Archive for the ‘IRA’ Tag
Back to Basics Part XXXII – Form 8889 – Health Savings Account
Filed under: Back to Basics, Healthcare Costs | Tags: 2015, COBRA insurance, contribution limit, custodial parent, dependent, disabled, distribution, divorce, earnings, exemption, health insurance, health savings account, high deductible health plan, HSA, IRA, long-term care, Medicare, penalty, rollover, Roth-IRA, Schedule A
Leave a comment Originally published in the Cedar Street Times
February 5, 2016
Why Would an HSA Be Valuable to Me?
A Health Savings Account, or HSA for short, is a fantastic vehicle to pay for out-of-pocket qualified medical expenses which insurance does not cover in-part or in-full. It effectively allows you to get a tax deduction for nearly all of your unreimbursed expenses whether or not you itemize deductions. It also works great for those who itemize, but do not have enough medical expenses to get over the 7.5 percent or 10 percent (depending on your age) of adjusted income threshold before those deductions are counted. Many people assume they are receiving a tax benefit for these expenses when they are not. Simply look at your Schedule A, line 4. If it says $0, or if you do not even have a Schedule A, you are not benefitting from your itemized medical deductions. Even if you have a number there, line three will show you how much you are getting zero benefit from due to the threshold.
How do I Qualify and What Kind of Account Is It?
In order to qualify for an HSA, you must have a “high deductible” health insurance plan. For 2015, this means you have to have a minimum annual deductible of $1,300 for self-only coverage, or $2,600 for family coverage (or approximately the cost of breathing the air in a hospital lobby). Your plan must also have a maximum annual out-of-pocket limit of $6,450 for self-only coverage or $12,900 for family coverage. If you meet these requirements, you are eligible to set up an HSA account for yourself.
An HSA account is kind of like having a checking account just for qualified medical expenses, but is shares characteristics with an IRA account. A lot of people think the accounts are married to the health insurance providers, but they are not. Lots of banks and investment companies offer them. The account is a custodial account held for your benefit, and you get to choose the company that is the custodian, and you can move the money from one custodian to another, just as you could move your IRA from Fidelity to Vanguard, for instance. You often get a checkbook and/or a debit card. The custodian follows certain rules laid out by the IRS, and reports to the IRS at the end of each year the total contributions to and distributions from your account. The custodian is not responsible, however, for verifying that your expenses are qualified medical expenses, as that responsibility falls to you.
If you have health insurance through an employer and the plan qualifies, often your employer and its health insurance representative are instrumental in getting this account established, and they will select an initial custodian. Many employers will even contribute a monthly amount to your HSA account since the high deductible aspect often saves the employer money on the premiums. But even if your employer does not set an HSA up, you can do it. And as long as your health insurance plan qualifies, you can contribute to it.
How Do I Put Money Into the HSA?
Anyone is actually allowed to contribute to your HSA account (if you should be so lucky!), but there is a total contribution limit of $3,350 per year for self-only plans, and $6,650 for family plans in 2015. And you get an above-the-line tax deduction for the amount put into the account each year. Unlike IRAs, there are not even any income phaseouts that would prevent you from getting the tax deduction if you are a high-income earner. If your employer does not contribute enough to max out the contribution limit, you can always write a check to the account for the difference. You even have until April 15 (18 this year) to make the contribution for the prior year (similar to an IRA). If you are over 55 years old (IRAs are 50), you can make an additional $1,000 contribution each year.
If you are enrolled in Medicare or are being claimed as a dependent on someone else’s return, you cannot contribute to an HSA. In years where you change from self-only coverage to family coverage, or if you get married, or go through a divorce, stop insurance, start insurance, etc. be aware that there are special rules and limitations on contributions during those years, and you could subject yourself to a penalty if handled incorrectly. If you find that you have overcontributed for any reason, you generally have until the extended due date of your tax returns to get the money out without penalty. You do have to take out any earnings it generated as well, and those would be taxable in the year you physically take the money out of the account.
Can I Transfer Money Into My HSA from an IRA?
If you are desperate to get some additional money into your HSA, you can make a once in a lifetime transfer from your Traditional or Roth IRA to the HSA via a trustee to trustee transfer. However, it is still limited to the annual contribution cap, and it would be reduced by any other contributions you made to the account during the year! So it has very limited usefulness. If you were going to do that, your first choice would almost inevitably be the traditional IRA since the Roth IRA is already a tax-free account.
What/Who Can I Spend the Money On?
All medical expenses that would normally qualify for a deduction on Schedule A, would be a qualified HSA distribution, except for insurance. Generally, you cannot pay your health, vision, dental premiums, etc. from your HSA. Exceptions to this which you could pay from your HSA include long-term care insurance for the HSA account holder (subject to normal limits on long-term care insurance deductions found in the Schedule A instructions), COBRA insurance premiums for you, your spouse, or your dependents, or health insurance paid while you, your spouse, or dependents are receiving federal or state unemployment compensation. Also, if you are 65 or older, you can pay your Medicare and other health insurance premiums (except supplemental Medicare policy premiums) from your HSA.
For the bulk of the qualified medical expenses, you can deduct them for yourself, your spouse, your dependents, or for someone you could have claimed as a dependent except that they were disqualified simply because they filed a joint return, had gross income over $4,000, or were married filing jointly and one of the spouses could have been claimed as a dependent. If you are divorced with children, you can also pay for your children’s medical expenses whether or not you are a custodial parent or claim a dependency exemption, as long as least one of you qualifies to claim the dependency exemption.
If you take money out of the account and do not use it for medical expenses, it will be taxable income, and you will hit a 20 percent tax penalty as well. When you reach age 65, however, you can take the money out and use it for any purpose with no penalty (as opposed to 59.5 for most IRA owners). So in a lot of ways, should you never use it for medical expenses, it acts like another IRA.
Also for people that become permanently disabled, they can escape the 20 percent penalty tax even if used for nonqualified expenses.
In two weeks we will conclude the discussion on HSA accounts and discuss topics such as whether or not you have to pay qualified medical expenses directly from your HSA, strategy for large bills that exceed your HSA balance, having separate accounts for spouses, what happens to the account when you pass away, pitfalls to avoid, and a discussion of the Form 8889 itself.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041.
Back to Basics Part XXI – Form 5329 – Penalties on Retirement Accounts
Filed under: Back to Basics | Tags: 25%, 401(k), 457, 50%, 529 plan, 59.5, 70.5, Coverdell ESA, Early Distribution, Excess Contribution, Form 5329, HSA, IRA, MSA, nonqualified, penalty, Qualified Plan, Required Minimum Distribution, RMD, Roth-IRA, SEP-IRA, SIMPLE IRA, ten percent
Leave a comment Originally published in the Cedar Street Times
August 21, 2015
The official name for Form 5329 is “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.” In other words, “penalties on incorrect contributions to or withdrawals out of retirement accounts, education accounts, and medical accounts.”
Most people are familiar with the fact that retirement accounts such as 401(k)s, 457 plans, IRAs, Roth IRAs, SIMPLE IRAs, SEP IRAs, etc. have limits on the amount of money you can contribute each year. They also limit your ability to withdraw money from those accounts until you are generally 59.5 years old, or meet one of a handful of limited exceptions.
Most people are also familiar with fact that you MUST begin taking distributions by the time you reach 70.5 years old (with a few exceptions such as for Roth IRAs, certain employees that have not yet retired from their job, or non-spouse inherited IRAs). You can delay the distribution in the year you turn 70.5 until April 1st of the following year, but if you do that, then you have to take two distributions that year. IRS instructions are often very poorly worded on this particular matter, and often people misunderstand this important point.
Education savings accounts such as 529 plans or Coverdell ESAs as well as tax favored medical spending accounts such as HSAs and Archer MSAs also have annual contribution limits. In addition, you must use the funds for qualified education or medical expenses, respectively.
If you fail to follow the rules, either by accident or out of necessity, you will generally incur penalties, which are calculated using Form 5329 for most of these infractions.
So, how much are the penalties? If you over-contribute to a retirement plan, education account, or medical spending account there is a six percent penalty on excess contributions if you do not withdraw the excess contribution (plus any related investment earnings) within six months of the original due date of the return, excluding extensions (so by October 15 for almost everybody). Any earnings generated by the over-contribution will be treated as distributions of cash to you in the tax year the correcting withdrawal actually occurs. The rules governing distributions (discussed later) will apply and you may be subject to penalties on that portion. The custodian of the account will calculate the related earnings that need to be pulled out of the account when you inform them of the need to withdraw funds.
If you over-contribute for multiple years in a row before realizing it, the penalty compounds. So you would file a Form 5329 for each of the past years (no 1040X needed) and pay six percent on the excess contributions for the year of the 5329 you are filing, plus any prior excess contributions that still had not been taken out. In other words, you pay six percent every year on the excess contribution until you take it out. Interest would also be assessed on top of the penalties.
If you fail to take a Required Minimum Distribution (RMD), the penalty is 50 percent of the amount that was supposed to be taken out, but was not. Unlike the six percent over-contribution penalty that applies every year until you take the funds out, the 50 percent penalty only applies once. But you would need to withdraw the funds and file a 5329 for each past year you failed to take an RMD. Interest would also be assessed on top of the penalties. Fortunately, the IRS has been pretty lenient with the steep 50 percent penalty, and you can often get them to waive the penalty for reasonable cause once you withdraw the money.
Early distributions for all retirement accounts that do not qualify for an exception are subject to a ten percent penalty, (plus inclusion as taxable income for the portion related to original contributions for which you received a tax deduction as well as on any earnings generated while in the account). SIMPLE IRAs have a special rule that increases the penalty to 25 percent if the date of your first contribution to the SIMPLE IRA was less than two years ago.
Distributions from education savings accounts for nonqualified purposes are subject to a ten percent penalty.
Distributions from medical spending accounts that are not used for qualified purposes are generally subject to a 20 percent penalty. These 20 percent penalties, however, are calculated on different forms (8889 for HSAs and 8853 for MSAs). With HSAs when you reach 65, you can use the money for whatever purpose you want, without penalty. You can also rollover an MSA into an HSA.
Regarding the Form 5329 itself, the first two parts deal with distribution penalties for retirement accounts and education accounts (health account distribution penalties are calculated on other forms). The third through seventh parts deal with excess contribution penalties for each different type of account. The final section, part VIII, deals with penalties on RMDs not distributed.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
We Buy Gold…FIFA World Cup Trophies
Filed under: General | Tags: 28 percent, Capital Gains, collectibles rate, FIFA, gold, IRA, MLB, NBA, NFL, NHL, soccer, tax deferral, trophy, USA, World Cup
Leave a comment Originally published in the Cedar Street Times
June 27, 2014
As a young lad, I played a lot of soccer. The first team I was on was called the “Half-Pints.” I think I was four or five years old, but I can still remember our green and white uniforms and the coach wearing jacked-up tube socks with colored stripes along the top. When I was six and seven I played on the “Chiefs” – I am not sure that team name and logo with the Native American headdress would be allowed today. Around that time, I also played on the “Jedis” – probably because the original Star Wars trilogy was in its heyday.
By the time I was in middle school, my brother and I were both on traveling soccer teams often playing at opposites ends of the state on any given Saturday. We played a fall outdoor season, a winter indoor season, a spring outdoor season, and then attended soccer camps during the summer. In high school I played on regular club teams as well as the high school team. One very vivid memory was winning the state championship my junior year in high school. The opposing team had two players that went on to play in the MLS, one of which even played on two U.S. World Cup teams. I went to college and played a few more years there until other priorities began to emerge.
Throughout my time playing soccer, there was one thing that eluded me – a real gold trophy! Cheap plastic trophies at the end of a season, or after winning a tournament remained pretty consistent. They seemed like treasures when I was young and most survived through the years with only minor dents and scratches. A few unlucky ones had lost an appendage or their fake gold hair paint had rubbed off leaving the embarrassing white plastic beneath. Eventually, they all got round-filed save one early trophy as a momento.
If I had only managed to keep playing, gain citizenship in a powerhouse soccer country, join the national team, and then win the World Cup, my dream could have been realized! With the World Cup currently in full swing, some country is only two-and-a-half weeks away from holding the world’s most valuable trophy. Not only in symbolic worth to the world, but also in perceived collectible value and sheer melt value, the FIFA World Cup Trophy is the world’s most valuable trophy.
The trophy is not gold-plated as most other major sports trophies are, but its 13.6 pounds is made almost entirely of 18k gold. If you took the championship trophies from the NHL, NFL, NBA, and MLB and melted them all down, their combined value would be worth only about 28 percent of the melt value of the World Cup Trophy, which currently has about $200,000 of gold in it with an estimated collectible value of $10 – $20 million.
What does this have to do with taxes? – Not a whole lot, but it was a good excuse to talk about soccer. I will say this: buying and selling gold has been quite popular since the markets bottomed out in 2009. It seems that everybody has a sign that says, “We buy gold.” I think I even saw that written on the back of an “Anything will help” sign from a panhandler.
There are a lot of special tax and regulatory rules surrounding gold sales, so you need to make sure you get the right advice before you buy a bunch of gold or gold coins thinking you are making a solid investment to protect you from inflation. For instance, if you owned the FIFA World Cup Trophy, you would be subject to special collectibles tax rates of 28 percent if you tried to sell it, as opposed to lower long-term gain rates even if held over a year. People wanting to hold gold directly in their IRAs also have special rules to follow regarding the purity of the gold they purchase, in order to maintain the tax deferral.
So, scout it out before you buy gold! Besides, it’s better to just win the gold. Go USA!
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
When Can I Throw Out My Tax Returns?
Filed under: General | Tags: 1099-B, basis, document retention, FTB, how long should I keep my tax returns, installment sale, IRA, IRS, rental property, save tax returns, statute of limitations, throw away tax returns
Leave a comment Originally published in the Cedar Street Times
May 3, 2013
It is time to do some spring cleaning! Do not miss your opportunity as summer is coming quickly, at which point you will be required to keep everything for another year. Perhaps you will find that old pair of muddy tennis shoes in the garage – now the home to three indignant spiders as you turn their palace upside down. Or maybe you will find that half-used bottle of hotel shampoo under the sink – a small, but satisfying entitlement for a $300 room charge. Ah, and then there are those tax returns you filed way back in April – is it time to get rid of those too?!
You can do whatever you want, but my advice is to keep them. In fact, I would say you may want to keep every tax return (and the supporting documents) you have ever filed – I know I have. Record retention is always an interesting debate and you hear a lot of people say three, five, or seven years as a rule of thumb for many types of documents. Regarding tax returns, the real answer is unique to each person depending on his or her tax circumstances and risk tolerance.
Someone that works a W-2 job, has no other sources of income, no investments, contributes to no retirement plans, and files the returns correctly would have little risk if discarding the returns after four years. If you do make retirement plan contributions, depreciate any assets, have an installment sale agreement, or a host of other things, it would not really be wise to discard the returns in accordance with a rule of thumb.
The IRS generally has three years from the later of the due date (or extended due date) or the date you file to audit your returns. The California FTB has four years from the later of the non-extended original due date or the date you file in order to audit. You should never throw out returns or source documents until you are outside of these statutes of limitation. If you have understated your gross income by more than 25 percent (even if by accident), then the IRS has six years to audit you. People can get tripped up on this pretty easily if they fail to report stock sales. I have seen this before with people preparing their own tax returns that ignore the 1099-B issued year-after-year because they did not really understand it. If you filed a false tax return or there was any kind of fraud, there is no statute of limitations.
Even if you are outside the statute of limitations, however, you may still need prior tax returns to support positions you are taking on current tax returns that are inside the statute of limitations. Think about someone that has been contributing to an IRA for many years and was unable to take deductions due to income limitations. Each of these nondeductible contributions would have created basis in the IRA which would lower the taxable amount of distributions while in retirement. If the IRS audited your returns in retirement and questioned your basis, having all the past tax returns showing the nondeductible contributions would be a saving grace.
People that have rental properties or home offices may find tax returns from twenty-five years ago helpful in proving the basis in the property when it is eventually sells due to depreciation deductions taken on each past return. I have also had situations where clients had no idea what their cost basis was for a stock sale, and we were able to help recreate and substantiate the cost basis by reinvested dividends reported on tax returns stretching back several decades.
The safest thing to do is just keep them, or at least scan them and maintain the electronic files through the years.
One other pointer – be sure you do not throw out purchase records, refinance documents, or receipts of improvements to any type of property you own as you will likely need this information if you ever sell it.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
SIMPLE-IRA – 10 Days Left!
Filed under: Retirement Assets | Tags: 401(k), employer match, IRA, October 1, retirement, Savings Incentive Match Plan for Employees, self-employed, SEP-IRA, SIMPLE, SIMPLE IRA, small business
Leave a comment Originally published in the Cedar Street Times
September 21, 2012
If you started a business in 2012 or have an existing small business, you have ten days left (October 1) until the annual deadline to establish a SIMPLE-IRA if you want to make contributions this year for yourself or your employees. A SIMPLE-IRA is a solid retirement option for small businesses for a number of reasons. The first reason is that they are free and easy to set-up. By comparison, if you start a plan such as a 401(k), you can bank on approximately$1,000 a year in administrative fees. The SIMPLE-IRA (Savings Incentive Match Plan for Employees) is established by filling out an easy form (IRS Form 5304-SIMPLE) and signing and dating it. You also need to contact a custodian which will be responsible for initially handling the funds. If you have a financial advisor, this person will often be the point-person. Otherwise, you can contact Vanguard, Fidelity, Schwab, or a number of other financial companies and they will be happy to set you up at no charge in minutes. They may have account fees, but those should be minimal.
The SIMPLE-IRA allows the employees (and the owner) to contribute up to $11,500 of their wages through payroll deductions into a retirement account. This directly reduces their taxable wages. The other part is the employer match. Each year, before the year starts, the employer chooses a one, two, or three percent match, or a two percent guaranteed contribution. If the employer chooses one of the match options, they will match the employee’s (and their own) contributions dollar-for-dollar up to a cap of one, two, or three percent of the employee’s annual wages. The match is tax deductible by the business but is not taxable income to the employee. A business can choose to exclude employees that are not expected to make over $5,000 during the year or have not made over $5,000 in any two prior years (whether or not consecutive).
Self-employed individuals with or without employees can also take advantage of this plan. If you are a sole proprietor, your wages are determined by your net income at the end of the year. You must submit your contributions by January 30 of the following year. The match for your employees and yourself does not have to be submitted until the tax return due date.
Self-employed individuals with no employees that net over $70,000 may wish to consider a SEP-IRA since you can contribute more at that point. A SEP-IRA is also easy and inexpensive to maintain.
Of course, the best reason to set up a SIMPLE plan is to start contributing to your retirement and helping others see the value as well.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Don’t Want to Lock up Cash in a Retirement Account? Consider Roth by April 17.
Filed under: Retirement Assets | Tags: contributions, conversions, five year rule, IRA, penalty free, retirement, rollover, Roth-IRA, tax free, Traditional IRA, withdrawal
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
April 3, 2012
A lot of people like the idea of contributing to a retirement plan, but do not like the idea of locking up the money until retirement without being penalized. People are often concerned about supplementing income if they lose their job, or have an unexpected major expense, or even if they are saving for a big purchase such as a car or a home. If you find yourself keeping money in a taxable investment account, savings, or checking account for these purposes, I strongly encourage you to start contributing it to a Roth IRA if you are eligible.
The beauty of a Roth IRA is that you can take out your direct contributions tax-free and penalty-free at any point. For example, if you contribute $5,000 a year for three years, you can always take out up to that $15,000 at any point. What you cannot take out are the earnings. If it grows to $16,000 through interest, dividends, or appreciation, you cannot take out that last $1,000 without penalty and tax until you retire. The big benefit is that your Roth IRA is an umbrella that protects the assets under it from being taxed if they generate income. You will pay no tax on the $1,000 earnings in the Roth IRA – whereas, you would if it was held in a taxable account. You can hold almost any investment in a Roth-IRA including cash, stocks, bonds, mutual funds, or even alternative investments such as rental property. You can currently contribute up to $5,000 a year ($6,000 over age 50) and you have until April 17, 2012 to contribute for tax year 2011. Don’t miss out!
Some advisors incorrectly cite a five-year rule that says you have to have the account open for five years before taking penalty-free withdrawals. This applies in certain circumstances, but not to direct contributions. What they are failing to understand are the ordering rules for distributions. I will say again, you can always take out up to the sum-total of your direct contributions made to the account with no tax and no penalty. Be aware that rollover conversions from other retirement plans and traditional IRAs are not considered direct contributions. You should get competent tax advice if you are going to take out beyond your direct contribution total.
To be eligible to make a Roth IRA contribution, you must have at least as much earned compensation as you want to contribute. If you file jointly, you can contribute for your spouse even if he/she does not work enough (or at all) assuming you earn enough compensation between the two of you. Your ability to contribute starts phasing out as your income hits $107,000 if filing single, and $169,000 for married filing jointly. These amounts are based on special modifications to your adjusted gross income, so you would want to verify with your tax professional if you are close to these thresholds. You can also contribute to a Roth IRA even if you contribute to an employer-provided plan (some exceptions for married filing separate), however, your contributions to traditional IRAs and Roth IRAs are aggregated for contribution limit purposes.
One other advantage of the Roth is that you can continue to contribute during your entire life as long as you have earned compensation, and there are no required minimum distributions when you reach age 70 1/2 as there are for traditional IRAs.
What you might find by contributing, is that something else works out in your financial life whereby you do not end up needing that cash or part of it after all, and at that point, you will be very glad you contributed to the Roth during those years. To set up a Roth IRA, talk to your financial advisor. If you do not have an advisor, you can go online to a financial institution like Vanguard or Fidelity and set one up in 15 minutes.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Losses on 401(k)s, IRAs, and 529 Plans
Filed under: Retirement Assets, Tax Strategy | Tags: 401(k), 529 plan, basis, Coverdell ESA, Form 8606, IRA, losses, miscellaneous itemized deductions, nondeductible IRA contributions, retirement, Roth-IRA, SEP-IRA, SIMPLE IRA
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
September 21, 2011
The stock market seems like a pinball these days bumping off financial forecasts and being paddled by fiscal policy promises. Unable to stomach some of the lows over the past few years more than a few people gave up the game and pulled money out of investments seeking the “security” of cash. Others may have felt they had no choice, and cashed out their retirement savings to live on; some realizing they contributed more money to the plan than they got back! Perhaps this happened to your retirement or education savings accounts, or will happen at some point. But can you get a tax deduction for the loss in value you have incurred?
Well, it depends. The chief determining factor is whether or not you have basis in your account. Basis in a retirement or education account is created if you make contributions for which you receive no tax deduction when contributed. For example – Roth-IRA contributions are not deductible when they are made, so the original contribution amount each year adds to your basis. Education savings through section 529 plans and Coverdell Education Savings Accounts are the same way. Many employers now offer a Roth contribution option within a 401(k) plan. These contributions also create basis.
Traditional 401(k), SEP IRAs, SIMPLE IRAs, and traditional IRA contributions provide you with an immediate tax deduction, so they provide no basis. However, if you were over a certain income threshold and tried to make traditional IRA contributions, you may have been allowed to contribute to the account, but prohibited from taking the deduction. This is termed a “nondeductible IRA contribution;” it would have created basis; and it is tracked on Form 8606 in your tax returns.
If it is determined you do have basis, and for a strategic reason (or by necessity) you end up liquidating the IRA (all IRAs of the same type must be liquidated for this to work), and the value of the IRA is less than your basis in the account, then you are eligible to take the loss as a miscellaneous itemized deduction subject to the two percent threshold. If you have more than one section 529 plan, the calculation is a little different.
Liquidating your retirement accounts to get a possible tax deduction is not typically an advisable course of action for many reasons, and you would want to discuss this with your tax professional and investment advisor first. However, sometimes, this can be a strategic move. More often, it will have been done out of perceived necessity or by accident. If it happens, however, you certainly want to make your tax professional aware of your losses and take the deduction if you are eligible.
Two quick examples: 1) Melissa, a parent, starts a 529 account (only has one) and contributes $10,000 towards her child’s future education. A year later, the investments have fallen, and the account is only worth $6,000. Melissa could liquidate the account and take a $4,000 loss on Schedule A. Then she could start a new 529 plan putting the $6,000 back into the plan. Melissa has just harvested a $4,000 loss. 2) Joseph opened his first Roth-IRA three years ago and contributed $14,000 over the three years. He received some bum advice from a friend and invested most of it in a penny stock mail-order belly-dancer business that went belly-up. Joseph’s account is now only worth $1,000. He could liquidate his Roth-IRA and take a $13,000 loss on Schedule A.
There may be other circumstances and specific rules that affect you, and you should consult with a qualified tax professional regarding your tax situation. Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950. He can be reached at 831-333-1041.
Travis H. Long, CPA, Inc. Blog 