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MONTHLY TAX NEWSLETTERJanuary 2010
Beginning in 2010, taxpayers with incomes exceeding $100,000 finally have the opportunity to convert their traditional IRAs and other qualified retirement accounts into a Roth IRA. What makes the decision to convert so appealing are some of the unique benefits available to Roth IRA’s, including:
As part of your decision to convert existing IRAs to a Roth IRA, you need to weigh the pros and cons. Some reasons influencing a decision to convert to a Roth IRA include the following:
Conversely, the primary reasons influencing a decision not to convert to a Roth IRA include the following:
There is one additional item to consider for 2010 conversions only. Under the current rules, you can elected to either report 100% of the taxable income on your 2010 tax returns or claim 50% of the conversion amount as taxable in 2011 and then claim the remaining 50% in 2012. Don't forget that rates may be on the way up in 2011, however, since the tax cuts enacted as part of the 2001 Tax Act are set to sunset at the end of 2010.
If you have existing IRAs (traditional IRAs, rollover IRAs, SEP-IRAs, SIMPLE IRAs) and/or 401(k) or 403(b) accounts held with a former employer and are considering converting some or all of those funds to a Roth IRA, please contact one of the MDTAXES CPAs to help you work through a detailed analysis prior to making your final decision. A small amount of planning may result in a large amount of tax savings.
The IRS announced that the standard mileage rate will decrease to 50 cents per business mile driven in 2010. That is a hit of just over 9% from the 55 cents allowed in 2009. According to the IRS, "The new rates for business, medical and moving purposes are slightly lower than last year’s. The mileage rates for 2010 reflect generally lower transportation costs compared to a year ago."
When you use your car for business, driving between job sites is deductible. So is driving between your home and a temporary job site, job interviews, and conferences. Commuting between your home and a regular place of business generally isn't tax deductible.
There are two ways for you to calculate your automobile expenses. You can either claim $.55 per business mile driven in 2009 (decreasing to $.50 for 2010), or you can base your deduction on the percentage of miles your car was driven for business multiplied by the actual costs incurred during the year. Allowable costs include gas, insurance, repairs, parking at home, and either your lease payments, or if you own your car, a factor for depreciation.
Generally, unless you drive your car relatively few miles each year, with most of those miles being allowable business miles, you're better off basing your deduction on the standard mileage rate.
Let's say you lease a car for $400 a month that you drive only 3,000 total miles during the year. And of those miles, 2,000 qualify as deductible business miles. By calculating your deduction based on the standard mileage rate, you'll end up with a deduction of just $1,000 (2,000 business miles * $.50 per mile).
What would your deduction be based on the actual expenses incurred, assuming you spend $1,200 on insurance, $.10 per mile driven for gas, and $1,200 on parking at home? Based on $7,500 of total automobile expenses (including the lease payments), multiplied by two-thirds (2,000 business miles divided by 3,000 total miles), your allowable deduction for your automobile expenses jumps to $5,000 - or five times the $1,000 calculated using the standard mileage rate.
Now let's see what happens if you drive 20,000 total miles during the year. Assuming your allowable business miles remain at 2,000, you can either claim an automobile deduction of $1,000 based on the standard mileage rate, or $920 based on one-tenth (2,000 business miles divided by 20,000 total miles) of your actual automobile expenses incurred.
How to Claim The Deduction
Taxpayers who are compensated as employees generally will claim their deductible automobile expenses as an unreimbursed employee business expense. These type expenses are reported on a Form 2106 and are deducted as a miscellaneous itemized deduction on the Schedule A. Keep in mind that miscellaneous itemized deductions are only allowable to the extent they exceed 2% of your income, and are not allowable when calculating the Alternative Minimum Tax (AMT).
Those taxpayers compensated as independent contractors will generally claim their allowable automobile expenses directly against their self-employment income. For these taxpayers, automobile expenses should be reported the Schedule C.
Other Deductible Miles
The use of an automobile in connection with a charitable activity is deductible at a rate of 14 cents per mile for 2009 and 2010 and should be reported with other charitable contributions as an itemized deduction of the Schedule A.
Any mileage driven in connection with a qualified move is deductible at a rate of 16.5 cents per mile in 2010, down from 24 cents per mile in 2010, and should be reported on a Form 3903, Moving Expenses.
And don't forget that medical related mileage is also deductible. Medical mileage is allowable at 24 cents per mile in 2009, before falling to 16.5 cents per mile in 2010, and should be reported with all other medical expenses on the Schedule A.
Why such a huge decrease for medical and moving mileage rates? According to the IRS, "The standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs as determined by the same study. Independent contractor Runzheimer International conducted the study."
Let's review how to calculate the income to report on your Roth conversion, assuming you've made post-tax contributions to your traditional IRA over the years. To best demonstrate how these rules work, we'll look at two examples:
In both examples, you have $20k of post-tax contributions within your IRAs. And in both examples, the IRA account that is holding your post-tax contributions is worth $25k.
The big difference in these two examples is that while you have no additional IRA money in example #1, you have an additional $175k held within a variety of different IRA accounts in example #2. That additional IRA money dilutes your IRA basis and, therefore, causes more of the Roth conversion to be taxable.
Let's see what happens if you only convert the $25k IRA account that holds your post-tax contributions. In example #1, you will report 20% of the amount you converted (or $5k) as taxable, and then will have no remaining post-tax basis in your IRAs.
In example #2, you will pay taxes on 90% of the $25k converted, or $22.5k. You will then have $17.5k in post-tax IRA basis remaining that you'll need to continue to track on a Form 8606.
When trying to determine whether it makes sense to convert your IRAs to a Roth IRA, it's very important that you compare the total post-tax contributions you made to a traditional IRA over the years with the total value of ALL of your IRA accounts, including SEPs, SIMPLES, and Rollover IRAs.
Based on these rules, one strategy to minimize the taxes owed on the Roth conversion is to roll out your rollover IRAs to your employer sponsored 401k or 403b plans to reduce total value of IRAs. If your employer has updated their 401k or 403b plan to incorporate 2001 Tax Act, you might also consider rolling some of your non-rollover traditional IRA into your employer’s plan to bring the total value of your IRAs to be equivalent to your post-tax basis in your IRA.
We wrote about this strategy in last month's newsletter available at www.mdtaxes.com/news1209.html.
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