Think Carefully Before Converting to a Roth IRA

Think Carefully Before Converting to a Roth IRA

In the 2017 Tax Cuts and Jobs Act, Congress eliminated the special rule that allows a traditional IRA converted to Roth IRA to be recharacterized back to traditional IRA. The change goes into effect for conversions made on or after January 1, 2018. Note, however, a Roth IRA conversion made in 2017 may still be recharacterized as a contribution to a traditional IRA if the recharacterization is made by October 15, 2018.

The Advantages of Converting

First of all, we should explain what we mean by converting. A Roth conversion means taking all or some part of the balance of an existing traditional IRA and moving it into Roth IRA. Doing this, can hold certain advantages:

  • A Roth IRA entitles you to take tax-free withdrawals in retirement. With a traditional IRA, you would pay taxes on any earned income from your investments and on any contributions your previously deducted on your taxes.
  • With a Roth IRA there’s no required minimum distribution (RMD) when you reach 70 ½ years of age. With a traditional IRA, you’d be forced to take a distribution and lose the tax-free growth on that money. With the Roth, your money can stay in the account and keep growing forever.
  • If you leave your Roth IRA to your heirs, they will have to take an annual RMD, but they will not have to pay any federal income tax on those withdrawals, if the account has been open for five years or more.

Going Forward

Under the new tax laws, Roth conversions are subject to greater market timing risk. They can still make sense, particularly in a down market, for taxpayers who take a longer view. A strategy of regular conversions will iron out market fluctuations over time, and annual conversion amounts can be adjusted according to what makes sense for each tax year.

Now that a conversion cannot be reversed, it is essential to consider carefully whether a Roth IRA conversion is the best strategy for you. Be sure to speak with your tax professional to discuss your situation and strategy for retirement, and the pros and cons of a Roth IRA conversion.

ABC Test Ensures Independent Contractors Aren’t Really Employees

With the rapid rise of so called “gig” workers nowadays, many employers need to make the distinction between an employee and an indpendant contractor. While making this distinction would seem straightforward, this has traditionally been a point of uncertainty for many businesses. Now, as the result of a landmark court case, and a new three-pronged test, there is more clarity to this issue.

In April of 2018, the California Supreme Court ruled that the ABC test should be used to determine whether a worker is an independent contractor or an employee and therefore covered under the state’s Wage Orders. The Wage Orders address minimum wage, overtime, meal and rest breaks, and related issues across various industries and cover employees, but not bona fide independent contractors.

A trucking and transportation case that will affect most industries

In Dynamex Operations West, Inc. v. Superior Court, an employer had reclassified delivery drivers from employees to independent contractors in 2004. Two delivery drivers later sued, alleging the employer misclassified them as independent contractors and that the decision led to violations of California’s Wage Order No. 9 in addition to other violations.

The employer and delivery drivers disagreed about which test should be used to determine whether they were employees or independent contractors. The employer argued that the court should use a multifactor test under which no single factor is determinative and the unique circumstances of each case is weighed and balanced. The delivery drivers argued that the ABC test should be used, which is generally a more difficult test to satisfy since all three factors must be met.

The California Supreme Court ultimately ruled that the ABC test should be used for determining whether a worker is an employee or independent contractor for the purposes of the state’s Wage Orders.

Unraveling the ABC Test

Under the ABC test, a worker is considered an independent contractor if all three of the following factors are met:

  1. Free from control and direction
    Similar to the previously used common law test, if it is found that a worker who is, either by contract or by practice, subject to the type and degree of control a business typically exercises over employees then this prong is not satisfied.;

  2. Outside of the usual course of business
    If the worker engages in work that is in the same business as the hiring company, and therefore providing services to the business in a role comparable to that of an employee they should be considered as working as an employee;

  3. Customarily engaged in independent trade
    This last prong attempts to identify those workers that have taken steps to create their own business not associated with the hiring company. If workers have independently made the decision to go into business for themselves, they are likely to be found as satisfying this third prong.

In addition to adopting this test, the Court ruled that the hiring entity has the burden of establishing that the worker is an independent contractor who was not intended to be covered by the Wage Order. The hiring entity must show that all three factors of the ABC test are met.

Compliance Recommendations:

For purposes of determining coverage under the state’s Wage Orders, California employers should apply the ABC test. If the worker fails to satisfy one or more parts of the test, they must be treated as an employee (entitled to minimum wage, meal and rest breaks, and other protections). Employers who work with independent contractors may want to consult legal counsel as well their qualified tax professional to review those classifications and to address reclassifications if necessary.

Perform a Paycheck Checkup With New IRS Withholding Calculator

With the new tax laws in effect for 2018 its a good idea to do a quick checkup on the amount of taxes you’re having withheld. The IRS has made with this simple to do with its new online Withholding Calculator.  The Calculator helps you identify your tax withholding to make sure you have the right amount of tax withheld from your paycheck at work.

There are several reasons to check your withholding:

  • Checking your withholding can help protect against having too little tax withheld and facing an unexpected tax bill or penalty at tax time next year.
  • At the same time, with the average refund topping $2,800, you may prefer to have less tax withheld up front and receive more in your paychecks.

If you are an employee, the Withholding Calculator helps you determine whether you need to give your employer a new Form W-4, Employee’s Withholding Allowance Certificate. You can use your results from the Calculator to help fill out the form and adjust your income tax withholding.

Tax payers with simple situations might not need to make any changes. Simple situations include singles and married couples with only one job, who have no dependents, and who have not claimed itemized deductions, adjustments to income, or tax credits.

People with more complicated financial situations might need to revise their W-4. With the new tax law changes, it’s especially important for these people to use the Withholding Calculator to make sure they have the right amount of withholding.

Among the groups who should check their withholding are:

  • Two-income families.
  • People with two or more jobs at the same time or who only work for part of the year.
  • People with children who claim credits such as the Child Tax Credit.
  • People who itemized deductions in 2017.
  • People with high incomes and more complex tax returns.

As always, if you have any questions about your withholding or your tax situation in general, you should contact your tax professional. More information is also available in the special Withholding Calculator Frequently Asked Questions.

New Limits on Business Interest Deduction

While the The Tax Cuts and Jobs Act of 2017 is generally seen as being loaded with benefits for businesses, there is at least one exception. In an effort to discourage companies from becoming too indebted or taking on too much leverage, the new law caps the business deduction for net interest expenses. Regardless of whether your business is over-leveraged or under-leveraged you should be aware of some of the important points surrounding business interest deduction.

Beginning in 2018, the deduction for business interest is limited to:

  • business interest income for the tax year;
  • 30 percent of adjusted taxable income for the year, including any increases in adjusted taxable income as a result of a distributive share in a partnership or S corporation (discussed below), but not below zero; and
  • floor plan financing interest of the taxpayer for the tax year.

In effect, the new law limits the deduction to 30 percent of adjusted taxable income. Adjusted taxable income is not the same as taxable income, but rather is determined by a special formula defined in the new law.

Exceptions to the limitation

There are, however, exceptions to this limitation:

  • the limitation does not apply for small businesses with average gross receipts of $25 million or less;
  • floor plan financing used by automobile dealers is permitted to the full extent of business interest income and floor plan financing interest; and
  • certain real property or farming businesses may elect to be excluded from the limitation.

Even though the Tax Cuts and Jobs Act lowered corporate tax rates, the limitation on interest deductions may result in higher tax liability for certain businesses.  Be sure to speak with your tax professional (phone 916-372-8577) who can help determine whether you will be affected by this new law, and if so to work with you to reduce its impact on your business.

Special Tax Considerations for Victims of Recent Wildfires

There’s no doubt that 2017 was a year plagued by wildfires that resulted in catastrophic destruction to the environment and personal property. In October alone, wildfires that tore across Northern California numbered more than a dozen. Some of these stand out as among the most damaging to ever hit the state.

In light of the devastation, President Trump declared that a major disaster existed in the State of California. Following that disaster declaration issued by the Federal Emergency Management Agency, the IRS announced that affected taxpayers in California would receive tax relief.

If you have suffered a loss to personal property due to the recent California wildfires, you may be eligible for special tax treatment.

Usually, a personal loss from a casualty or theft must exceed 10 percent of your adjusted gross income to be deductible; but for losses arising in the California wildfires disaster areas in 2017, that 10 percent threshold is waived. However, the dollar threshold for net losses, which is normally $100, is increased to $500 for losses in this disaster.

Loss Threshold for Deduction Normally Due to Wildfires
% Adjusted Gross Income Must exceed 10% No threshold
Minimum Amount of net losses $100 $500

Deduction may be available even if you don’t itemize
Generally you must itemize your deductions in order to take a casualty or theft loss. However, under special rules available for losses due the California wildfires disaster, you can take an additional standard deduction for the amount of your net loss even if you don’t itemize.

Consult your tax professional
Facing loss as the result of a natural disaster is burdensome. Now is the time to lessen at least some of your loss by taking advantage of the tax benefits provided for those who have suffered from this disaster. As always, be sure to contact your tax professional (phone 916-372-8577), in order to get a full understanding of the benefits you may be entitled to.

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