Should You Convert to a Roth?
Key questions to answer
Is this the year you finally convert to a Roth IRA? It could be if it makes sense for your situation, but there are numerous factors that come into play. Do not make any rash decisions.
Basic premise: Generally, distributions from a traditional IRA are fully taxable at ordinary income rates reaching as high as 37%. Also, traditional IRA payouts may trigger or increase the 3.8% net investment income tax (NIIT) due to the way it is calculated. In contrast, qualified distributions from a Roth IRA in existence at least five years—including those made after age 59½—are completely exempt from tax. Other Roth distributions may be wholly or partially tax-free under special “ordering rules.”
However, a Roth conversion is currently taxable and that is often the problem. Here are several questions you should answer before you convert.
Q. Can I afford the current tax?
A. Determine if you will have to tap into your retirement funds to pay the conversion tax. This will erode your nest egg and could actually hurt more than a conversion will help. The more money you convert and the higher your tax bracket, the bigger the tax hit.
Q. What is your expected tax rate in retirement?
A. If you anticipate being in a significantly lower tax bracket when you receive payouts than you are in now, it may be easier to absorb tax on those future distributions than it is to pay a conversion tax this year. Conversely, if you expect to be in a higher or the same tax bracket in retirement, a current conversion may be suitable, absent extenuating circumstances. To complicate matters, tax rates could change in the future.
Note that you may be able to reduce the tax fall-out by making a series of conversions over the course of time.
Q. What are other expected sources of income in retirement?
A. If the bulk of your assets needed for retirement have been salted away in vehicles like growth stock and a 401(k) account, a Roth conversion may provide the flexibility you will need later in life. It may help meet your lifestyle or estate planning objectives without triggering tax on every withdrawal. Because you do not know how the tax structure might change over time, it may also be a good idea to build some tax diversification into your accounts.
Q. How do you plan to pass retirement assets to your heirs?
A. With a traditional IRA, you must begin taking required minimum distributions (RMDs) for each tax year, beginning by April 1 of the year following the year you turn age 72 (recently increased from age 70½). For each subsequent tax year, the RMD must be taken by December 31 of that year. But there are no mandatory lifetime distributions with a Roth, giving it an edge for those who want to preserve more funds for their heirs.
This is just the tip of the iceberg. There are other considerations that go into the decision to convert to a Roth IRA or not. Practical advice: Analyze your personal situation with assistance from your professional tax and financial advisors.
Spending Time on Corporate Minutes
Seek protection for your company
Naturally, it takes some effort to record the “corporate minutes” of a business. But it is usually time that is well spent. Plus, it is easier to have minutes prepared than it was “back in the day,” due to computer software.
Significantly, corporate minutes can serve as the proof you need to back up your position if the IRS challenges an item on your return. Furthermore, they can help shield a business owner from personal liability for corporate debts. In particular, corporate minutes can be especially valuable in three key areas.
1. Executive compensation: Your company can deduct compensation paid to corporate officers— salaries, bonuses, etc.—as a business expense. However, the compensation must be “reasonable in amount” for services rendered. If the IRS considers the compensation unreasonable (e.g., a disguised dividend), the deduction may be denied. There are a few steps you can take in preparing the minutes to justify the deductibility of compensation paid.
• Establish the salaries of all officers and specify the procedures for salary adjustments and bonuses.
• Have the board of directors declare a dividend and specify the return on its capital investments.
• Spell out the details of any unusual circumstances (e.g., an officer who takes on additional responsibilities due to the current labor shortage).
• Describe the nature and complexity of each officer’s duties.
2. Accumulation of earnings: If a company retains earnings beyond the reasonable needs of the business, it may have to pay a 20% penalty tax. This tax is not imposed unless the accumulated earnings exceed $250,000 (the limit is $150,000 for personal service corporations).
However, corporate minutes may be able to protect your company from this penalty. For example:
• The minutes can show detailed expansion plans that justify retention of earnings.
• They can point out extenuating business circumstances (e.g., a cyclical sales flow or the threat of a strike).
• The minutes can reflect the intent to retain earnings only to cover working capital for the year, based on a precise formula.
3. Records of board meetings: Whenever the board of directors meets, a record of the discussions should be included in the corporate minutes. Reason: If a dispute arises later on, the minutes can be used to settle the controversy. For instance, minutes can be valuable in the following situations: election of officers, declaration of dividends, acceptance of contracts, approval for mergers, authorization of loans, project reports and compliance with governmental regulations.
Of course, there is no absolute guarantee that a dispute will be settled in your favor, but the minutes probably are the best proof you can have.
In summary: It is important that your minutes are accurate and precise. But that is not enough. You also must make sure that they are updated to reflect any changes.
Hit Tax Jackpot on Gambling Losses
How to maximize your deductions
In the past, you may have been able to deduct a hodgepodge of miscellaneous expenses. Unfortunately, the Tax Cuts and Jobs Act (TCJA) generally suspends deductions for those expenses, effective for 2018 through 2025. But one type of deduction often thought to be “miscellaneous” is not: the write-off for gambling losses.
Nevertheless, you cannot deduct all your gambling loses without any restrictions. Special rules still come into play.
Background: Prior to the TCJA, miscellaneous expenses were deductible to the extent that the total for the year exceeded 2% of your adjusted gross income (AGI). Therefore, if your annual AGI was $100,000 and you had $5,000 in miscellaneous expenses, you could deduct $3,000.
There is no such AGI limit on gambling loss deductions. That is the good news. Now the bad news: Your annual losses are deductible only up to the amount of your winnings.
Example: Say that you incur $10,000 in gambling losses and pull down $8,000 in winnings in 2022. As a result, your gambling loss deduction is limited to $8,000. Conversely, if you have $5,000 in losses, you can write off the entire $5,000.
Note that the gambling deduction is only available to itemizers. You receive no tax benefit from these losses if you claim the standard deduction.
As you might imagine, taxpayers often try to play fast and loose with these rules, so the IRS stays on its toes. You must keep a diary or similar records to back your claims in case the IRS challenges your gambling loss deductions. If you do not have all the proper records, you may be leaving tax money on the table. This can vary based on the activity as shown below:
• Bingo: A record of the number of games played, cost of cards purchased and amounts collected on winning cards.
• Keno: Copies of the keno tickets that were validated by the gambling establishment, copies of the casino credit records and copies of the casino check cashing records.
• Racing (horse, harness and dog, etc.): Records of the number of races, amounts of wagers and amounts won and lost.
• Slot machines: A record of the machine number and all winnings by date and time the machine was played.
• Table games (e.g., blackjack, craps and roulette): The number of the table where you played and casino credit card data indicating where credit was issued.
• Lotteries: A record of ticket purchases, dates, winnings, and losses. Supplemental records include unredeemed tickets, payment slips and winnings statements.
These records may be supported by other means (e.g., unredeemed ticket stubs from the racetrack). However, the supporting records must be legitimate.
Note that winnings and losses from sports betting are also subject to these rules. Keep a log and rely on Form W-2G.
Going pro? Finally, a different set of rules applies to taxpayers who gamble professionally for a living. Among other requirements, you must be engaged in the activity with the intention of turning a profit. If you qualify, the activity is generally treated like a business, so you may be able to deduct all of your losses. Consult with your professional tax advisor.
Aim Straight at Financial Targets
Five goals to zero in on
If you are part of the “younger generation,” you may have started on the path to a promising career and financial security. Along the way, you are likely to set certain goals. Here are five targets to shoot at before retirement beckons.
1. A realistic budget: One of the keys to financial success is to save more than you spend. But this is extremely difficult to do if you are not tracking income and expenses and then budgeting accordingly.
It does not have to be exact, but make calculations based on your recent history. You may find that you are over-spending in some areas where you need to cut back. Online calculators and programs can make budgeting easier, so take advantage of these tools.
2. Reduced credit card debt: In the best-case scenario, you can reduce your credit card debt to zero, or not have any debt other than your regular monthly credit charges. But that is not always possible, especially for big spenders.
At the very least, try to save enough to cut credit card debt down to a manageable level. Typically, you would pay off charges with the higher interest rates first. It may make sense to consolidate debts if you can obtain a reasonable rate, including potential increases down the road.
3. A retirement fund: When is the best time to start saving for retirement? As soon as you begin working on a full-time basis. By taking advantage of various retirement-saving devices, such as 401(k) plan at work or IRAs, or both, you can benefit from tax-deferred compounding of funds.
The tax law limits for contributions are generous. For instance, someone under age 50 can defer up to $20,500 to a 401(k) plan in 2022 on a pre-tax basis, plus your employer may provide “matching contributions” up to a stated percentage. In addition, you can contribute up to $6,000 to an IRA. Even modest contributions early in life can help you accumulate a tidy nest egg over time.
4. An emergency fund: When you are starting your career, and if you are in the prime of life, you may not envision a time when you will be in dire financial straits. But no one is immune from potential dangers. An unexpected illness or injury or loss of a job can be devastating, especially if you are paying a mortgage and trying to save for college for your kids.
Set aside savings in an emergency fund as a protective measure. Most important, you should have easy access to the money. If possible, avoid tapping into funds earmarked for retirement.
5. Beneficiary designations: Finally, make sure that you have made proper beneficiary designations on your financial accounts, including qualified retirement plans and IRAs, as well as your life insurance policies. Ensure that the money will go the parties you want in the event of the death of you or your spouse (or both of you).
Do not assume that the designations you made years ago are still up-to-date. Circumstances may have changed (e.g., deaths, births and divorces). Review your designations regularly.
The sooner you can cross these goals off your to-do list, the better. Coordinate activities with your other financial plans.
IRS Pumps Up Mileage Rates
If you have been feeling the pinch at the gas pumps lately, at least there is some tax consolation: The standard mileage rates used by certain taxpayers in lieu of deducting actual expenses are going up for the last six months of 2022. Effective on July 1, 2022—
• The rate for business driving increases to 62.5 cents per mile from 58.5 cents per mile;
• The rate for driving for medical reasons increases to 22 cents per mile from 18 cents per mile; and
• The rate for moving expenses for active duty military personnel increases to 22 cents per mile from 18 cents per mile.
The prior rates still apply to driving during the first six months of 2022. The rate for charitable travel, which is set statutorily, remains at 14 cents per mile.
Note: With the higher costs of driving, it may be even more advantageous, although not as convenient, to do the extra recordkeeping for actual expenses if you qualify.
Facts and Figures
Timely points of particular interest
Plug-in Tax Breaks—Are you considering an electric vehicle due to rising gas prices? Remember that you may qualify for a special tax credit of up to $7,500 if you purchase a plug-in electric vehicle. But the credit begins to phase out when the manufacturer has sold at least 200,000 qualified vehicles for domestic use. Visit the IRS website at www.irs.gov to find an updated list of eligible vehicles and their credit amounts.
Record Destruction—The Treasury Inspector General for Tax Administration (TIGTA) recently reported that the IRS destroyed an estimated 30 million tax return documents in 2021. The action was intended to help the agency catch up on the massive backlog of paper returns. Although TIGTA does not say that any 1040s were destroyed, supporting information returns did end up on the scrap heap. Make sure your records are in order.