High Net Worth Family Tax Report, Vol. 4 No. 3.

Table of Contents:

Roth IRA Conversion Becomes Available to High Income Taxpayers in 2010 Taxpayers Prevail on Use of Fixed Dollar Formula Valuation Clauses Five Year Carry Back of Net Operating Losses Extended and Expanded First Time Home Buyer Credit Extended and Expanded California Property Tax Entity Change of Ownership Reporting Is Now Mandatory Taxpayers Prevail in Two Tax Shelter Cases Like-kind Exchange Runs Afoul of the Related Party Rules Estate and Gift Tax Update Roth IRA Conversion Becomes Available to High Income Taxpayers in 2010

I n 1997, Congress enacted the Roth IRA provisions. If you have a Roth IRA, your contributions to that IRA are not tax deductible, but (like a regular IRA) amounts earned in the Roth IRA are not subject to income tax. However, unlike a regular IRA, amounts that are withdrawn from the account are not subject to income tax, and there is no requirement to begin taking distributions no later than the year you attain age 70 1/2,

A regular IRA may be converted to a Roth IRA by paying income tax on the amount of pre-tax contributions and untaxed earnings in the regular IRA. For this treatment to apply, funds must remain in the Roth IRA for at least five years following the conversion.

Until now, Roth IRAs have been beyond the reach of high income individuals as they have been limited to individuals earning less than an inflation adjusted amount. For 2009, the ability to maintain a Roth IRA is phased out for a couple filing a joint return at income levels between $166,000 and $176,000. In addition, individuals having a modified adjusted gross income of greater than $100,000 have not been permitted to convert a regular IRA to a Roth IRA.

Beginning in 2010, the $100,000 limit on conversions is eliminated, and individuals at any income level can convert a regular IRA to a Roth IRA. If the conversion is made in 2010, the payment of the income taxes that result from the conversion may be deferred and paid in two installments, for 2011 and 2012. However, the taxes on the converted amount will be based on the prevailing rates in those years, and there is a very good chance that those rates will be higher than they are currently.

State and local income tax rules regarding Roth IRAs must also be taken into account when evaluating the conversion of a regular IRA to a Roth IRA. The Roth IRA provisions under the California, New York and New York City income tax laws are exactly the same as federal law, so the same conversion rules are also applicable.

Roth IRAs can also have significant estate planning implications, since neither the original nor successor owners pay income tax on distributions. Moreover, although successor owners cannot delay distributions indefinitely in the same manner as the original owner, they can take distributions over their projected lifetimes and thereby further extend the benefits of tax free build up of the account's investments. If your estate can pay the estate taxes attributable to a Roth IRA with other estate assets, the successor owner (perhaps your children) can obtain many of the income tax deferral benefits available to you.

The analysis of whether it makes sense to convert is complex. The person converting the account must pay tax now, but in return the amounts in the Roth IRA accumulate tax-free past age 70 1/2, and can ultimately be withdrawn from the Roth IRA free of income taxes. Many of the financial advisory firms have created financial models to assist in making this decision. While circumstances may differ, in general, conversion may make sense if: i) you have funds available to pay the resulting income taxes without using your IRA funds; ii) you do not anticipate that you will need to use the IRA funds for living expenses until well past age 70 ½, and iii) you do not anticipate moving from a high income tax state (like California or New York) to a low income tax state (like Nevada or Florida). These factors determine the extent to which you will be able to benefit from the additional tax-free accumulations of the account earnings after the payment of income taxes resulting from the conversion. The greatest benefit of converting may result if you are able to live indefinitely by using other funds and are therefore able to leave your Roth IRA to your heirs. To make the conversion and pay taxes now, you also have to trust that the federal and state governments will not change the rules in the future and subject Roth accounts to taxation.

In order to evaluate whether converting a regular IRA into a Roth IRA may be a smart move, we suggest that you consult with your financial advisor. They can help you evaluate your specific circumstances and make an informed decision.

Taxpayers Prevail on Use of Fixed Dollar Formula Valuation Clauses

Taxpayers have prevailed in two cases where the amount given to a charity was to be determined by reference to asset values as finally determined for estate or gift tax purposes. In Estate of Christiansen, Helen Christiansen left her estate to her only child, her daughter Christine Christiansen. However, her will provided that if Christine disclaimed any portion of the estate, 25% of the...