Let the Debate Begin: Waiting for Tax Reform Details

Posted on Apr 25, 2017 in Community, Philanthropy, Planning, Simplicity, Tax

Now that your 2016 tax return is behind you, you might be thinking about how tax reform changes expected under the Trump Administration might affect you. We are expecting a big announcement tomorrow, but despite some advance hype of “massive” changes, we’re likely to get only minimal details. The tax code is 4,029 pages and covers a multitude of taxes and entities. Tax reform, like Repeal and Replace, is going to take longer than originally planned.

The Big Three Goals of current tax reform proposals are:

1-Reduction of the corporate tax rate
2-Lower tax rates on individuals (reducing tax brackets from 7 to 3)

In general, Republican proposals strive to broaden the tax base and lower tax rates. Under the banner of freedom and personal responsibility, these proposals support the idea that government should be as small as possible, providing minimal benefits to individuals, but counter that with lower tax rates, meaning more after-tax dollars in pocket, with which people are free to do what they want.

What are the things to watch for tomorrow? Here’s what I’ll be watching for:

1. Corporate tax rate: Republicans originally wanted a 20-25% top rate, which even they felt was unrealistic. Expect Trump to hold out for the 15% corporate rate he campaigned on.

The argument for a lower corporate tax rate is one of global competitiveness. The Tax Foundation reported that the US ranks 32 of 43 countries in the OECD in terms of international competitiveness. Note that the Tax Foundation is the oldest non-profit think tank in the country, described as an “independent tax policy research center” but it is also noted for a conservative, business-friendly bias.

The top US corporate tax rate is 35%. But who really pays this? The US Government Accountability Office (GAO) issued a report in March 2016 that reviewed US corporate taxes over a five-year period. “From 2008-2012, profitable large US corporations paid, on average, US federal income taxes amounting to about 14% of the pretax net income that they reported in their financial statements. When foreign and state and local income taxes are included, the average effective tax rate across all of those years increases to just over 22%.”

One of my sources for tax policy research is the Tax Policy Center (TPC), a nonpartisan joint venture between the Urban Institute and the Brookings Institution. From TPC’s perspective, a 15% corporate tax rate would make the US one of the lowest corporate tax regimes – until other countries cut their own rates, as they did after the Tax Reform Act of 1986. It would also create a ginormous loophole for high-income individuals. Under the Trump proposal, the 15% rate would apply to partnerships and sole proprietorships, which would create a huge path for tax avoidance by sheltering wages through such an entity. If the new rules let pass-through entities, such as sole proprietors and LLCs (like this firm) be taxed at the lower corporate tax rate, then that benefits me (and dentists).

Let’s be clear about how this works: it’s not like there is one bucket for corporate tax receipts, and a separate one for individual tax payments, and yet another for payroll taxes. All tax receipts go into the same bucket, and go right out again to pay our collective expenses. Those countries with lower corporate tax rates also have much higher personal tax rates. (The plan in the US is to cut those too – at least at the very top levels. You can guess where this is headed.)

The one bright idea in corporate tax reform proposals is to tie corporate tax rate reform to reform of individual tax rates, potentially aligning rates and eliminating this type of income-shifting loophole.

2. Fewer tax brackets for individuals: The idea is to simplify the tax system. The following chart shows how your tax bracket might change under the proposed simplification.

By the way, this doesn’t come without a cost. The deficit is expected to increase by $6 trillion in 10 years. That’s more than a 25% increase. Your kids and grandkids get to figure out how to pay for that.

Ultimately what you care about is what you have in your pocket, as well as what things you have to pay for (health care, city services, college, retirement, etc). While marginal tax brackets are expected to change, if some deductions and exemptions are eliminated as expected, you could end up paying more in taxes. Fortune magazine took a look at the impact of expected changes on take-home pay, and this is the result:

If you’re in the Top 1% of earners, this works for you.

Hand-in-hand with the compressed brackets are higher standard deductions ($15,000 for a single filer, $30,000 for marrieds).  The higher standard deduction could make your tax calculations simpler by eliminating the need to itemize.  It may also make your tax liability higher, and remove incentives for certain spending and investment.

3. Deductibility of state income tax:  One of the items on the chopping block is the deductibility of state income taxes. Let’s not kid ourselves about this being payback to states that went blue and voted for Clinton. The states most effected: California, New York and New Jersey.

That said, Trump is not the only President to use tax reform to rectify political slights. We have the current rule on the non-deductibility of donations to not-for-profit organizations with a political agenda because President Lyndon Johnson was miffed over a preacher literally using his pulpit to bully Johnson. Trump has suggested repealing the Johnson Amendment, which essentially shut down lobbying activity by 501c3 organizations.

But if you don’t have itemized deductions of at least $30,000 for a married couple (or $15,000 for a single filer), it might not make that much difference to you, and might simplify your tax return.

4. Deductibility of mortgage interest: This is a classic middle- to upper-income deduction on the block. Each household can deduct mortgage interest on mortgage indebtedness up to $1,100,000 on up to two homes (that means loans totaling up to $1.1 million, not a deduction of $1.1 million). So mortgage interest on your house (and vacation home) is deductible up to these limits. What if you hold a multi-million loan on your home? Or own more than two homes? You’re not able to deduct that interest anyway. No skin off your nose.

5. Cap on total itemized deductions & 6. Deductibility of charitable donations: One proposal last summer from House Republicans suggested eliminating all itemized deductions except those for home mortgage interest and charitable contributions. The latest scuttlebutt puts charitable donations on the chopping block too. Or at least capping them.

Trump campaigned on capping all itemized deductions at $100,000 for single people and $200,000 for couples. You might not care about this one either, if you’re not making seven figures. But a lot of support to not-for-profits comes from higher earners. A taxpayer making over $1 million paid an average of $260,000 on state and local taxes according to the TPC. At this point, this taxpayer’s itemized deductions would be capped, eliminating the tax incentive for charitable giving by high earners.

One of the arguments made by those favoring smaller government is that people should have the choice of how their money is spent, and if they want to give to social services and other philanthropic causes, they can give to charity directly. Congress created the charitable deduction 100 years ago this year, to incent Americans to support their communities. With smaller government and a capped or eliminated charitable deduction, the landscape of American society will fundamentally change.  If you are in the camp that believes an American spirit of generosity is in part responsible for the success of capitalism (as I am), things won’t be changing for the better. The “compassionate conservatives” in the Republican Party won’t be happy with the reduction in tax incentives for charitable giving either, as it would affect donations to religious organizations.

7. Limits on donor-advised fund deductions: It’s unlikely we’ll hear anything tomorrow on this detail of the tax code. There are already some limits based on income for large charitable contributions, either directly to an organization or to a donor-advised fund (DAF). A DAF allows a taxpayer to “bunch” deductions for future charitable contributions into a single tax year. I recommend DAF contributions to charitably-inclined clients when they have a windfall, to off-set some of the tax they would otherwise pay in that year. Proposals here have included a time limit on the pay-out of DAF money through grants. Under current law, there is no limit on how quickly you need to make donations from a DAF; some proposals are suggesting funds be distributed to charities in 5 years.

Simpler is not always better. In my view we have the wacky tax code we have due to the same strong special interests we have always had, and because our economic world has grown more complicated. If you think about the tax code as a tool to incent certain behavior, as an example, you get to deduct your mortgage interest and property taxes because as a society we think it’s better for wealth building and maintaining capital stock for individuals to own their own homes. We have other tax rules to rectify imbalances, such as the Alternative Minimum Tax (AMT), which was created because in 1962 it was discovered that a bunch of millionaires were paying no tax, and that seemed unfair. That it was not inflation-adjusted and had unintended consequences years later doesn’t mean it was a bad idea, it means it needed to evolve as the economic landscape did.

For a quick overview of the three main proposals and detail on some of the main changes up for consideration that you may hear about tomorrow, check out

Remember that Trump views himself as a disrupter and a master negotiator, and as such, he’s not likely to start with a centrist proposal meant to bring everyone into the fold. Once we do have a detailed bill to consider, the legislative process begins. That means lots of hearings, followed by changes, more review and comments before the House then Senate vote. But Democrats in Congress are not aligned, and Republicans  may attempt to push through a tax bill with only Republican votes, though they may not have enough.

Alternatively, Republicans can use the Budget Reconciliation process to overcome this legislative hurdle. There are many rules that need to be followed, but it’s possible we’ll get tax reform this way. We got the Affordable Care Act this way under Obama and the 2001 tax cuts under Bush.

To date, there has generally been strong support for tax incentives for retirement savings, home ownership, and some charitable giving. Under the proposals being floated thus far, these tax-preferenced items are expected to have less value in the future.

We’ll find out more tomorrow.

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Planning in the New Year

Posted on Jan 9, 2017 in Community, Family, Planning, Tax

You all know I love to plan. The power of planning comes from setting your intention, and taking action to make it happen. It’s about dreaming, but it’s more about doing.

Starting a new year is a perfect time to set your intention on how you want to affect the world outside your personal sphere. I know I’m not alone in that while I am glad to put 2016 behind me, I’m not altogether too sure about 2017. All the more reason to have a plan about how you want things to go down. It can be overwhelming to figure out where to start. So start at the beginning:

1. FOCUS – Ask yourself what the top issue is for you – it’s overwhelming to try and solve all the world’s problems at once. Believe me, my mom and I tried over numerous cups of coffee. What is the area that you feel most concerned about protecting? Civil rights? Climate change? Women’s health? Choose one (or two, tops) and put your energies here.

When we’re talking about your portfolio, diversification is beneficial. For philanthropic investments, concentrating your giving – of time and money – focuses your precious resources on the specific goal you want to support, and can enhance your involvement in something you care about.

2. Next, DECIDE how you’d like to help. There are three main ways to support the causes that matter to you:

• Gifts to traditional charities
• Gifts to not-for-profits with a political agenda
• Gifts of action

Gifts to Traditional Charities
Our tax code currently provides some incentive for charitable giving, allowing a tax deduction for giving to not-for-profit – and generally non-political – groups. We’re entering a whole new world this year, both with potential changes to the tax code and changes in the political climate.

We don’t yet know how the changes to the tax code will affect charitable giving from a tax perspective. One thing we can know with some certainty is that there will be less spending of our collective tax dollars for social services or human rights protection. Organizations that work in these areas – food banks, civil rights groups, women’s health – are going to need your help more than ever. If they are 501(c)3 organizations, you can take a tax deduction to the full extent of the law as it stands now.

From what we have heard thus far, the new administration is proposing tax reform that stresses simplification, part of which would reduce the number of tax brackets and substantially increase the standard deduction (from $6,300 to $15,000 for single filers, $11,500 to $30,000 for jointly-filed tax returns). Meaning many people who may have itemized and received a tax benefit for charitable giving will now receive no additional tax benefit from this unless their total itemized deductions exceed the standard deduction.

Gifts for Political Action
There are many reasons to give beyond a tax deduction, and giving to groups that lobby or otherwise take political action may now be on an equal footing tax-wise with giving to tax-exempt organizations. Some not-for-profit groups which lobby or otherwise participate in political campaigns don’t have 501(c)(3) status, so your donation may not be tax-deductible.

It’s easy to get overwhelmed by the many areas of need, and you’re going to need to pick your battles. On one of his first post-election shows, comedian John Oliver of Last Week Tonight offered a solid list of organizations you may want to help. Oliver made a very serious call to action on his program, noting that until now we’ve generally felt that the rights of all Americans would be protected by those in Washington. But many may feel that will no longer be the case, and some groups will need help under the new administration. He organized his list by cause:

Women’s health: Planned ParenthoodCenter for Reproductive Rights           

Climate change: Natural Resources Defense Council

Refugees:  International Refugee Assistance Project

Civil rights: American Civil Liberties UnionNAACP Legal Defense FundThe Trevor Project,

Mexican-American Legal Defense and Education Fund

All of these groups, with the exception of the ACLU, are 501(c)3 organizations and donations to them are tax deductible to the full extent of the law. Note you can donate to the ACLU Foundation to make a tax-deductible gift to support their work on civil rights issues.  Here’s a description of the difference: Giving to ACLU or ACLU Foundation: What is the Difference?

If you want to make your own list — and not rely on one from a fake news show — check out Charity Navigator or Guidestar to search for organizations doing work you want to support. You can search by area of interest.  On Charity Navigator you can start with its Perfect 100, charities that execute their missions such that they’ve received top marks for good governance.

Gifts of Action
You may want to take action beyond writing checks. While you can blog and tweet and email and post about how the world should change, coming together with others is what creates a message that cannot be denied.

You can do this without leaving your house. Just last week, plans to alter the House of Representatives independent Office of Congressional Ethics (OCE) were scrapped after thousands of phone calls opposing the move tied up Representatives’ telephone lines. The fight to curb the power of the OCE was not new, nor was the tool used to voice disapproval. You have your First Amendment Rights for a reason. Likewise, over dinner recently with a long-time friend, she surprised me by saying if the new administration rolls out a Muslim registry, she’s planning to register. She is not Muslim nor of a targeted ethnicity. It was her way to disrupt a rounding up of people according to religion or ethnicity, and she was betting it was unlikely that the authorities would come round to arrest a white, middle-aged mom in the suburbs.

I felt obliged to remind her that that was a reasonable bet now, but perhaps not in the future. (See point #3, below).

3. If you plan to act, PLAN to act

You know this is all really leading up to some planning. Whether you give money – for a tax deduction or not – or decide to take action yourself, make sure you plan for it. It will take time out of your already busy lives, to research a charity, to call your Congressperson, or better still, to show up en masse at his or her office. To work on a committee, to meet up with others to plan, to work, to act. It will use nights, weekends, vacation, PTO. And you’re going to need to protect yourself when you do.

When I was in graduate school, a visiting professor taught a course on ethics. I was skeptical about what ethics you could teach to MBA students, but her approach was pragmatic. Specifically, she talked about how to be prepared in case you found yourself working somewhere in which you found corporate behavior to be illegal or unethical. There is often an enormous toll for speaking out, not only in legal costs but in damage to your career in the short- and sometimes long-term, to your social and professional networks, personal financial security, and to personal health. At a minimum, you need to be able to walk away. We all want to be the kind of person who acts when needed, but not everyone feels they can for some of these reasons.

One of the things she taught us was to have a cash reserve. Yes, I’ll always recommend you have an emergency fund. Beyond cash for a short-term shortfall, consider building another kind of reserve. Have “pin money,” bail money, a Go F*ck You Fund, a reserve in case you need to make a change, or end up at Santa Rita after your weekend activities.

A Brave New World
Progress often feels like two steps forward and one step back. We are at the beginning of a new cycle for social justice, and things are going to get bad before they get better. It’s going to take work and sacrifice to make progress. Civil rights, women’s rights, human rights all seem under threat as we move into this New Year.

You can leave it to others. 56% of Californians and 39% of Washingtonians did not vote, they left the decision to others. Don’t leave the work to others. Plan for your part in it, whatever that is.

I’m encouraged by the numerous people in the media, experts in disparate professions, and yes, even some politicians, who understand what is at stake and who are ready to put their time and effort towards moving us forward. Find your cause, find others working towards the same goals, find your tribe. At a minimum, it’s an opportunity to get to know your neighbors, co-workers, kids, parents in new ways. It’s our connection to others that gives us a rich life, and believe it or not, this year and beyond could prove to be some of the most moving and meaningful times we might have. It takes courage, and time and effort. Set your intention: what do you want to look back on with pride at the end of this year? It is a New World in this New Year, and we need to be brave in it.

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A Post-Election Note

Posted on Nov 9, 2016 in Community, Investments, Planning, Tax, Women

Like me, you may have felt that the world would look different this morning (if we even woke up at all) after the results of the presidential election. And yet, the sun rose, the day began, and here we are.

What we know after the election is that our country is seriously divided. As we saw when we elected Barack Obama, we want real change. The trouble as I see it is that the direction in which President Trump will lead us will be more of the same. Right now, markets — and the people who make them up — are orderly. There may come a time when the emotions that drove this election will react negatively to a lack of any real change.

Here are a few thoughts on what comes next:

Economics – We have limited specifics on Trump’s plans for “national growth and renewal” in the economy, but there are echoes of Reaganomics: lower taxes, relaxed regulation, big government spending. If the fiscal stimulus he plans repairs and expands our infrastructure, that’s a plus. Reduced regulation (such as repeal of the new DOL Rule (which requires advisors to your 401k to act in your best interest), repeal of Dodd-Frank (Wall Street reform), repeal of the Affordable Care Act) means you’ll be more on your own to protect your interests.

Taxes – We can expect lower taxes, at least on higher earners. I am doubtful Trump’s plan to bring overseas corporate earnings home; if he is able to do this, that’s again a plus for higher earners. Given the structure of our Federal budget, we can’t grow our way out of a deficit spending situation, so lower taxes means increasing deficits.

The World – We are more connected globally than ever, and building walls and reducing trade is likely to hurt us economically, as well as in our leadership role in the world. Bombastic rhetoric in discussions with other leaders and nations could have dire consequences.

The Rhetoric – The most difficult part of the campaign for me has been the vitriolic, threatening language that stirred up some of the ugliest facets of the American character. As a woman, I feel unheard, less safe and decidedly second-class. But I believe we can’t change what we don’t acknowledge, and we must admit this election cycle has revealed a dark side we have wanted to ignore. How we continue the conversation around these issues and change them is the real challenge.

Markets are mixed this morning, after some strong negative indications overnight. We can expect to see more volatility in the months and years ahead, and increasing economic inequality. What we can do is focus on what we can control: diversifying the risk in portfolios, organizing your accounts for tax diversification and to keep expenses as low as possible, saving more, and when we spend, spending with intent.

The table next to mine at the Election Watch Party I attended last night joked that at least here in California we also passed a recreational marijuana law, which we’ll need all the more after this election. (To be clear: I don’t recommend that as a personal financial strategy.)

In the meantime, we need to continue the conversation, and fighting for what we believe: “Let us not lose heart in doing good, for in due time we will reap if we do not grow weary.”

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What Is Tax Loss Harvesting?

Posted on Sep 27, 2015 in Investments, Planning, Tax

Part of what a good financial advisor does is help you respond to changes in our economic environment. Sometimes that includes managing your money when markets are behaving badly. No advisor has a crystal ball, and financial markets will go up and down. When they go down, what can you do about it?

You can sell, hold, or tax-loss harvest. For many investors, taking investment gains and harvesting tax losses can be an important tool for reducing taxes now and in the future. If used properly, this active tax strategy can save you money and help keep your portfolio diversified. It won’t restore your losses, but it’s a silver lining in a dark economic climate.

What is “tax loss harvesting”?  Investment losses have tax benefits. Selling and staying out of the market locks in your losses, but it gives you a tax break. Continuing to hold a security that has lost value means you stay invested, but you have to wait for markets to make up for the decline in your holding. With tax loss harvesting, you sell an investment that has experienced a loss in value, but replace it with a similar one, realizing a tax benefit while maintaining your target asset allocation.

Benefits of tax loss harvesting are two-fold:

  • You have a store of tax losses that can be used to off-set future gains, and
  • You have up to $3,000 each year in tax losses to use against ordinary income

How does this work?  Investments fall into asset classes: Short-Term Bonds, Large-Cap Stocks, International Developed Markets, and the like. Let’s say you invested $10,000 in XYZ S&P 500 Fund. As you likely know, the S&P 500 index tracks a list of 500 large US companies, so in our example, our investment in XYZ gives us a holding in Large-Cap Stocks.

You hold on to XYZ S&P 500 Fund for a couple of years, it goes up and down, and then we have a financial downturn. The value of your XYZ S&P 500 Fund holding falls to $6,000. While this may start the acid in your stomach churning, it’s helpful to take a deep breath and not panic. You are a long-term investor and know that markets have cycles, downturns are temporary, and the S&P 500 will recover (if it doesn’t, we have bigger problems). So you want to stay invested in the market, but who knows how long it will take to recover your losses.

If you sell your holding, you have a tax benefit in the form of the $4,000 investment loss ($6,000 current value of your investment – $10,000 purchase price, or cost basis). Let’s say you sell and take your tax loss. But then you’re out of the market. A better strategy might be to take your losses – but stay invested:

SELL XYZ S&P 500 Fund; take the $4,000 tax loss  THEN

BUY ABC Large Cap Fund

 ABC Large Cap Fund is also in the Large-Cap Stock asset class, just like XYZ S&P 500 Fund. You have “banked” the tax loss from your original investment, and stayed invested in the same asset class by investing in a similar fund. You won’t miss out on a recover in large cap stocks, and you don’t have to try to time the market to do it.

The Benefits   When you file your tax return for the year, let’s say you have $500 in capital gains from other investments. You can use $500 of your tax losses to off-set the $500 gain (saving you $75 in federal taxes if you’re subject to the 15% capital gains tax rate). You can then use $3,000 from your “tax loss bank” to off-set ordinary income (wages, interest income, etc) on your tax return. At a 25% marginal tax rate, that saves you $750. You also have $500 in tax losses remaining from the original $4,000 that will carry-forward to the next tax year.

The Rules   The IRS won’t let you simply sell an asset for a loss and immediately buy the same asset solely for the purpose of paying less tax. The loss will be disallowed if the same or substantially identical asset is purchased within 30 days. This is called the “wash-sale rule.” After the 30 days have passed, you can buy the asset you sold and still have the tax loss.

But you can immediately purchase a similar asset that is highly correlated with the one you’ve sold if you don’t want to wait the 30 days. Correlation means the two investments move up and down together in response to market changes. We wouldn’t expect stocks to change in value in the same way bonds would, given a certain economic hiccup; they are not highly correlated. But we would expect an S&P 500 fund and a Large Cap Stock fund to move closely in tandem.

Other Considerations To effectively use tax loss harvesting, you’ll need to consider transactions costs. How much is it going to cost you to buy and sell? If it costs you $10 each trade and your loss was $40 instead of $4,000, it doesn’t make sense to harvest your losses. Also, tax loss harvesting is only for taxable accounts – 401ks, 403bs, 457s, and IRAs are all tax-protected and as such have no tax loss/gain that you experience along the way. Additionally, transacting every time the market goes down can be costly from a tax-preparation standpoint. Lastly, with the latest round of “tax simplification” we now have four different capital gains tax rates, so a loss banked now may not always help you more later.

We can’t do anything about fluctuations in the market, but you can be smart about managing your own “harvest time” and taking tax losses carefully, while remaining invested in down markets. In this case, we saved $825 in tax, with a carry-over benefit to enjoy in future years. Research has shown regular tax loss harvesting to improve portfolio performance by 0.50% to over 1%. During the Financial Crisis in 2008-09, savvy advisors were “banking” losses for clients through tax loss harvesting, keeping their clients invested in the market so they enjoyed the tremendous growth we’ve experienced since then, while using a chunk of their tax losses each year to offset gains. Tax loss harvesting is one way you can take an active role in managing your portfolio with a strategy based on opportunity created by tax law, not market speculation.

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Tax-Diversify Your Portfolio Part 3: Back-Door Roth IRAs – Advanced

Posted on Apr 1, 2014 in Philanthropy, Tax

For those of you with income higher than the limits to contribute directly to a Roth IRA, you can still achieve tax-free savings through a “back door” Roth strategy: contributing first to a Traditional (non-deductible) IRA, followed by conversion to Roth.

This “Contribute-then-Convert” strategy provides a tax efficient way to tax-diversify your accounts provided that you do not have other IRAs that contain pre-tax contributions.   These IRAs with pre-tax savings include rollover IRAs from 401ks or 403bs, and SEP-IRAs from self-employment.  The existence of these other IRAs changes the math involved in the conversion calculation, and lessens the tax efficiency of the strategy.  The non-taxable part of a Roth contribution is calculated according to the following formula:


Tax basis of all IRAs

——————————————————            X   Amount of IRA converted to Roth = NONTAXABLE

Value of all IRAs at end of year of conversion


Example: If you had contributed $11,000 to a Traditional IRA (and taken no tax deduction), you have an IRA with a tax basis of $11,000 (the total of after-tax contributions).  If you convert that IRA to a Roth when its value is $11,050, the non-taxable part of the conversion is ($11,000 / $11,050) x $11,050 = 0.9955 x $11,050 = $11,000.  $11,050 converted – $11,000 not taxable = you’ll owe tax on $50.

Example: Same facts as the previous example, but now let’s say you also have a rollover IRA (all pre-tax savings from a 401k) valued at $100,000. If you convert the $11,050 IRA to a Roth, you’ll have to include the $100,000 balance of the rollover IRA. In this case, the non-taxable part of the conversion is ($11,000 / $111,050) x $11,050 = 0.0991 x $11,050 = $1,095.  $11,050 converted – $1,095 not taxable = you’ll owe tax on $9,955.

In each case, you only converted $11,050 to Roth, but the tax consequences were vastly different, given the presence of the other IRA money.


If you have other IRAs with pre-tax savings that will dilute your Roth conversion, there are some things you can do.  The effort to tidy up accounts to lay the foundation for a tax efficient Contribute-and-Convert strategy is not immaterial.  But the long-term benefits are numerous:

  • Never having to take taxable required minimum distributions
  • Tax-free compounding on savings until you need the money
  • When you need your Roth savings, you can take it out tax free
  • Your heirs can take it out any income from a Roth you leave them tax free
  • A Roth can reduce the impact of the new American Taxpayer Relief Act of 2012 (“ATRA”), which brought back the phase-out of itemized deductions and gave us the new net investment income tax
  • If you believe your accounts will grow in value, converting a smaller account balance results in a smaller tax liability today, with any future growth now occurring in a tax-free account

Here are some tips if you find yourself in a Roth conversion situation complicated by other IRA assets:


Planning Tip #1: If You Have an Old IRA – Roll It to Your 401k

Many employer plans will accept rollovers of previous employer’s plan balances.  If you rolled a previous employer’s 401k or 403b to a rollover IRA, check with your current employer’s plan administrator to see whether you can roll those old retirement plan funds into your current plan.  You need to complete this “roll-up” of your old 401k/403b into your current plan in the tax year before you convert any other IRA balances to Roth. One drawback of using your existing employer plan is that will be limited to the investment choices in your plan. 


Planning Tip #2: If You Have an Old SEP – Roll It to Your New Solo 401k

If you are self-employed, you can use a variation on Tip #1.  While a SEP-IRA would be included in the Roth conversion calculation, a Solo or Independent 401k (available to self-employed workers) would not be.  You can roll a SEP into a Solo 401k, and that takes the SEP-IRA out of the Roth conversion calculation, provided you moved the SEP to the Solo 401k in the tax year before the conversion of any other IRA balances to Roth.  Note that here you would not necessarily be limited in your investment choices.


Planning Tip #3: If You Have an Old IRA – Accelerate Charitable Giving

If you can’t move an old IRA with pre-tax savings into a qualified retirement account (i.e., 401k, 403b) and you are charitably inclined, you could accelerate your charitable giving using a donor-advised fund (DAF)  to “bunch” future years’ giving into the tax year of the conversion.  You need to consider your long-term financial needs, but if you can afford it, your contribution to a DAF in the year of a Roth conversion can help off-set some of the tax from the conversion. 


Planning Tip #4: Note Each Spouse Treats His/Her IRAs Separately

Sometimes one member of a client couple can do a tax efficient conversion, while the other cannot, so we look at conversion of each person’s accounts.  Note that the Roth conversion calculations for couples is based on what each spouse owns;  if he has a rollover IRA that would make a Roth conversion strategy less tax efficient, and she has no rollover IRA, she can do a tax efficient Roth conversion.  His rollover IRA does not affect her Roth conversion calculation, even if they are filing a joint tax return.


Satori Financial LLC has been working with clients over the past several years to clean up their IRA accounts, rolling them into existing 401k and other employer plans where possible when the investment choices in those plans are solid, to great tax advantage.   The rules can be complicated, so proceed with caution, or better still, seek advice from a tax professional familiar with Roth IRA conversion strategies.  Contact Satori Financial LLC to see how we can help you. 

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Tax-Diversify Your Portfolio Part 2: Back-Door Roths – Contribute & Convert

Posted on Mar 31, 2014 in Tax

The uncertainty of future income tax rates makes planning for taxes more critical.   Effective IRA planning is one way to achieve tax diversification to manage this uncertainty.

As noted in Part 1 of this series, you may be limited in your ability to contribute directly to a Roth IRA. But you can use a “back door” strategy to convert non-deductible contributions to a Traditional IRA to Roth, and thus make tax-deferred savings tax-free.

Tax-Free Savings

If you are not eligible for the up-front deduction of a Traditional (deductible) IRA, you may be eligible to contribute to a Roth IRA.  Roth IRAs don’t give you an up-front deduction, but earnings are tax-free under current law.  For tax diversification, this can be a better option that the deductible IRA.  But you are only eligible to contribute if you have MAGI below certain limits:

 Roth Contribution Limits Based on MAGI


Can contribute

Up to maximum

Can contribute

reduced amount

Cannot contribute

to Roth

Single <$112,000 $112,000-$127,000 $127,000+
Married Filing Jointly <$178,000 $178,000-$188,000 $188,000+


Contributions with No Income Limits

Despite these income limitations for Roth contributions, taxpayers with any level of income can contribute to a Traditional (non-deductible) IRA.  You won’t be able to deduct your contribution, but the earnings will grow tax-deferred.  And despite your level of income, you can then convert the Traditional IRA to a Roth IRA with little or no tax cost.


The Contribute-and-Convert Strategy

When you convert the Traditional IRA to a Roth IRA, you will only be taxed on any earnings.  If you made a $5,500 contribution to the Traditional IRA and it’s worth $5,510 at the time of conversion, you will only owe tax on the $10 of earnings.  Because your contribution to the IRA was made with after-tax dollars (i.e. you didn’t receive any tax deduction for the contribution), you have what is called basis in the IRA.  These dollars have already been taxed, and won’t be taxed again on conversion.

After conversion, the savings now reside in a Roth IRA, where earnings will grow tax free under current tax law.

A $5,000 contribution earning 5% annually will grow to $18,625 in 25 years.  The Traditional IRA account may have provided a $1,540 deduction at the time of the contribution, but it comes with a deferred tax bill of $5,215 on distribution, assuming a 28% marginal federal tax rate.

Beyond tax-free growth, Roth IRAs offer flexibility in pre-retirement distributions: you can always withdraw your contributions without penalty, and you are not required to take distributions from these accounts after age 70-1/2 as you are with other IRAs and 401ks (including Roth 401ks).  This flexibility make Roth IRAs excellent vehicles for savings that could be used for multiple goals (retirement, education), and make ideal assets to leave to future generations.

Don’t hesitate to consult your tax professional about your options – but note that many may not be familiar with the contribute-and-convert strategy, or may be partial to reducing all taxes today, without planning strategically for flexibility in the face of future tax rates.  Contact Satori Financial LLC to find out how we can help you determine your Roth contribution or conversion options.

If you have other IRAs, the Contribute-and-Convert strategy isn’t as tax efficient.  See Part 3: Back Door Roth Conversions-Advanced if you have any rollover, SEP or other IRAs with pre-tax savings.




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