10 July 1998
The New, Friendly IRA. Congress has passed the IRS Restructuring and Reform Act of 1998 and Mr. Clinton has indicated that he will be signing this legislation. The primary thrust is a managerial reorganization aimed at correcting the abuses that came to light during last year's Senate hearings.
There are also several taxpayer friendly procedural changes. For example,
You are charged interest when you underpay a tax liability and you are paid interest on tax refunds. However, the IRS had been charging a higher interest rate on taxes due than it had been paying on tax refunds. The legislation corrects this anomaly.
There is good news for those unable to pay their taxes. The legislation halves the failure to pay penalty (but not interest) if you pay in installments and makes it easier to reach a compromise with the IRS when you are unable to pay the full tax liability.
If a dispute goes to court, the IRS has to prove you wrong on the factual issues. Be aware that this shift in the burden of proof only applies if you have "cooperated with reasonable requests for information" and thus the IRS could maintain their guilty until proven innocent attitude by claiming you have not been cooperative.
The legislation extends attorney client confidentiality to enrolled agents and CPAs. Thus you are no longer required to disclose my advice on tax planning or strategy. In addition, you will have more opportunity to quash a summons for any of your records in my possession. This privilege is limited and does not apply to the Franchise Tax Board or to other state tax situations. It also does not apply to the information used in preparing your tax returns nor in criminal investigations.
The legislation makes important changes to the Roth IRA.
Roth Conversions can be reversed before you file your tax return. This is an important change for taxpayers whose modified adjusted gross income is close to the $100,000 MAGI ceiling. Previously, if you ended the year a few dollars above the ceiling, a conversion would have been reclassified as a withdrawal, meaning accelerated taxes, the loss of future tax sheltering and possible penalties.
Minimum required IRA distributions after age 70« will not be counted in the $100,000 ceiling - beginning in 2005.
The tax on 1998 conversions can be paid in four annual installments or with your 1998 tax return. Recognizing all the income in 1998 could be attractive if you have an AMT carryover or if your income will be a lot higher in the next couple of years.
There are new, complicated penalties if you withdraw from a Roth IRA within the first few years after conversion. These penalties should not be of concern with a properly designed conversion strategy, however.
California may adopt these changes, but it has not yet done so. My recommendation is to make your conversion decision in the fourth quarter. Be sure to review your fourth quarter estimated tax payments. Give me a call if I can be of assistance.
The new legislation also eliminates the 12 - 18 month holding period for capital gains effective January 1, 1998.
Gains are taxed at a 20% maximum rate if held more than one year.
There will probably be no requirement to file a Schedule D if the only gains are from mutual fund distributions, as was the rule before 1997. This will be a simplification for many taxpayers and is one of the reasons for the change.
California does not have a special tax rate for capital gains.
I have mentioned only a few of the new provisions. The full text can be found at http://thomas.loc.gov; look for HR 2676 (enrolled version) or Committee Report 105-599. There is also a nice analysis entitled "Tax '98 Legislation Highlights" at http://www.cch.com. Give me a call if you have trouble locating these citations or if you have questions about how the legislation applies to your situation.
Stock Market Performance. My diversified benchmark of stock index funds was up 15% in the first half and has advanced at annualized rates of 24, 29 and 21% over the trailing one, three and five year periods, net of expenses. Values have increased substantially more over the last five years than one might have predicted from historical data. I hope that this reflects a permanent gain in performance, but I doubt it.
Since there probably will be a market correction one day, should you make defensive changes to your portfolio? It would certainly be prudent to review your stock and bond valuations and to cut back on stocks if they have appreciated above your target ratio. It would also be prudent to review your diversification among asset classes (e.g., US vs. international stocks vs. real estate) and among investments within an asset class.
I'd approach other changes cautiously since timing the market is notoriously difficult.
I hope that you and your family are enjoying a pleasant summer and that your garden is handling our unseasonably cool weather better than my garden is. As always, feel free to call or e-mail me with your tax and planning questions.
Sincerely,
Peter James Lingane
Addendum. Mr. Clinton signed the IRS Restructuring Bill into law on July 22, 1998.
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