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Regard Roth Conversion Carefully

The article “Rethinking retirement contributions” explains why the new TCJA devalues putting money into traditional tax-deferred plans and favors Roth versions. Does the same reasoning apply to conversions from Roth to traditional accounts? From a tax viewpoint, the answer may be yes, but other factors indicate you should be cautious about such moves.

Example 1: Fred and Glenda Polk would have had $220,000 in taxable income in 2017 without contributing to their employers’ traditional 401(k) plans. However, they contributed a total of $40,000 to the plan, bringing their income down to $180,000. The couple was in the 28% bracket last year, so the income deferral saved a total of $11,200 in tax: 28% times $40,000.

Assume they kept their $11,200 of tax savings in the bank. If their employers have a 401(k) plan that offers designated Roth accounts, they could convert the $40,000 they contributed in 2017 to the Roth side if the plans allow such moves. Alternatively, depending on the plan terms and the Polks’ circumstances, they might be able to rollover the $40,000 to a Roth IRA. Yet another possibility, the Polks might leave the $40,000 in their 401(k)s but convert $40,000 of pretax money in their traditional IRAs to Roth IRAs.

With any of these strategies, the couple would generate a $9,600 tax bill (24% of $40,000) on the Roth conversion, because their joint income falls into the 24% tax bracket in 2018, in this example. The Polks could pay that $9,600 from their $11,200 of tax savings in 2017 and wind up ahead by $1,600.

Therefore, people who move into a lower tax bracket this year might be able to come out ahead with Roth conversions of income that had been deferred at a higher tax rate. Going forward, the money transferred to the Roth side may generate tax free rather than taxable distributions.

One-way street

Nevertheless, there are reasons to be cautious about Roth conversions now. For instance, U.S. stocks are trading at lofty levels. Roth conversions could be highly taxed at today’s equity values.

Example 2: Heidi Morris has $300,000 in her traditional IRA, all of which is pre-tax. Investing heavily in stocks, Heidi has seen her contributions grow sharply over the years. With an estimated $100,000 in taxable income this year, Heidi calculates she can convert $50,000 of her traditional IRA to a Roth IRA in 2018 and still remain in the 24% tax bracket.

However, stocks could fall heavily, as they have in previous bear markets. The $50,000 that Heidi moves to a Roth IRA could drop to $40,000, $30,000, or even $25,000. Heidi would not want to owe tax on a $50,000 Roth conversion if she holds only $25,000 worth of assets in the account.

Under previous law, Heidi had a hedge against such pullbacks, at least for Roth IRA conversions. These conversions could be recharacterized (reversed) to her traditional IRA, in part or in full, until October 15 of the following calendar year. In our example, Heidi could have recharacterized after a market setback, avoided a tax bill, and subsequently re-converted at the lower value. (Timing restrictions applied.)

Such tactics are no longer possible because the TCJA has abolished recharacterizations of Roth IRA conversions. (Conversions to employer-sponsored Roth accounts could never be recharacterized.) Now moving pre-tax money to the Roth side is permanent, so the resulting tax bill is locked in.

In the new environment, it may make sense to take it slowly on Roth conversions in 2018. If stocks rise, boosting the value of your traditional retirement accounts that hold equities, you won’t be sorry about the increase in your net worth; you can convert late in the year at today’s lower tax rate. On the other hand, if periodic corrections occur, they could be an opportunity for executing a Roth conversion at a lower value and a lower tax cost.

Is Your Employer’s Retirement Plan Getting Less Attractive?

The TCJA generally lowered federal income tax rates, with some exceptions. Among the ways in which lower rates impact tax planning, they make unmatched contributions to traditional employer retirement plans less attractive.

Example 1: Chet Taylor has around $100,000 in taxable income a year. Chet contributed $12,000 to his company’s traditional 401(k) in 2017, reducing his taxable income. He was in the 28% tax bracket last year, so his federal tax savings were $3,360 (28% of $12,000). An identical contribution this year will save Chet only $2,880, because the same income would put him in a lower 24% bracket.

Not everyone will be in this situation.

Example 2: Denise Sawyer has around $200,000 taxable income a year. Denise contributed $12,000 to her company’s traditional 401(k) in 2017, reducing her taxable income. She was in the 33% tax bracket last year, so her federal tax savings were $3,960 (33% of $12,000). An identical contribution this year will save her $4,200 because the same income would put her in a higher 35% bracket.

Planning pointers

Considering the changes in tax rates, participants in employer sponsored retirement plans should review their contribution plans. If your company offers a match, be sure to contribute at least enough to get the full amount. Otherwise, you’re giving up a portion of your compensation package.

Beyond that level, decide whether you wish to make unmatched tax-deferred contributions to your traditional 401(k) or similar plans. The value here is tax deferral and the ability to compound potential investment earnings without paying current income tax. Deferring tax at, say, 12%, 22%, or 24% in 2018 will be less desirable than similar deferrals were last year, when tax rates were 15%, 25%, or 28%.

On the Roth side

If you decide to cut back on tax-deferred salary contributions, spending the increased current income won’t help you plan for your future retirement. Other savings tactics may be appealing.

For instance, your employer might offer a designated Roth account in its 401(k) plan. These accounts offer no upfront tax benefit because they’re funded with after-tax dollars. The advantage is all withdrawals, including distributions of investment income, will avoid income tax after age 59½, if you have had the Roth account for at least five years. (Other conditions can also qualify distributions from a Roth account for full tax avoidance.)

Generally, the lower your current tax bracket and the higher your expected tax bracket in retirement, the more attractive Roth contributions can be.

Example 3: Ed Roberts, age 30, expects his taxable income (after deductions) to be around $50,000 this year, putting him in the 22% tax bracket. Ed hopes to have a successful career, so he might face a higher tax rate on distributions in the future. Therefore, Ed contributes $6,000 ($500 a month) to his company’s traditional 401(k) to get some current tax relief, and $6,000 to the Roth 401(k) for tax free distributions after age 59½.

Some advisers suggest going into retirement with funds in a regular taxable account, funds in a tax-deferred traditional retirement account, and funds in a potentially tax-free Roth account. Then, you may have considerable flexibility in choosing tax-efficient ways to draw down retirement cash flow.

Other options

What if Ed’s employer’s 401(k) plan does not offer designated Roth accounts? A possible solution for Ed would be to contribute to a Roth IRA instead. In 2018, he can contribute up to $5,500 ($6,500 for those 50 and older). Roth IRAs also offer completely tax-free distributions after five years and age 59½.

Example 4: Assume that Ed’s employer will match up to $4,500 of his 401(k) this year and that Ed plans to save $12,000 for his retirement. Ed could contribute $5,500 to a Roth IRA and $6,500 to his traditional 401(k).

With higher incomes ($120,000 or more of modified adjusted gross income for single filers in 2018, $189,000 for couples filing jointly), Roth IRA contributions are limited or prohibited. People facing this barrier may able to fund a nondeductible traditional IRA, up to $5,500 or $6,500 this year, then convert those dollars to a Roth IRA with little or no tax at this year’s tax rates. (IRA contributions for 2017, with slightly different income limits, are possible until April 17, 2018.)

Ultimately, the choice between traditional and Roth retirement accounts will largely depend on expectations of future tax rates. Deferring tax in a traditional plan this year and saving 24% in tax may not turn out to be a good deal if future withdrawals are taxed at 28%, 30%, or 35%. The fact that the TCJA rates are among the Act’s provisions that are due to sunset in 2026, reverting to 2017 rates, may tilt the scales a bit towards the Roth side, where distributions eventually may escape tax altogether.

 

Retirement rules 

  • Participants in 401(k) and similar employer sponsored retirement plans can contribute up to $18,500 this year, or $24,500 if they’ve reached age 50.
  • If your company’s 401(k) plan offers a designated Roth account, contributions to the plan can be divided in any manner you choose between a pre-tax account and a designated Roth account, but the total can’t exceed the $18,500 or $24,500 ceilings.
  • Any employer match usually goes into the traditional 401(k), even if the contribution is to the Roth version, so income tax on the matching money is deferred.

Do You Know Your True Tax Rate?

It has been widely reported that the TCJA lowers federal income tax rates for many people. The highest tax rate, for example, has fallen from 39.6% to 37%. Many people who are in lower brackets also stand to benefit.

Example 1: Alice Young had $100,000 of taxable income in 2017. As a single filer, Alice was in the 28% tax bracket. If Alice has that same $100,000 in taxable income in 2018, she will be in a 24% bracket. Indeed, Alice could add as much as $57,500 in taxable income this year and maintain her lower 24% tax rate.

Not for Everyone

However, there are some quirks in the new tax rates. Some people actually face higher rates.

Example 2: Brad Walker had $220,000 of taxable income in 2017, which put him in a 33% tax bracket. With the same income in 2018, Brad will face a 35% tax rate.

In addition, the federal tax rates such as 24% or 35% are just one factor in determining the true rate you’ll pay by adding taxable income, or the true amount you’ll save with a tax deduction. Many people owe state or even local income tax, which might be fully or partially deductible on a federal tax return or not deductible at all. Various other provisions of the tax code will also impact your marginal tax rate—the percent you’ll owe or save by adding or reducing taxable income.

Knowing your true tax rate can help you make knowledgeable financial decisions, some of which are explained elsewhere in this issue. By starting with your 2017 tax return and incorporating your expectations as well as your plans for 2018, HLB Gross Collins, P.C. can help you determine the value of tax related actions.

Corporate, Personal Income Taxes: Governor Signs IRC Conformity Update and Rate Cut.

 

Georgia has adopted legislation that:

  • updates the corporate and personal income tax federal Internal Revenue Code (IRC) conformity date to February 9, 2018, with certain exceptions;
  • doubles the standard deduction, effective January 1, 2018 and expiring December 31, 2025;
  • lowers the top income tax rate for businesses and individuals from 6% to 5.75%, effective January 1, 2019 and expiring December 31, 2025; and
  • if the General Assembly and governor provide further approval, the top income tax rate would decrease to 5.5% effective January 1, 2020 and expiring December 31, 2025.

The previous IRC conformity date was January 1, 2017. The IRC conformity update applies to tax years beginning on or after January 1, 2017.

IRC §179 Deduction

The federal and Georgia IRC §179 deduction maximum dollar limitation and investment limitation is:

  • limited to $510,000, with a $2,030,000 phase out in 2017;
  • limited to $1 million, with a $2.5 million phaseout in 2018.

Georgia has not adopted the Section 179 deduction for certain real property. However, Georgia follows the separate reporting requirement to shareholders of S corporation and partners of partnerships for:

  • the gain from asset sales for which a §179 deduction was claimed; and
  • the §179 deduction.

The gain should not be reported directly on the S corporation or partnership return. The gain should be reported separately to the shareholders or partners.

Net Operating Losses

For net operating losses incurred in taxable years ending on or after December 31, 2017, Georgia follows the new federal laws regarding:

  • no carryback and unlimited carryforward;
  • 2 year carryback for farming losses; and
  • the 2 year carryback and 20 year carryforward for certain insurance company net operating losses.

For losses incurred after January 1, 2018, Georgia follows the 80% limitation on the usage of net operating losses (the state 80% limitation is based on Georgia taxable net income). The federal and state 80% limitation does not apply to certain insurance company net operating losses.

IRC Exceptions

Georgia has not adopted the following IRC sections:

  • “bonus depreciation” (§168(k));
  • income attributable to domestic production activities (§199);
  • 20% qualified business income deduction (§199A);
  • federal deferral of debt income from reacquisitions of business debt at a discount in 2009 and 2010 for five years (§108(i));
  • modified rules for high yield original issue discount obligations (§163(e)(5)(F) and 163(i)(1)).
  • tax benefits for particular property (New York Liberty Zone (§1400L), Gulf Opportunity Zone (§1400N(d)(1), §1400N(f), §1400N(j), §1400N(k), and §1400N(o));
  • special allowance for certain reuse and recycling property (§168(m));
  • special allowance for qualified disaster assistance property (§168(n));
  • increased first-year depreciation limit for passenger automobiles if the passenger automobile is “qualified property,” (§168(k));
  • classification of property (§168(e)(3)(B)(I), 168(e)(3)(E)(ix), and 168(e)(8));
  • modified rules relating to the 15 year straight-line cost recovery for qualified restaurant property (allowing buildings to now be included) (§168(e)(7)); and
  • 5 year depreciation life for most new farming machinery and equipment (§168(e)(3)(B)(vii));

Parts of the IRC that are treated as they were in effect before the enactment of the Tax Cuts and Job Act address:

  • limitation of business interest (§163(j)); and
  • contributions to the capital of a corporation (§118).

Depreciation Differences

Depreciation differences due to the federal tax being computed differently for Georgia purposes should be treated as follows:

  • taxpayers should attach the current year IRS Form 4562 to the Georgia return and add federal depreciation by entering it on the other addition line;
  • then compute depreciation on Georgia Form 4562 and enter it on the other subtraction line of the return.

Domestic Production Activities

Taxpayers should enter this adjustment on the addition line of the applicable return. If the partnership or S corporation is not allowed the Section 199 deduction directly an adjustment is not required. The partnership or S corporation should pass through the information needed to compute the deduction to the partners or shareholders.

Other Differences

Decoupling from certain federal provisions may have other effects on the calculation of Georgia income. Adjustments for the items listed below should be added or subtracted on the Georgia income tax form:

  • if property is sold, after federal bonus depreciation was claimed, there will be a difference in the gain or loss on the sale for Georgia purposes; and
  • the depreciation adjustment may be different if the taxpayer is subject to the passive loss rules and is not able to claim the additional bonus depreciation on the federal return.

Finally, Georgia has adopted certain federal provisions enacted to assist combat-injured veterans to recover income taxes that were improperly collected by the Department of Defense. The legislation extends the 3-year period for filing a refund claim with Georgia to the same date that is allowed federally.

 

 

 

HLB International Appoints New Member in Costa Rica

 

HLB International, one of the leading global accountancy networks with presence in 150 countries, continues its growth with the recent signing of a new member firm in Costa Rica, Grupo Camacho Internacional S. A. This is a major move and will have a big impact on the Central American market.

 

Grupo Camacho  Internacional S. A. is based in San Jose, the capital city of Costa Rica. Established in 1988, the firm provides services in Transfer Pricing, International Tax, International Tax Restructuring and BEPS. The firm’s Transfer Pricing expertise will be a strategic asset for the HLB network.

 

Carlos Camacho Cordoba, Managing Partner of Grupo Camacho Internacional S. A., commented: “With a strong focus on meeting the current and potential needs of our clients and a vision towards quality, innovation and achievement of added value for our clients, joining the HLB network will further enhance our client services. We very much look forward to working with HLB members globally.”

 

Grupo Camacho Internacional S. A. is already working closely with other HLB members in the region and will form part of the federation of representative member firms in Costa Rica, which will make a substantial addition to our Central American and global coverage.

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