August 5, 2020 Tax Update

 Want to convert a traditional IRA to a Roth?

Now might be a good time to consider it.  You’ll have to pay income tax on the converted funds for the year of the switch, but once the money is in the Roth IRA, future earnings, and distributions that you take from the account are tax-free.  Present and future income tax rates are key in figuring whether a Roth conversion makes sense. If you expect the tax rate that you’ll pay in retirement will be equal to or higher than the rate on conversion, then switching to a Roth IRA can pay off taxwise, provided you don’t have to tap IRA funds to pay the tax bill on the conversion. If your tax rate in retirement will be lower, tax-free Roth payouts are less advantageous. Income tax rates are low right now, but that might very well change in the future, depending on the state of the economy and who is elected president in Nov.

Other factors to consider when pondering a Roth conversion:  There is no required minimum distribution for owners of Roths… And RMDs from traditional IRAs are waived for 2020 under the stimulus law. Usually, if you do a Roth conversion in a year that you are subject to the RMD rules, you must first take your distribution from your traditional IRA. But not this year.  Converting can pay off if assets in your traditional IRA are depressed in value.

Switching to a Roth before the assets rise in value will result in a lower conversion tax.

The additional income from converting can trigger higher Medicare premiums. For example, individuals owe a monthly surcharge for Medicare Parts B and D coverage for this year on top of their regular premiums if their modified adjusted gross income for 2018 exceeded $87,000…$174,000 for married people who filed a joint tax return.  These figures will be somewhat higher in 2020 for figuring 2022 monthly surcharges.  Income from converting to a Roth IRA is included when calculating modified AGI, so doing a Roth switch this year could lead to higher monthly surcharges in 2022.

Converting can also subject more of your Social Security benefits to tax. 

You don’t need to convert the entire amount to a Roth in one swoop. You can transfer the money in increments over time and space out the tax hit.  Another thing to consider: You can’t undo the conversion for tax purposes. Prior to 2018, if you converted all or part of a traditional IRA to a Roth IRA, you had until Oct. 15 of the year following the conversion to undo the switch and eliminate the tax bill by transferring the funds back to a traditional IRA.  This is called a recharacterization and usually made sense if the Roth lost money after the conversion, as some retirement accounts have done since Jan. 1. Unfortunately, the 2017 tax reform law ended recharacterizations of Roth conversions. You can still convert your IRA to a Roth, but you won’t be able to undo it later. So, if you do a Roth conversion, you are stuck with your original tax bill, even in cases where your IRA assets go down in value after the conversion.

A temporary tax law change helps people who donate lots of cash this year.  The 60%-of-AGI limit on charitable gifts of cash by individuals is suspended for 2020. Gifts to donor-advised funds and private nonoperating foundations are excluded. The easing applies only to charitable cash contributions made this year and deducted on the 2020 Form 1040 or 1040SR that you will file in 2021. Carryovers of excess charitable contributions from prior years don’t get the break.

 Employers must suffer economic hardship from the COVID-19 pandemic to qualify for the break. Eligible employers are those who had to close shop or reduce hours because of a governmental order, or whose gross receipts in a quarter have declined by over 50%, compared with the same quarter in 2019. Tax-exempt groups qualify.

 The credit is 50% of up to $10,000 in qualified wages paid per employee…  So, the maximum credit is $5,000 per worker. Qualified wages are wages paid from March 13 through Dec. 31 of this year and depend on the number of employees in 2019. For firms averaging more than 100 employees, qualified wages are wages paid to employees who aren’t providing services. For smaller firms, all wages are qualified.  Qualified wages also consist of the firm’s cost of employer-provided health care, including the employer’s cost of health coverage for unpaid, furloughed workers. Qualified wages do not include wages computed in figuring the new payroll credit for providing mandated paid sick and family leave to workers affected by COVID-19.

The credit offsets the employer’s 6.2% share of Social Security taxes…  With the excess refundable. Employers claim the credit on Form 941.  They can get the breaks quickly by reducing employment tax deposits otherwise owed to IRS by the amount of payroll credits the business qualifies for. Employment taxes that can be reduced include withheld federal income tax and the employees’ and employer’s shares of Social Security tax and Medicare tax.

Firms can seek advance payment for credits in excess of payroll deposits by filing new Form 7200. Employers can fax the 7200 to IRS at 855-248-0552. Employers will need to reconcile the payroll tax credits, reduced deposits and any advance payments they got when they file their quarterly Form 941.

The provision in the stimulus law that suspends RMDs for 2020 applies to IRAs; defined-contribution retirement plans such as 401(k)s, 403(b)s and 457(b) plans from government employers; and the Federal Thrift Savings Plan.  Owners of inherited IRAs and plans also qualify for the RMD waiver.

Here’s a COVID-19 retirement-related easing that hasn’t got much attention: The 10% fine on pre-age-59½ payouts from retirement accounts is waived on up to $100,000 of coronavirus-related distributions in 2020 from 401(k)s, 403(b)s and IRAs. A coronavirus-related distribution is defined as a payout to an individual who experiences financial difficulties from being diagnosed with COVID-19; who has a spouse or dependent with the disease; or who was laid off, furloughed, saw reduced work hours or had child care issues. The administrator of the plan can rely on the individual’s written certification that he or she meets the conditions.

Employer retirement plans such as 401(k)s are not required to adopt this easing.  Income tax on coronavirus-related distributions can be paid over three years, beginning with the payout year, unless the individual elects to pay the tax all at once. Individuals will use new Form 8915-E to spread the tax on payouts from plans or IRAs.  Amounts recontributed within the three-year time span won’t be taxable. They will be treated as rollovers, and the federal income tax that was paid on the distribution can be recovered by filing an amended return on Form 1040-X.

IRS gives bad news to small firms that take out paycheck protection loans:  The businesses can’t deduct expenses that result in forgiveness of the loan. The stimulus law says that loans forgiven under the Paycheck Protection Program are nontaxable. But the legislation is silent on whether expenses that are funded by the PPP loan proceeds, such as payroll costs, utilities, and rent, are tax-deductible in cases where the loan is forgiven. IRS answered that question in public guidance. To prevent a double tax benefit, the expenses are not deductible (Notice 2020-32).  Congress may need to provide a legislative fix. And that is definitely possible. Did you file a 2019 1040 and elect to apply your refund against 2020 taxes?  You could file a superseding return and get the money paid to you this year if you need the funds. Just file another Form 1040 by the July 15 due date. The second return supersedes the first one and becomes the original return filed. You will have to send the Revenue Service a paper copy of the second 1040.

 Data analytics are increasingly the norm in IRS’s enforcement arsenal. Data-mining software can sift through taxpayer information, expose suspicious activity, identify cases for audit and pull together evidence for cases that go to court. The technology also boosts efficiency, a bright spot for an agency lacking in resources.