In last month’s visit I gave you the main course from the buffet of changes in the latest tax law, enacted in July. There was a lot packed into that law, so here are a few side dishes you should know about.
Roth IRAs. Most people are concerned with putting money into Roth IRAs or converting regular IRAs into Roths. But Congress took the opportunity to refine the rules on withdrawals from Roth IRAs.
The general rule is that to get the favorable treatment of distributions, the Roth IRA must be open for five years. The latest law clarifies that the five-year rules does not apply to each contribution you make to the Roth IRA. The Roth IRA itself has to be open for only five years for any distribution from it to receive the best tax treatment. You don’t establish a separate five-year holding period for each contribution or conversion.
This can be a good planning tool for those of you who won’t convert a regular IRA into a Roth IRA this year but might in a few years. It makes sense for you to open a Roth IRA this year with a small contribution (if you have earned income). That gets the five-year holding period started and lets you take tax-free distributions from a future conversion sooner than you would have.
Last month I told you that if you convert to a Roth IRA this year and pay the taxes over four years, the tax payments are accelerated if you take a distribution before the four years is up. That four-year holding period still stands. The five-year holding period I just discussed applies only when you are not paying taxes over four years after a conversion.
Another Roth IRA change is the “ordering rules.” Roth distributions could be subject to penalty taxes, especially if withdrawn before age 59½. When a Roth IRA includes both converted amounts and regular contributions, you don’t determine which are withdrawn first; the tax law does. The first withdrawals are considered to be regular Roth IRA contributions, followed by converted amounts in the order they were converted. Investment earnings are withdrawn last. These rules matter only if you withdraw money early so that it might be subject to penalty taxes.
Family business estate planning. A big benefit of the 1997 tax law was that it increased the exempt amount of each estate, and added an additional exemption for a family-owned business, allowing up to $1.3 million to pass tax free. But there was a lot of confusion about the family business exemption, so Congress refined this in the latest law.
The law makes a number of technical changes, the details of which should concern you. But the bottom line is that more of the family-owned business is likely to qualify for estate tax benefits than under the original version, and your executor has options that allow him or her to choose the best result for you r estate.
The bad news is that to get and keep the estate tax benefits, the family must continue to own and operate the business for another 10 years. The rules are complicated, and a small change in ownership or management could trigger a big bill for your heirs down the road. So you must be sure that the tax rules will work for your family.
Gift tax protection. The IRS, supported by the courts, has claimed that it can revalue a gift anytime it wants to. The revaluation won’t let the IRS impose additional gift taxes on you if the three-year statute of limitations expired. But because of the way estate taxes are computed, the revaluation could trigger higher estate taxes.
Congress decided that it is a bit unfair for the IRS to be able to revalue a gift after many years have passed and the donor has died. So the new law lets you protect your estate from revalued gifts. Under the new law, the IRS cannot challenge the valuation of a gift after the gift tax statute of limitations has passed if the gift was adequately disclosed.
That means you can save your heirs a lot of trouble by filing a gift tax return for non-cash gifts when there is any question about their valuation. Proper disclosure to the IRS means the issue will be closed after three years. But failure to disclose means the issue will be open until your estate tax return is closed. When in doubt, file a gift tax return.