John Bullis: Make lemonade out of sour tax lemons
June 12, 2012
So, your 2012 financial situation looks terrible. You will probably have $30,000 more losses and/or itemized deductions (Form 1040, Schedule A) than taxable income. You expect to have negative taxable income (Page 2, Line 43 of Form 1040). It seems like all you have are lemons!
You expect to have taxable income in future years, but 2012 is going to be very low taxable income year for tax purposes. Perhaps your rental has been vacant, or your business has suffered, or is suffering losses in 2012. Maybe your wages have been reduced or eliminated for part of the year, but you still have lots of “itemized deductions” for the mortgage interest, etc.
If you have some regular IRA accounts, why not convert some to Roth IRAs before 2012 ends? By converting, you can turn lemons into lemonade.
Roth IRA conversions are one of the few tax elections that you can “do over” if it turns out you don’t like it. The conversion done in 2012 can be reversed or undone as late as Oct. 15, 2013. The technical word is “recharacterized.”
You might consider converting more than one regular IRA account to a Roth IRA account. That way, if one of the accounts goes down in value a lot, you could elect to “recharacterize” that one (reverse it back to the regular IRA). Your IRA custodian (usually your stockbroker) can set up multiple regular IRA accounts out of your one IRA account; maybe one that has a majority of bonds and another one that has a majority of stocks.
But if you converted a regular IRA account of $10,000 in 2012 and September 2013, the value has dropped to only $6,000, you could elect to change it back to a regular IRA before Oct. 15, 2013. Why pay tax on $10,000 when it is only worth $6,000?
Your Roth IRAs don’t have required minimum distributions. They can be inherited with the same tax free withdrawals feature. They can be invested like regular IRAs. If it is left as a Roth IRA for five years and are withdrawn after you are age 59 1/2, the earnings are not subject to income tax.
If you convert a regular IRA account to a Roth IRA, the value on the day of conversion is taxable income. If you have higher other losses and deductions than income in that year, a conversion to a Roth IRA can be done at low or maybe no tax.
Like all tax rules these days, it is a bit more complicated than it should be to convert to Roth IRA accounts. Maybe you should get some help to see if this idea is something you might consider doing to improve your 2012 situation.
It is perfectly legal to do planning and arrange your affairs in ways to reduce your income tax. The tax rules have many deductions, credits, allowances, etc.
Did you hear: “Looking at the bright side of things will improve, not damage, your insight.”
• John Bullis is a certified public accountant, personal financial specialist and certified senior adviser serving Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs, LLC.