gross income is based on the definition of adjusted gross income applicable under section 219(g)(3)(A) for determining the amount, if any, that a taxpayer may deduct for a contribution to a traditional IRA where the taxpayer is an active participant in an employee plan. However, the definition of modified adjusted gross income applicable to Roth IRAs provides that any amount includible in gross income because of a Roth IRA conversion is disregarded in determining modified adjusted gross income. Additionally, for taxable years beginning after December 31, 2004, modified adjusted gross income does not include the amount of any required minimum distribution from an IRA for purposes of determining conversion eligibility. As with traditional IRAs, regular contributions to a Roth IRA may be made as late as the Roth IRA owner's Federal income tax return due date (not including extensions) for the taxable year to which they relate. Thus, Roth IRA contributions may be made by most taxpayers for taxable year 1998 at any time until April 15, 1999. Unlike traditional IRAs, contributions to a Roth IRA may be made after the Roth IRA owner has reached age 70-1/2. CONVERSIONS Proposed section 1.408A-4 provides rules regarding Roth IRA conversions. In general, a taxpayer whose modified adjusted gross income does not exceed $100,000 may "convert" an amount held in a non-Roth IRA (i.e., a traditional IRA or SIMPLE IRA) to a Roth IRA. The conversion may be made in one of three ways: (1) a distribution from a non-Roth IRA may be rolled over to a Roth IRA within 60 days; (2) an amount in a non-Roth IRA of one financial institution may be transferred in a trustee-to-trustee transfer to a Roth IRA of a different financial institution; or (3) an amount in a non-Roth IRA may be transferred to a Roth IRA of the same financial institution. (In the third case, no physical transfer of assets is necessary, but the instrument governing the non-Roth IRA must, of course, be replaced by a Roth IRA instrument.) The conversion amount must be a qualified rollover contribution under section 408A(e) and, therefore, must satisfy section 408(d)(3) (other than the one-rollover-per-year rule of that section). Any amount distributed from a non-Roth IRA prior to the 1998 taxable year may not be contributed to a Roth IRA as a conversion contribution. In the case of a conversion made by means of a distribution and rollover contribution, the $100,000 limit applies to the year in which the distribution from the non-Roth IRA is made. For married taxpayers, the $100,000 limit applies to the joint modified adjusted gross income of the couple, and a married taxpayer filing a separate return is not allowed to convert regardless of modified adjusted gross income (although a taxpayer who has lived apart from his or her spouse for the entire taxable year is treated as not married for these purposes). The proposed regulations provide that amounts held in a SEP IRA or a SIMPLE IRA may be converted to a Roth IRA. In the case of a SIMPLE IRA, a conversion may be done only after the expiration of the 2-year period described in section 72(t)(6). See Q&A I-2 of Notice 98-4 (1998-2 I.R.B. 25). Once a SEP IRA or SIMPLE IRA has been converted to a Roth IRA, the SEP IRA or the SIMPLE IRA becomes a Roth IRA and ceases to be part of a SEP or a SIMPLE IRA Plan; thus, no SEP or SIMPLE IRA Plan contributions may be made to the Roth IRA. Amounts held in retirement plans other than IRAs --such as section 401(a) qualified plans and section 403(b) annuity contracts --cannot be directly converted to a Roth IRA. Any amount converted from a non-Roth IRA to a Roth IRA is treated as distributed from the non-Roth IRA and rolled over to the Roth IRA regardless of the actual means by which the conversion is effected. The conversion amount is generally includible in gross income for the year of the conversion under sections 408(d)(1) and 408(d)(2). For this purpose, in the case of a conversion effected by an actual distribution and rollover contribution (rather than a trustee-to-trustee transfer or a transfer between IRAs of the same financial institution), the year of the distribution from the non-Roth IRA is the year that the conversion amount is includible in gross income. The conversion amount generally is not subject to the 10-percent additional tax under section 72(t). However, section 408A(d)(3)(F) provides that the 10-percent tax applies to a distribution of a conversion amount made within the 5-taxable-year period beginning with the taxable year in which the conversion to which it is attributable was made. Additionally, the proposed regulations provide that a taxpayer's conversion of an amount from a non-Roth IRA from which the taxpayer was receiving a series of substantially equal periodic payments under section 72(t)(2)(A)(iv) will not be treated as a modification of that series under section 72(t)(4) and thus will not trigger recapture of the section 72(t) tax on previous distributions from the non-Roth IRA as long as the series of substantially equal periodic payments is continued under the Roth IRA (or if section 72(t)(4) would otherwise not apply). Taxpayers making conversions during 1998 are eligible for a 4-year spread under which a conversion amount can be included in income ratably over taxable years 1998 through 2001 rather than solely in 1998. Special rules apply to this 4-year spread if a taxpayer dies before inclusion of the full conversion amount. In such a case, any remaining includible portion of the conversion amount generally must be included in the taxpayer's gross income for the taxable year that includes the date of his or her death. However, if the taxpayer's surviving spouse is the sole beneficiary of all the taxpayer's Roth IRAs (as determined under the aggregation rule of section 408A(d)(4)(A)), the spouse may elect to continue application of the 4-year spread. Finally, the distribution of any amount attributable to a 1998 conversion to which the 4-year spread applies will accelerate the inclusion of any amount otherwise deferred to a later taxable year. A required minimum distribution may not be converted to a Roth IRA because section 408(d)(3)(E) prohibits the rollover of any such distribution. Under the proposed regulations, if a non-Roth IRA owner has reached age 70-1/2, any amount distributed (or treated as distributed because of a conversion) from the IRA for that year consists of the required minimum distribution to the extent that an amount equal to the required minimum distribution for that year has not yet been distributed (or treated as distributed). Thus, if a taxpayer who is required to receive a minimum distribution of $10,000 from his or her non-Roth IRA for a taxable year attempts to convert $11,000 to a Roth IRA prior to receiving the required minimum distribution, $10,000 of the conversion amount would be treated as the required minimum distribution and would be ineligible for conversion. This result is not affected by the means through which the taxpayer effects the conversion or by whether an amount greater than or equal to $10,000 remains in the taxpayer's non-Roth IRA after the conversion. RECHARACTERIZATIONS OF IRA CONTRIBUTIONS Proposed section 1.408A-5 provides special rules for the recharacterization of IRA contributions (including Roth IRA regular and conversion contributions). Section 408A(d)(6) provides that, except as otherwise provided by the Secretary of the Treasury, an IRA contribution that is transferred to another IRA in a trustee-to-trustee transfer on or before the Federal income tax return due date (with extensions) for the taxable year of the contribution is treated as made to the transferee IRA and not the transferor IRA. Section 408A(d)(6) requires that the transfer include allocable net income on the contribution and that no deduction be allowed for the contribution to the transferor IRA. This statutory provision was intended to permit a taxpayer who had converted an amount held in a non-Roth IRA to a Roth IRA and later discovered that his or her modified adjusted gross income for the year of the conversion exceeded $100,000 to correct the conversion by retransferring the converted amount to a non-Roth IRA. The proposed regulations interpret section 408A(d)(6) liberally to provide broad relief to taxpayers who wish to change the nature of an IRA contribution (and not only to allow taxpayers to correct Roth IRA conversions for which they were ineligible). Moreover, the proposed regulations make application of section 408A(d)(6) elective by the taxpayer and permit the taxpayer to recharacterize all or any portion of an IRA contribution. Under the proposed regulations, a taxpayer may elect whether to recharacterize a contribution made to one type of IRA by having it transferred in a trustee-to-trustee transfer to a different type of IRA. As with a conversion, a recharacterization can be effected simply by transferring IRA assets between two IRAs of a single financial institution. Regardless of how effected, a recharacterization transfer is not considered a rollover for purposes of the one-rollover-per-year rule of section 408(d)(3). The taxpayer makes the election to recharacterize by notifying both the transferor IRA trustee and the transferee IRA trustee and by providing certain information to these trustees (including a direction to make the transfer). Notification to the trustees constitutes the taxpayer's election to apply section 408A(d)(6), and the taxpayer cannot revoke or modify that election after the recharacterization transfer has been made. A recharacterized contribution will be treated for Federal income tax purposes as having been contributed to the transferee IRA (rather than the transferor IRA) on the same date and for the same taxable year that the contribution was initially made to the transferor IRA. In effect, the transferee IRA "steps into the shoes" of the transferor IRA with respect to the taxpayer's original contribution. The recharacterization transfer must include allocable earnings on the original contribution, and the proposed regulations provide that the rules of Treasury Regulations section 1.408-4(c)(2)(ii) apply for determining such allocable earnings. If the original contribution has experienced net losses as of the time of the recharacterization, the transfer of the entire original contribution less such losses will generally constitute a transfer of the entire contribution. The taxpayer must treat the contribution as made to the transferee IRA on his or her Federal income tax return for the year to which the original contribution (to the transferor IRA) relates. Amounts that cannot be recharacterized include amounts paid into an IRA by tax-free rollover or transfer (other than a rollover or transfer from a traditional IRA to a SIMPLE IRA) and employer contributions under a SIMPLE IRA Plan or a SEP. The proposed regulations also provide that, once an amount has been contributed to an IRA, any tax-free rollover or transfer of that amount to another IRA may be disregarded in applying the recharacterization rules. Thus, for example, if a taxpayer contributes $2,000 to a Roth IRA during a taxable year and rolls that contribution over to another Roth IRA during the following taxable year, the rollover between Roth IRAs is disregarded, and the taxpayer may recharacterize the $2,000 Roth IRA contribution by having it transferred from the second Roth IRA to a traditional IRA in accordance with section 408A(d)(6) and the proposed regulations. DISTRIBUTIONS Proposed section 1.408A-6 provides rules for the treatment of Roth IRA distributions. Under section 408A(d), qualified distributions from a Roth IRA are not includible in gross income. A qualified distribution is a distribution that is both (1) made after the end of the 5-taxable-year period that begins with the first taxable year for which an individual first makes any regular or conversion contribution to a Roth IRA and (2) made at any time after the Roth IRA owner has reached age 59-1/2, made to a beneficiary (or to the Roth IRA owner's estate) after the Roth IRA owner's death, attributable to the Roth IRA owner's being disabled within the meaning of section 72(m)(7), or made for a first-time home purchase to which section 72(t)(2)(F) applies. The proposed regulations provide that any distribution from a Roth IRA made to the surviving spouse of a Roth IRA owner who has elected to treat the Roth IRA as his or her own in accordance with the terms of the trust instrument or under Q&A-4 of Proposed Treasury Regulations section 1.408-8 is not treated as made after the Roth IRA owner's death. The proposed regulations provide that the 5-taxable-year period for determining whether a distribution is a qualified distribution is not recalculated when a Roth IRA owner dies. Thus, if a Roth IRA owner contributes an amount to a Roth IRA in 1998 and dies in 2004, a distribution made to a beneficiary in 2004 will be a qualified distribution. Generally, the 5-taxable-year period with respect to a beneficiary's inherited Roth IRA is determined independently of the 5-taxable-year period for any Roth IRA of which the beneficiary is the owner. However, if the beneficiary of a Roth IRA is the surviving spouse of the Roth IRA owner and if the surviving spouse owns his or her own Roth IRA, the 5-taxable-year period for both the Roth IRA of which the surviving spouse is the beneficiary and the Roth IRA of which the surviving spouse is the owner ends with the earlier of the 5-taxable-year periods for the two Roth IRAs. A Roth IRA distribution other than a qualified distribution is generally includible in the taxpayer's gross income to the extent that the distribution, when added to all prior distributions from the taxpayer's Roth IRAs (whether or not those distributions were qualified distributions) exceeds the taxpayer's total contributions to all his or her Roth IRAs. To the extent includible in gross income, such a distribution will also be subject to the 10-percent additional tax of section 72(t) unless there is an applicable exception under that section. Such a distribution, however, will not be includible in gross income if it is rolled over to another Roth IRA in accordance with section 408(d)(3). Also, a distribution of an excess contribution under section 408(d)(4) is not includible in gross income (although the allocable net income that must be distributed with the excess contribution is includible in gross income for the taxable year of the excess contribution). The proposed regulations provide aggregation and ordering rules for Roth IRAs in accordance with section 408A(d)(4). Under these rules, a Roth IRA is not aggregated with a non-Roth IRA, but all a taxpayer's Roth IRAs are aggregated with each other. Roth IRA distributions are treated as made first from Roth IRA contributions and second from earnings. Distributions that are treated as made from contributions are treated as made first from regular contributions and then from conversion contributions on a first-in, first-out basis. A distribution allocable to a particular conversion contribution is treated as consisting first of the portion (if any) of the conversion contribution that was includible in gross income by reason of the conversion. The proposed regulations provide that, in applying these aggregation and ordering rules: all distributions from all of a taxpayer's Roth IRAs during a taxable year are aggregated; all regular contributions made for the same taxable year to all the individual's Roth IRAs are aggregated and added to the undistributed total regular contributions for prior taxable years; all conversion contributions received during the same taxable year by all the individual's Roth IRAs are aggregated (with a special rule for a conversion contribution made by distribution during 1998 and rollover during 1999 to which the 4-year spread applies); and rollovers between Roth IRAs are disregarded. The proposed regulations also provide special rules for applying the aggregation and ordering rules in the case of recharacterizations under section 408A(d)(6). Distributions of excess contributions and allocable net income pursuant to section 408(d)(4) are treated differently under the ordering rules. Specifically, an excess contribution that is distributed under section 408(d)(4) is treated as though it was never contributed, and any allocable net income thereon is includible in gross income for the taxable year of the contribution without regard to whether the taxpayer still has undistributed basis in his or her Roth IRAs. The proposed regulations provide that, for purposes of these ordering rules, different types of contributions are allocated pro rata among multiple Roth IRA beneficiaries after the Roth IRA owner's death. Unlike traditional IRAs, the pre-death minimum distribution rules of sections 408(a)(6) and 408(b)(3) (which incorporate the rules of section 401(a)(9)) do not apply to Roth IRAs. Under the proposed regulations, on the death of a Roth IRA owner, the rules in Proposed Treasury Regulations section 1.408-8 apply as though the Roth IRA owner died before his or her required beginning date. Thus, the entire amount of the Roth IRA must generally be distributed within five years of the Roth IRA owner's death unless it is distributed over the life expectancy of a designated beneficiary beginning prior to the end of the calendar year following the year of the owner's death. The proposed regulations also provide that, where the sole beneficiary of a Roth IRA is the Roth IRA owner's surviving spouse, the spouse may delay distributions until the Roth IRA owner would have reached age 70-1/2 or may treat the Roth IRA as his or her own. Under the proposed regulations, section 401(a)(9) applies separately to Roth IRAs and other retirement plans; it also applies separately to Roth IRAs inherited by a beneficiary from one decedent and any other Roth IRAs of which the beneficiary is either the beneficiary of another decedent or the owner. The proposed regulations provide that section 3405 withholding applies to distributions from Roth IRAs and to Roth IRA conversions (although transition relief is provided for 1998 conversions effected by means of direct transfers of funds between IRAs). The proposed regulations provide that the basis of property distributed from a Roth IRA is its fair market value as of the date of the distribution and that any amount distributed from a Roth IRA and contributed to a retirement plan other than a Roth IRA is not a rollover contribution under section 408(d)(3) or a qualified rollover contribution under section 408A(e). The proposed regulations also provide that a transfer of a Roth IRA by gift would constitute an assignment of the Roth IRA, with the effect that the assets of the Roth IRA would be deemed to be distributed to the Roth IRA owner and, accordingly, treated as no longer held in a Roth IRA. =========================================================== To unsubscribe: send email to majordomo@majordomo.net and put "unsubscribe BL-newsletter" in the body of the message. This newsletter is published without charge by BenefitsLink, http://www.benefitslink.com/