Tax Update from Miller Cooper & Co.

March 2010

Edited by Susan Klein,

Senior Tax Manager, Miller Cooper

In this issue:

Important Questions to Ask about Roth IRA Conversions

Deduct Donations to Haiti Relief on 2009 Returns

A New Option for Your Federal Tax Refund: Savings Bonds 

Mortgage Forgiveness Debt Relief Act and Debt Cancellation

Facts about the New Vehicle Sales and Excise Tax Deduction

Important Questions to Ask about Roth IRA Conversions

Talk about the Roth IRA Conversion is everywhere. It seems like everyone is doing it. But should they or shouldn’t they? Better yet, should you or shouldn’t you? Below, we answer some of the questions you should ask before moving ahead with a Roth IRA conversion. We also strongly encourage you to talk to your tax advisor before making a final decision or contact one of our tax principals listed at the end of this newsletter.

What is a Roth IRA?

As in a traditional IRA, funds in a Roth IRA grow tax-free. However, the similarity ends there. In traditional IRA accounts, contributions are deductible and are tax-deferred until withdrawal. Funds in a Roth IRA are contributed after taxes are paid and withdrawals are tax-free at the Federal level.

For retired taxpayers, Roth IRAs offer the following benefits over traditional IRAs:

• Roth IRAs do not have required minimum distributions (RMDs).

• In most cases contributions can be withdrawn at any time without penalty. However, earnings may not be withdrawn until the taxpayer is 59 ½ and holds the Roth account for at least five years.

• Roth IRA distributions are not subject to the income calculation for taxability of Social Security benefits

• Taxpayers can continue to contribute to their Roth IRA after retirement.

Finally, the income tax-free status of a Roth IRA can pass to the holder’s heirs as part of an estate plan.

Why the urgency to convert this year?

The income limit on converting an IRA to a Roth IRA was eliminated as of December 31, 2009. Previously taxpayers (except married, filing separately) with adjusted gross income greater than $100,000 could not convert their IRAs to Roth IRAs.

A further enticement to convert during 2010 is special tax treatment for conversions made during this calendar year, which allows taxpayers to defer paying taxes on the converted funds until 2011 and 2012. For example, if a taxpayer converts $100,000 from an IRA to a Roth IRA in 2010, they would report $50,000 in income on their 2011 return and $50,000 on their 2012 return, providing they don’t withdraw any of the converted funds during that time period. Taxes would be paid at the rates in effect during 2011 and 2012.

While much of the focus is on the conversion of traditional IRA accounts to Roth IRAs, taxpayers can convert other retirement accounts to a Roth IRA, including 401(k) plans and 403(b) under the new rules.

Does it make sense for me to convert my IRA to a Roth IRA?

The opportunity to convert funds to a Roth IRA and defer taxes has a number of tax planning implications. However, it is not going to benefit everyone. The following taxpayers may benefit the most from the Roth IRA conversion:

• High net worth individuals and young earners in high income tax brackets

• Those who expect their tax bracket to remain the same or be higher when they retire

• Individuals seeking future estate tax reductions

Can I change my mind after the conversion?

Taxpayers may reverse (recharacterize) a Roth IRA conversion if they do so within six months of the tax return’s due date, October 15 for most people if the return was extended on April 15. This may seem like an odd thing to do, but could make sense if there is a significant decline in the value of the Roth IRA in the months following the conversion. For example, if the taxpayer converted $100,000 to a Roth IRA and recognized $100,000 for income tax purposes only to have the value of the Roth IRA drop to $50,000, it might make sense to recharacterize rather than pay taxes on $50,000 that no longer exists.

This is a brief overview of new rules governing Roth IRA conversions. The facts and circumstances of each taxpayer’s situation should be reviewed carefully to determine if conversion is the right option for them.

Deduct Donations to Haiti Relief on 2009 Returns

If you are donating to charities providing earthquake relief in Haiti, you may be able to claim those donations on your 2009 tax return. Here are 10 facts to know about this special provision.

1. A new law allows you to claim donations for Haitian relief on your 2009 tax return, which you will be filing this year.
2. The contributions must be made specifically for the relief of victims in areas affected by the January 12, 2010 earthquake in Haiti.
3. To be eligible for a deduction on the 2009 tax return, donations must be made after January 11, 2010 and before March 1, 2010.
4. In order to be deductible, contributions must be made to qualified charities and cannot be designated for the benefit of specific individuals or families.
5. The new law applies only to cash contributions.
6. Cash contributions made by text message, check, credit card or debit card may be claimed on your federal tax return.
7. You must itemize your deductions in order to claim these donations on your tax return.
8. You have the option of deducting these contributions on either your 2009 or 2010 tax return, but not both.
9. Contributions made to foreign organizations generally are not deductible.
10. Federal law requires that you keep a record of any deductible donations you make. For details, contact your tax advisor.

A New Option for Your Federal Tax Refund: Savings Bonds 

If you are receiving a federal tax refund, you can choose to use that money to purchase U.S. savings bonds. Here are the details:

1. You may use a portion of your refund to purchase up to $5,000 in U.S. Series I Savings Bonds.
2. The total amount of saving bonds purchased must be a multiple of $50. Additional money over the specified amount must be deposited into another financial account – such as a checking or savings account.
3. The bonds will be issued in your name. For married taxpayers filing a joint return, the bonds will be issued in the names of both spouses.
4. You will receive the U.S. savings bonds in the mail.

If you are interested in selecting this option, let your tax preparer know so the correct forms can be filled out.

 

Mortgage Forgiveness Debt Relief Act and Debt Cancellation

If you owe a debt and it is canceled or forgiven, the canceled amount may be taxable. 

What is Cancellation of Debt?

If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances. When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is normally reportable as income because you no longer have an obligation to repay the lender.

Here’s a very simplified example. You borrow $10,000 and default on the loan after paying back $2,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $8,000, which generally is taxable income to you.

Is Cancellation of Debt income always taxable?

Not always. There are some exceptions. Common situations when cancellation of debt income is not taxable involve:

• Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.

• Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.

• Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.

• Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.

Deferral of Cancellation of Debt Income

The 2009 Stimulus Act allows taxpayers to defer cancellation of debt income arising from the repurchase of debt in 2009 and 2010. Specifically, the reacquisition of debt in 2009 can be deferred for five years and the reacquisition of debt in 2010 for four years. The taxpayer must then include the cancellation of debt income ratably over five years beginning in 2014. The election is irrevocable.

Facts about the New Vehicle Sales and Excise Tax Deduction

If you bought a new vehicle in 2009, you may be entitled to a special tax deduction for the sales and excise taxes on your purchase. Here are important facts to know about this deduction.

1. State and local sales and excise taxes paid on up to $49,500 of the purchase price of each qualifying vehicle are deductible.

2. Qualified motor vehicles generally include new cars, light trucks, motor homes and motorcycles.

3. To qualify for the deduction, the new cars, light trucks and motorcycles must weigh 8,500 pounds or less. New motor homes are not subject to the weight limit.

4. Purchases must occur after Feb. 16, 2009, and before Jan. 1, 2010.

5. Purchases made in states without a sales tax — such as Alaska, Delaware, Hawaii, Montana, New Hampshire and Oregon — may also qualify for the deduction. Taxpayers in these states may be entitled to deduct other qualifying fees or taxes imposed by the state or local government. The fees or taxes that qualify must be assessed on the purchase of the vehicle and must be based on the vehicle’s sales price or as a per unit fee.

6. This deduction can be taken regardless of whether the buyers itemize their deductions or choose the standard deduction. Taxpayers who do not itemize will add this additional amount to the standard deduction on their 2009 tax return.

7. The amount of the deduction is phased out for taxpayers whose modified adjusted gross income is between $125,000 and $135,000 for individual filers and between $250,000 and $260,000 for joint filers.

For more information on these articles, please contact Ricky Max, Principal or Avrum Katz, Principal. You can also call us at 847-205-5000.

Miller, Cooper & Co., Ltd.

1751 Lake Cook Road, Suite 400, Deerfield, IL  60015     500 West Madison St., Suite 3350, Chicago, IL  60661