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MONTH YEAR: Lead Article: 1 ¾ pages [2nd page about 45 lines]
Lead Article Title: Roth IRA ConversionsRoth IRA ConversionsSummary: To convert or not to convert, that is the question. Many websites, and even some advisers use simplistic calculators, that don’t do the decision justice. Others use modeling so sophisticated they could be mistaken for space shuttle algorithms. While some advisers bring nearly religious zeal to their views, the realities are that for some taxpayers the answer is obvious, for some a coin toss (not as cool as the slick models, but perhaps as effective of an analysis for many). We’ll try to demystify the issue with some background. Then we’ll try to help you identify whether you seem to be pretty obviously in the convert or not convert camp. For those in the gray zone in between we’ll try to give you some pointers to discuss with your advisers. In the end the Solomon-like approach of splitting the baby might just be the most prudent approach for the gray zone.

What’s the Deal?

Roth IRA’s are cool: ◙ All growth is tax-exempt. ◙ There are no minimum distributions required at age 70½ as exist for regular IRAs. That’s big since the assets can continue to compound tax free which enhances the Roth asset growth prospects (hopefully enough to cover the tax paid and then some) and possibly creditor protected. ◙ If your modified adjusted gross income (MAGI) exceeds $100,000 you cannot convert your regular IRA to a Roth but in 2010 that limit disappears. ◙ If you convert in 2010 the income tax due can be spread out over two years. You can elect out of this deferral and pay all the income tax in 2010 if that proves advantageous (e.g., large rise in future tax rates). Election has to be made by 10/15/11, on an extended return. Hedge your bets and extend.

Favoring Conversion

For conversion to make sense some of the following should be present: ◙ Future tax rates are higher than the rate you pay now when you convert. This creates a positive tax arbitrage. Rising rates seem like a Wilt the Stilt slam dunk…how could they not? ◙ You have significant tax attributes are available to offset the current income tax triggered (e.g, charitable contribution carryovers, investment credit carry-forwards, “Madoff-type” carryovers). ◙ Post-conversion Roth IRA funds will almost assuredly not be needed to support living costs for a long time if ever, so that the assets can remain invested to compound tax free to be bequeathed to your heirs. This is a key question which requires an analysis of your cash flow, assets and “burn-rate” (spending). If you’ll bequeath your Roth to a properly designed generation skipping tax (GST) exempt trust you grandchildren may be able to withdraw Roth IRA money over their life expectancies. That’s lots of years of income tax free growing. ◙ Adequate cash resources outside of IRA plans are available to pay the income tax due on conversion.

Asset Protection

Asset protection worries might make conversion a great deal if your post-conversion Roth will be protected under state creditor protection laws from claimants. Conversion could present an opportunity to convert a regular IRA to a Roth IRA, and using outside funds to pay the tax, you have effectively taken 60-cent dollars that are protected inside a regular IRA, and turned them into 100-cent dollars that are protected inside the resulting Roth IRA, and eliminated a non-protected asset by using it to pay the income tax on conversion. You can also continue making contributions to your Roth IRA after age 70½ and never have to withdraw from it. That leaves Roth dollars snug and safe. In contrast you cannot contribute to a regular IRA after 70 ½ and you have to take out minimum required distributions (MRDs) each year.

Other Factors

To get it right many variables need to be factored into your analysis. ◙ What will your post-conversion investment rate of return be? ◙ Is there a tax bracket arbitrage available? For example, if you’re terminally ill it might pay to convert while married filing joint at a lower tax rate than your surviving spouse will have if she takes distributions out of a taxable IRA at a single person’s tax bracket after your death. Arbitrage can be negative if converting pushes you from a current low bracket into a higher tax bracket. ◙ Will the government directly or indirectly taxing Roth dollars (e.g., via phase outs of other tax benefits based on Roth balances or withdrawals, etc.)? If the federal fisc remains hungry in decades to come most anything might be possible. ◙ What financial needs for health or other emergencies might cause Roth funds to be tapped before anticipated? ◙ Can you really model these factors? How can you guesstimate how the government may change the tax rules applicable to well to do taxpayers, yet alone guesstimate the percentage likelihood of such changes?. ◙ If you convert the tax you pay will be removed from your estate possibly lowering your estate tax. ◙ If you split the baby and only convert say ½ your IRA, perhaps you should first split the IRA into parts, say a bond part and equity part. Then convert the equity part only which has more likelihood of appreciation then the bond part.

Estate Tax and 691(c)

What’s the estate tax consequence of Roth versus not? Some background first. ◙ Your IRA is included in your taxable estate and could be subject it to a 45% estate tax. ◙ Since a regular IRA represents income that has not been subjected to income tax (ignoring non-deductible contributions), this is called “income in respect of a decedent” (IRD). IRD is subject to income tax as your heirs receive it. So the 55% left after the estate tax bite gets bitten again with a 35% income tax rate (which will likely increase in the future). Ouch! ◙ The double tax whammy is mitigated by an income tax deduction for the federal estate tax paid. Code Sec. 691(c). This is not a perfect offset. ◙ If you’re in a state that has an estate tax there is no offset for state estate taxes paid. ◙ The beneficiary paying the tax might not be the one inheriting the IRA and getting the benefit. ◙ The IRD deduction may be subject to phase out of deductions under Code Section 68 reducing the benefit. So, it might be a better deal to die Roth’d.

How to Convert

◙ If conversion still seems plausible after the initial evaluation review timing of tax payments with your CPA. You can pay all at once or spread the payments. ◙ Consider whether you can divide your IRA into separate IRAs by asset class and convert each asset class IRA separately. That way, if a particular asset class IRA declines in value before the extended due date for the return, you can un-convert (recharacterize) it and avoid the tax. So if you convert 1/1/10 right after the ball drops in Times Square, you can hold your tax breath until 10/15/11 to decide. That’s a 21 ½ month looky looky. Why pay income tax to convert a looser? Be wary that the IRS and/or Congress may get hip to this jig and try to kibosh it. They’re trying to do just that with zeroed out short term GRATs that similarly present a “head you wins, tails try again” paradigm. If you un-convert you have to wait 30 days before trying again. ◙ Review estimated tax payment requirements with your CPA.

Qualified Plans

If your child is your qualified retirement plan beneficiary she can direct your plan directly from the qualified retirement plan to either a: (1) Roth IRA; or (2) Non-spousal beneficiary regular IRA rollover IRA. However, once the qualified plan has been rolled into a regular IRA it cannot thereafter be converted to a Roth IRA. Caution – if you rolled an ERISA plan into a regular IRA and now Roth it some experts worry this might taint the protection you had under the Bankruptcy Protection Act.

Checklist: Second Article 2 lines less than One Page [about 54 lines]:
Checklist Article Title: Disability Issues

Summary: Professionals and business owners are often admonished to purchase disability income insurance to replace the income lost if they become sick or disabled, business overhead insurance to keep their practice afloat, and perhaps disability buyout insurance to fund the buyout of a disabled partner. So you’ve paid all 3 premiums dutifully for years and unfortunately suffer a debilitating illness which derails your career, dreams, and worse. The process of collecting on these can prove daunting.

√ Just diagnosed? Get someone not emotionally vested to shepherd you through the process. If you’re dealing with the emotional trauma of a new diagnosis or injury you need someone methodical and objective to deal with what might be several independent insurance companies. The paperwork can be voluminous. The technical issues (medical, tax, legal) may be complex. If your hands are full dealing with treatment plans, rehab, etc. get help. Paying for your accountant and a disability attorney to handle the submissions will cost a bit up front but can avoid tremendous difficulties. As a layperson, your imprecise use of terminology could delay or derail your case. You need to make sure the facts are appropriately and clearly presented.
√ Your planning should have involved more than just a disability income policy. You should have had an exit strategy from your business or professional practice. Don’t defer selling or transitioning your practice or business for too long if you’ll have to do so. If you run it into the ground there will be little to sell. If you have buy sell and other business agreements in place get your accountant and corporate attorney on the case as quickly as possible as there may be critical deadlines.
√ If you have a business overhead policy it should protect you if you cannot work full time. These policies are sold to help cover your fixed costs, like rent. You may have to prove partial or total disability to collect on them. You also have to corroborate the expenses you are incurring. Often these are geared to expenses that are deductible for tax purposes. It can be good as gap insurance while slowing down. The definitions and calculations may differ from those under your disability income policy. Again, the concepts are likely to be technical and the paperwork substantial. Consider involving your accountant. If you are totally disabled and close down your practice or business the coverage may prove ephemeral.
√ Try to be consistent with what you report to your business overhead insurer, disability company, the IRS, credit and mortgage applications, etc. The insurance companies will get access to all these documents. Consistency, unfortunately, is probably impossible given the different definitions and purposes of the financial and tax reporting you might be involved in. The confusion can be substantial and differences may have to be reconciled.
√ Your disability income company wants to know quality and nature of your work. They need to determine how you derive your income (e.g., surgery, office hours, lecturing). The quality and quantity of work you do defines the “duties of your occupation.” This might require some fancy cost accounting analysis that no one had ever focused on before.
√ Working while you are disabled, especially at earlier stages of a progressive illness, is common. You want to maintain normalcy as long as possible. Your business overhead coverage may be a huge help if you’re only partially cutting back. But be wary, disability income insurance companies may view your working initially as an indication that you can continue to work even though you’re sick. This could shift the dynamic to you if you cut back further in the future, or cease working, to demonstrate that even though you previously worked with the disability you can no longer do so. You may have to demonstrate a new development that has created the new change (e.g., no available job with the necessary accommodations, a worsening of your condition).
√ Be carefully about sending Emails. It’s too easy to hit that [send]. Instead write a Word document and attach it so you can review it make certain that the facts are listed correctly. If there are tax or accounting issues, have your CPA review it. If there are policy definition issues, consult with your agent. Have a disability attorney review everything before it is sent.

Recent Developments Article 1/3 Page [about 18 lines]:
■ RMD: You won’t have to take a distribution from your IRA for 2009 because the Required Minimum Distributions (RMDs) have been suspended for this year only. In Notice 2009-82, 2009-41 I.R.B. 491 the IRS addressed a number of issues created by the waiver of 2009 RMDs. Because these rule changes were enacted so late in the year, the IRS has provided some leniency to taxpayers. The IRS won’t consider a plan to have failed to be operated according to its terms merely because, between 1/1/2009 and 11/30/2009, 2009 RMDs were or were not made, beneficiaries weren’t given option of not receiving distributions that included 2009 RMDs, or direct rollover option was or wasn’t offered for 2009 RMDs. For taxpayers who have already received 2009 RMDs, the IRS extended the normal 60-day rollover period so that it doesn’t end before 11/30/2009. Thanks to Charles C. Shulman, Esq. Teaneck, NJ.
■ Innocent Spouse Relief: When spouses file a joint income tax return they are both jointly and severally on the hook for any tax. If certain requirements are met one spouse might qualify for relief from the tax attributable to the other spouse under IRC Sec. 6015: ◙ H&W filed a joint return; ◙ There was an understatement of tax due to an erroneous item of H; ◙ W didn’t know, and had no reason to know, of H’s understatement; ◙ It’s inequitable to hold W liable for the tax based on all the facts and circumstances; and ◙ W elects innocent spouse relief within two years of the IRS beginning collection. Linda Bruen , TC Memo 2009-249 (Tax Ct.)

■ Expatriates: Benjamin Franklin uttered the famous phrase in 1817: “In this world nothing can be said to be certain, except death and taxes.” Well expatriating to avoid the taxes probably won’t work either. In Notice 2009-85 the IRS explained the new Code Sec. 877A mark-to-market exit tax enacted as part of the “Heroes Earnings Assistance and Relief Tax Act” (HEART) in 2008. The tax can be on the unrealized appreciation of those assets over $600,000 (inflation indexed). If you receive a gift or bequest from an expatriate on or after June 17, 2008 you may face a tax under Code Sec. 2801 at the highest marginal gift or estate tax rate on the fair value of the property. But since the Notice was only 65 pages long it only addressed the 877A provisions, you’ll have to wait guidance on the 2801 rules.
Potpourri ½ Page:
■ What to do with Some Spare Cash: Tax refund, property finally sold, big birthday gift, what should you do with the dough?: ◙ Buy term life insurance. Everyone’s savings and retirement plans and house values have been hammered. If you get hit by a bus tomorrow will your family make it? Buy at least a 10 year term policy to supplement your family’s savings until your asset values regain former ground to support them. And since the estate tax looks long lived, you might just opt for a more comprehensive revision of your insurance plan. ◙ Consult with a fee only financial planner. They are objective. Everyone’s finances and planning has been put through the mill. Spend a few buck to get an objective non-sales compensated expert to look at your estate plan, investments, retirement planning, and get you back on track. ◙ Pay down costly debt. Some folks still have credit card and other debt that is accruing interest at high rates. Line up all your bills and pay off the most costly first. If you are at risk of not being able to pay off your debts, call up your creditors and tell them how much debt you have and what cash you have and offer to strike a deal. Some may be very willing to cut what you owe to get paid. If you can selectively do this you might get yourself “out from under” a lot of pressure for a lot less money than you thought you needed, and back on track to rebuilding. ◙ Put it away for that rainy day fund mom always warned you to have but which many people forgot about. Sorry mom! Many investors were really hurt by the market declines because they did not have a cash reserve to fall back on. As a result they had to liquidate stocks and missed out on the 50% recent run up in the market.
■ ID Theft. If your wallet was lost or stolen, report to it immediately to the IRS ID Theft Unit 800-908-4490. Your account will be flagged immediately. So if the “bad guy” makes any filing or refund request under your name or Social Security number it will be flagged and the IRS will contact you before taking any action.
■ Money Service Business. You thought an MSB meant a bank! A hotel, corner grocery store selling money orders and other businesses can be ensnared by the tough anti-money laundering compliance program. Your business needs a policy and procedures appropriate to the size and sophistication of the business. MSBs must register with FINCEN as money service business and renew by the end of second year from the initial registration. Maintain check cashing activity logs. Transactions over $10,000 must be reported. The penalties for non-compliance are huge! For info see www.fincen.gov go to MSB link, or www.irs.gov and click to MSB info. Center.
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Publications:

Seminars: “Chronic Illness Planning” ◙ Registration 7:30 am. Seminar 8-11am. ◙ 3 hours CPE/CFP credits. ◙ Open to the professional advisers, those living with chronic illness, and caretakers. ◙ 2 Dates and locations: ◙ Tuesday December 15 Marriott 100 Frank W Burr Blvd
Teaneck, NJ RSVP 201-845-8400 ◙ Thursday December 17 Marriott Hanover, 1401 Route 10 East, Whippany NJ RSVP (973) 451-9400

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