April is an important month for many as tax season comes to a close. If you have not filed your tax returns, please reach out to Dagley & Co. and we can set up a one-on-one appointment before Tax Day on April 18th. Here are all your important individual due dates for the month of April:
April 1 – Last Day to Withdraw Required Minimum Distribution
Last day to withdraw 2016’s required minimum distribution from Traditional or SEP IRAs for taxpayers who turned 70½ in 2016. Failing to make a timely withdrawal may result in a penalty equal to 50% of the amount that should have been withdrawn. Taxpayers who became 70½ before 2016 were required to make their 2016 IRA withdrawal by December 31, 2016.
April 10 – Report Tips to Employer
If you are an employee who works for tips and received more than $20 in tips during March, you are required to report them to your employer on IRS Form 4070 no later than April 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.
April 15 – Taxpayers with Foreign Financial Interests
A U.S. citizen or resident, or a person doing business in the United States, who has a financial interest in or signature or other authority over any foreign financial accounts (bank, securities or other types of financial accounts), in a foreign country, is required to file Form FinCEN 114. The form must be filed electronically; paper forms are not allowed. The form must be filed with the Treasury Department (not the IRS) no later than April 15, 2017 for 2016. An extension of time to file of up to 6 months may be requested This filing requirement applies only if the aggregate value of these financial accounts exceeds $10,000 at any time during 2016. Contact our office for additional information and assistance filing the form or requesting an extension.
April 18 – Individual Tax Returns Due
File a 2016 income tax return (Form 1040, 1040A, or 1040EZ) and pay any tax due. If you want an automatic six-month extension of time to file the return, please call this office.
Caution: The extension gives you until October 16, 2017 to file your 2016 1040 return without being liable for the late filing penalty. However, it does not avoid the late payment penalty; thus, if you owe money, the late payment penalty can be severe, so you are encouraged to file as soon as possible to minimize that penalty. Also, you will owe interest, figured from the original due date until the tax is paid. If you have a refund, there is no penalty; however, you are giving the government a free loan, since they will only pay interest starting 45 days after the return is filed. Please call this office to discuss your individual situation if you are unable to file by the April 18 due date.
Note: the normal April 15 due date is a Saturday, and the following Monday is a federal holiday in the District of Columbia, so for almost all individuals their 2016 Form 1040 returns aren’t due until the next business day, which is Tuesday, April 18.
April 18 – Household Employer Return Due
If you paid cash wages of $2,000 or more in 2016 to a household employee, you must file Schedule H. If you are required to file a federal income tax return (Form 1040), file Schedule H with the return and report any household employment taxes. Report any federal unemployment (FUTA) tax on Schedule H if you paid total cash wages of $1,000 or more in any calendar quarter of 2015 or 2016 to household employees. Also, report any income tax that was withheld for your household employees. For more information, please call this office.
April 18 – Estimated Tax Payment Due (Individuals)
It’s time to make your first quarter estimated tax installment payment for the 2017 tax year. Our tax system is a “pay-as-you-go” system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the “pay-as-you-go” requirement. These include:
- Payroll withholding for employees;
- Pension withholding for retirees; and
- Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.
When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This penalty is equal to the federal short-term rate plus 3 percentage points, and the penalty is computed on a quarter-by-quarter basis.
Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than $1,000 (the “de minimis amount”), no penalty is assessed. In addition, the law provides “safe harbor” prepayments. There are two safe harbors:
- The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of what is owed in the current year, you can escape a penalty.
- The second safe harbor is based on the tax owed in the immediately preceding tax year. This safe harbor is generally 100% of the prior year’s tax liability. However, for taxpayers whose AGI exceeds $150,000 ($75,000 for married taxpayers filing separately), the prior year’s safe harbor is 110%.
Example: Suppose your tax for the year is $10,000 and your prepayments total $5,600. The result is that you owe an additional $4,400 on your tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can’t avoid the penalty under this exception.
However, in the above example, the safe harbor may still apply. Assume your prior year’s tax was $5,000. Since you prepaid $5,600, which is greater than 110% of the prior year’s tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty.
This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc. Timely payment of each required estimated tax installment is also a requirement to meet the safe harbor exception to the penalty. If you have questions regarding your safe harbor estimates, please call this office as soon as possible.
CAUTION: Some state de minimis amounts and safe harbor estimate rules are different than those for the Federal estimates. Please call this office for particular state safe harbor rules.
April 18 – Last Day to Make Contributions
Last day to make contributions to Traditional and Roth IRAs for tax year 2016.
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Each year, the IRS publishes its list of the “dirty dozen” tax scams. This list is a variety of common scams that taxpayers may encounter anytime. Don’t fall prey!
Urgent appeals for aid – whether in person, over the phone, by mail, via e-mail, on a website, or through a social networking site – may not be on the up-and-up. Fraudsters pop up after natural disasters such as earthquakes and floods to try to coax people into making donations that will go into the fraudsters’ pockets – not to help victims of the disaster.
Unfortunately, legitimate charities face competition from fraudsters, so if you are thinking about giving to a charity with which you are not familiar, do your research so that you can avoid the swindlers who are trying to take advantage of your generosity. Here are tips to help make sure that your charitable contributions actually go to the cause that you support:
- Donate to charities that you know and trust. Be alert for charities that seem to have sprung up overnight in connection with current events.
- Ask if a caller is a paid fundraiser, who he/she works for, and what percentages of your donation go to the charity and to the fundraiser. If you don’t get clear answers – or if you don’t like the answers you get – consider donating to a different organization.
- Don’t give out personal or financial information — such as your credit card or bank account number – unless you know for sure that the charity is reputable.
- Never send cash. You can’t be sure that the organization will receive your donation, and you won’t have a record for tax purposes.
- Never wire money to someone who claims to be from a charity. Scammers often request donations to be wired because wiring money is like sending cash: Once you send it, you can’t get it back.
- If a donation request comes from a charity that claims to help a local community group (for example, police or firefighters), ask members of that group if they have heard of the charity and if it is actually providing financial support.
- Check out the charity’s reputation using the Better Business Bureau’s (BBB) Wise Giving Alliance, Charity Navigator, or Charity Watch.
Remember that, to deduct a charitable contribution on your tax return, the donation must be to a legitimate charity. Contributions may only be deducted if they are to religious, charitable, scientific, educational, literary, or other institutions that are incorporated or recognized as organizations by the IRS. Sometimes, these organizations are referred to as 501(c)(3) organizations (after the code section that allows them to be tax-exempt). Gifts to federal, state, or local government, qualifying veterans’ or fraternal organizations, and certain nonprofit cemetery companies also may be deductible. Gifts to other kinds of nonprofits, such as business leagues, social clubs, and homeowner’s associations, as well as gifts to individuals, cannot be deducted.
To claim a cash contribution, you must be able to document that contribution with a bank record, receipt, or a written communication from the qualified organization; this record must include the name of the qualified organization, the date of the contribution, and the amount of the contribution. Valid types of bank records include canceled checks, bank or credit union statements, and credit card statements. In addition, to deduct a contribution of $250 or more, you must have certain payroll deduction records or an acknowledgment of your contribution from the qualified organization.
Be aware that, to claim a charitable contribution, you must also itemize your deductions. It may also be beneficial for you to group your deductions in a single year and then to skip deductions in the next year. Please contact Dagley & Co. if you have questions related to the tax benefits associated with charitable giving for your particular tax situation.
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QuickBooks is perfect for many small business accounting departments. There are so many ways within the program to customize for your clients, customers, location, vendors, etc. to really make it your own. “Custom Fields” and “Classes” are two items Dagley & Co. recommends customizing on your QuickBooks Online account.
Start from the Beginning with Custom Fields
You can start working with custom fields and classes at any time. They’re most effective, though, when you build them in as you’re just starting to use QuickBooks Online.
Let’s look at custom fields first. When we refer to “fields,” we simply mean the rectangular boxes in records and forms that either already contain data or that can be filled in by you, either by entering the correct word or phrase, or by selecting from drop-down lists. Most of these are already named. On an invoice, for example, there are fields for information like Invoice date and Due date.
But you can add up to three additional fields to sales forms. To do so, click the gear icon in the upper right corner of the screen and select Account and Settings, then click Sales in the vertical navigation bar on the left. The second block here contains Sales form content. Click Custom fields, and you’ll see something like this:
Click the word Off if it appears, and it will change to On and display three blank fields. Think carefully about what you would like to appear here, as this isn’t something you’ll want to change. If you haven’t yet met with us about how to set up QuickBooks Online, let’s schedule some sessions to go over all your setup procedures, including custom fields.
Enter the words or phrases you want displayed on sales forms in the three fields. Then decide whether you want them to be visible only to you and your accounting staff or to your customers, too. Click within the Internal and Public to create check marks. When you’re done, click Save.
Additional Categorization with Classes
QuickBooks Online’s classes provide another way to categorize transactions. You can use them to differentiate between, for example, departments or divisions. If you’re a construction company, you might have different classes for New Construction and Remodel. Unlike custom fields, you’re not limited to three classes.
You can filter many reports by class. QuickBooks Online contains report templates designed specifically for reporting by class, like Sales by Class Detail, Purchases by Class Detail, and Profit and Loss by Class.
Here’s how you create your own list. Click the gear icon in the upper right of the screen and select Account and Settings. Then click Advanced in the left vertical navigation toolbar. Under the fourth heading, Categories, you’ll see Track classes. If the word “Off” appears to the right, click in the box to turn this feature on. A box like this will appear:
Even if you’ve defined a number of classes, they’re not required on transactions. If you want to be reminded should you forget to classify one, click in the box in front of Warn me when a transaction isn’t assigned a class. You can also choose to assign one class to an entire transaction or to each individual row. Click the arrow to the right of One to entire transaction to drop the option box down and make your choice. When you’re done, click Save.
You can create classes as you’re entering transactions by clicking the arrow next to Class over to the right of the screen and selecting +Add new. We recommend, though, that you think this through ahead of time and make at least an initial list by clicking the gear icon in the upper right and choosing All Lists, then Classes, then New.
These are two of the customization tools that are built into QuickBooks Online. Whether you’re just getting started or you’ve been using the site for a while, Dagley & Co. can introduce you to all the ways that you can make QuickBooks Online your own.
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Starting your own business or service can be an exciting, yet confusing time. To make it easier, we recommend working with us, as well as a financial planning team, to get off to a good start. We also recommend asking these ten questions to a professional:
#1: What should be in a basic business plan?
A business plan should outline each detail of your company including who will run it, how much you’ll charge, and what you expect to earn. Putting time into creating a thorough business plan is important. Work with your team to ensure your plan is accurate and represents your business well.
#2: Who will you need to pay taxes to?
Your local jurisdiction and state have specific taxation requirements. You’ll likely have to pay taxes on sales, but also costs associated with payroll. Ensure your accountant not only talks to you about who you need to pay, but payment deadlines as well.
#3: What is a projected cash flow for the business?
How much cash does your company need to keep on hand? The key here is to be able to anticipate how much it will cost you to operate your business. Most companies should not expect to have positive cash flow for at least a year, often longer. Your professionals can help you decide what your cash flow projections are.
#4: How much of an investment do you need to put into your company right now?
Your financial team can help you project the cost of setting up your new business. This will include costs related to establishing the physical business and paying for supplies. Your initial investment generally will be the highest amount put into the company by the founder, but it changes significantly from one company to the next.
#5: What is your break-even analysis?
This may be an important question to ask early on. How much do you need to make to break even? You’ll want to talk to your financial team about the timeline for this and what can be done to help ensure you break even as soon as possible.
#6: What liability insurance do you need?
While most tax professionals don’t offer recommendations here, having adequate policies to cover potential loss is important. Work with your team to ensure you have comprehensive protection to minimize risks against your company’s financial health.
#7: What will interest cost you?
Interest on loans is not something to overlook. You’ll want to ensure you have an accurate representation of how much you are paying in interest so you can make adjustments to pay off any borrowed debt sooner, make better decisions about borrowing, or factor in the cost.
#8: How will you manage payroll?
This is a very big component of starting up since it can be troublesome for most startups to actually know how to pay employees and meet all federal and state requirements. Working with a payroll provider is often the easiest option (and most financially secure since paying an employee to do this work tends to be more expensive).
#9: How can you reduce your taxes?
Tax professionals will work with you to determine if there are any routes to reducing taxation on your business including local incentives that may be available. You’ll also want to talk about projects taxes, investments that could reduce taxes, and having all possible deductions in place.
#10: What’s the right profit margin?
Working with a financial team often comes down to this question. How much should you charge to make the best profit possible while still ensuring your company can grow? It’s not a simple question, but having the right team by your side ensures it will be clarified as much as possible.
Make an appointment with Dagley & Co. to get your business off to the right start. We are here for you for any tax, payroll or accounting questions or issues you may have for your new business.
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Dagley & Co. is here to give you up-to-date tax and tax requirement details and due dates. Please read the following regarding a delay in a tax return due date:
The IRS, in an effort to combat rampant tax filing fraud, has introduced what they hope will be two new fraud-prevention measures for the upcoming filing season. The first will purposely delay until February 15 the issuance of refunds for tax returns where there is an earned income tax credit (EITC) and/or a refundable child tax credit (CTC), giving the IRS more time to match the income reported on these returns to the income reported by employers. These two tax credits have been the favorite target of scammers who have been filing fraudulent returns with stolen IDs and fabricated income before the IRS is able to verify the income and withholding claimed on the returns.
The second preventive measure is to require earlier filing of W-2 and 1099-MISC forms, which will enable the IRS to ferret out returns that report phony income and withholding. This measure will have a significant impact on employers by moving up the filing due date of the government’s copy of 2016 W-2s and 1099-MISCs to January 31, 2017 (the previous due date was February 28, or March 31 if filed electronically). January 31 has been and continues to be the date the forms are required to be provided to the employees (W-2s) or independent contractors (1099-MISCs).
The 30-day automatic extension to file W-2s is no longer automatic. The IRS anticipates that it will grant the non-automatic extension of time to file only in limited cases where the filer or transmitter’s explanation demonstrates that an extension of time to file is needed as a result of extraordinary circumstances.
With regard to the government’s copy of 1099-MISC forms, the earlier filing due date only applies to those 1099-MISC forms reporting non-employee compensation.
If you have questions related to W-2 or 1099-MISC requirements, please give Dagley & Co. a call at (202) 417-6640.
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It’s that time again! One year is coming to an end, and a new year is quickly approaching. At Dagley & Co., we urge you to start your end-of-year QuickBook tasks now, before time runs out. We have 4 things we suggest you fit into your busy schedule sometime this month:
1) Create and send year-end statements.
As your customers wrap up 2016, too, it’s good to send statements to past-due accounts.
In an ideal world, all of the invoices that are currently due would be paid off by the end of the year. We all know that that’s not usually the reality. Two reports can help you here: the A/R Aging Summary and Open Invoices.
Give everyone a chance to clear their accounts before December 31 by sending statements. Click Statements on the Home page (or Customers | Create Statements) to open the window pictured above.
You have multiple options here that are fairly self-explanatory. The screen above is set up to create statements for all customers who have an open balance as of the date you select, but not for inactive customers or those with a zero balance or no account activity. That way, no one who’s paid in full to date will receive a statement. Of course, if you didn’t want statements created for anyone who’s less than 30 days past due, you’d click in the box in front of Include only transactions over and enter a “30” in the following field. Questions about all of this? Give us a call.
Tip: You can also find out who’s overdue by clicking on the Customers tab in the left vertical pane to open the Customer Information screen. Click on the down arrow to the right of the field just below Customers & Jobs. QuickBooks provides several filters for your list.
2) Reduce your inventory.
Want to discount all or selected items in your inventory by the same percentage or amount? Open the Customers menu and click Change Item Prices. Dagley & Co. can work with you on the whole item pricing process.
The week between Christmas and New Year’s Day might be a good time to sell excess inventory by having a sale. If you only sell a few products, you probably know what hasn’t sold well in 2016. If your stable of products is larger, you can run QuickBooks reports like Inventory Stock Status by Item and Sales by Item Detail to identify your slow-sellers and discount them. You may need to filter your reports to see the right data. Talk to us about customization options if you’re unsure of this.
3) Clean up your contact lists.
If you don’t maintain your customer and vendor lists, you’ll eventually start wasting time scrolling through them when you enter transactions. So this would be a good time to designate those contacts that you’ve not dealt with in 2016 as Inactive (you can delete their records entirely, but we advise against that). Simply open a Customer record, for example, and click the small pencil icon in the upper right to edit it. Click on the box in front of Customer is inactive.
4) Run advanced reports.
Here’s where we come in. If we’re not already creating and analyzing QuickBooks’ advanced financial reports (found in the Accountant & Taxes submenu of Reports) monthly or quarterly, talk to us about it. They’re important, and they give you insight that you can’t get on your own. This is another activity that can spill into January.
We hope these few things help to get you started with your year-end QuickBook tasks. Give Dagley & Co. a call at 202-417-664 if you have any questions, or would like us to go through these steps with you one-on-one. Remember: even though we are located in Washington, D.C. are clients are around the country!
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How does your company keep track of its bills? A lot of small businesses are still dealing with a lot of paper. It’s probably pretty clear to you that this isn’t the best system. You could possibly miss payments because a bill was lost in transit or didn’t make its way to you. QuickBooks Online can help keep bill-payment running smoothly and your relationships with vendors on the up-and-up.
Before you can start paying bills, you have to enter them into QuickBooks Online. This will entail a bit of extra work the first time you deal with a particular vendor, but there are numerous benefits to handling your accounts payable in this fashion, like:
- Speed. Once you’ve created a framework (template) for a bill, it will take minimal time to pay it in the future.
- All of your bill payments will be recorded in QuickBooks Online, so you won’t have to hunt through checkbook registers or file folders to see if a bill was paid.
- QuickBooks Online will always remind you when a bill must be paid (if you’ve set it up correctly).
To enter a bill, click the plus (+) sign at the top of the screen and click on Vendors and then Bill. This screen opens:
You’ll enter information about each bill on a screen like this. There are fields not pictured here that you’ll sometimes have to complete. So let’s start a conversation about the whole process.
Looks pretty simple, doesn’t it? It is – if you have a simple bill like the one you receive for gas and electric. You select the vendor by clicking on the arrow next to the blank field in the upper left and choosing from the list that opens. The Mailing Address and Terms should fill in automatically if you’ve done all of your initial QuickBooks Online setup. If not, you can add and edit this information.
Bill date refers to the date of the bill itself, not the day payment is due to the vendor. That goes in the Due date field. Select your Account from the list that opens when you click in that field, and enter a Description and Amount. If that’s all that’s required for that bill, you can save it and proceed to the next. It’s now recorded as a bill that needs to be paid.
Some of your bills are just one-offs, but others arrive on a regular basis. So QuickBooks Online has tools that will minimize the time required to process them after you’ve entered the basic information once. After you’ve completed a bill, click Make recurring at the bottom of the page to see this screen:
QuickBooks Online lets you create templates for bills to use in future payments.
This screen is self-explanatory. You simply tell QuickBooks Online how much notice you want before a bill’s due date so you can process the payment. Take care with this screen to avoid paying bills too early, which affects your cash flow unnecessarily, or too late.
You have three options when you’re creating a Recurring Bill template. You’ll choose one from the list that opens when you click the arrow in the Type field:
- This is best used when the details of a transaction don’t change, like rent or a loan payment. You don’t have to do anything for the payment to be dispatched; it’s done automatically for you at the interval you set. You can, however, ask to be notified every time this occurs.
- You could use this for periodic payments that will require editing before they’re sent. For example, you’ll probably need to change the amount on your utility bills every month. QuickBooks Online will place a reminder in your Activities list on the home page.
- If you have bills that contain a great deal of detail but aren’t due on a set schedule, you can save the template and call it up when you need it by clicking the gear icon in the upper right and selecting Recurring Transactions.
If you are interested in starting to use QuickBooks Online, and you begin to enter bills and find that you’re having trouble completing the fields required for more complex bills, give Dagley & Co. a call to schedule a session or two.
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An income statement is a very important document that your company produces. This statement can be challenging to prepare if you are new to the business, or if you are not familiar. We have gathered some good tips and tricks to make it easier for you to read and prepare you income statement accurately.
What is an Income Statement?
An income statement, which may also be referred to as a “profit and loss statement,” is an important financial report that communicates your business’s ability to earn a profit. This statement includes information about the money that came into your company during a given period, the expenses your company incurred during that period, and the total amount of profit you earned after all expenses were paid. If your expenses during this time exceeded the amount of income you earned, your income statement will show a loss for the period.
Sections of an Income Statement
In most cases, your income statement will be divided into various sections, including Revenue, Operating Expenses and Taxes. Within each section, smaller subsections exist to provide more detailed information. The final line on the statement provides your net profit or loss, which is calculated as the difference between your revenue and all of the expenses paid to earn that revenue.
Not every income statement includes the same information. However, most statements will include the following lines:
- Heading– At the top of the statement, you will find a heading that provides the name of your company and the period of time the statement covers.
- Revenue– The “Revenue” subheading begins the section of the statement that provides details about revenue earned during the period.
- Gross Sales– This line of the statement tells you the value of all sales made during the period before any deductions for expenses.
- Returns and Allowances– Returns and Allowances include the cost of any goods returned by customers or discounted by your company.
- Net Sales– Net Sales is calculated by subtracting the value of Returns and Allowances from your Gross Sales.
- Cost of Goods Sold– This line lists the total wholesale cost of all of the goods you sold during the period.
- Gross Profit– Gross Profit is calculated by deducting the Cost of Goods Sold from Net Sales.
- Operating Expenses– The Operating Expenses subheading begins the section of the income statement that includes all of the expenses your company paid to operate during the period in question.
- Sales and Marketing– Beneath the Operating Expenses subheading, you will find a smaller subheading labeled “Sales and Marketing.” In this section, you will find a list of all of the expenses your company incurred in relation to marketing. Examples include advertising, commissions and direct marketing. At the bottom of this section, you will find a total of these expenses.
- General Administrative– This section of the document includes all of the administrative expenses paid during the period, including office supplies, utilities and more. At the end of this section, all general administrative expenses are totaled.
- Depreciation and Amortization– Under this heading, any expensive assets your business is currently depreciating will be listed, along with the total amount of depreciation for the period.
- Total Operating Expenses– This section of the income statement provides the total of your operating expenses for the period, including depreciation, administrative expenses and advertising expenses.
- Operating Income– Your Operating Income is the amount of income left over after all of your operating expenses are deducted from your gross profit.
- Non-operating Income– This section includes all of the income you earned outside of your standard operations, such as by the sale of assets or investments.
- Non-operating Expenses– Non-operating expenses include expenses you paid that were not related to the operations of your business. These expenses may be related to earning non-operating income.
- Income before Taxes– The value on this line is calculated by adding your Operating Income and Non-operating Income and then subtracting your Non-operating Expenses.
- Taxes– This section includes all of the taxes your business paid during the period, including prepaid income tax and payroll taxes.
- Total Net Income– The final line on your income statement is your total net income. It is calculated by subtracting your total Taxes from Income before Taxes. If your expenses for the period exceeded your income, this value will be negative, representing an overall loss.
Getting Professional Help
Preparing an income statement is no easy task, and interpreting it can also be difficult for many business owners. Dagley & Co. will not only ensure that your income statement is accurate, but we will also be able to help you gain important insight from these statements that can be used to boost your business’s profitability in the future. Give us a call today at (202) 417-6640.
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Are you a high-income taxpayer? Would like to contribute to a Roth IRA but cannot because of income limitations? There is a work-around that will allow you to fund a Roth IRA.
High-income taxpayers are limited in the annual amount they can contribute to a Roth IRA. In 2016, the allowable contribution phases out for joint-filing taxpayers with an AGI between $184,000 and $194,000 (or an AGI between $0 and $9,999 for married taxpayers filing separately). For unmarried taxpayers, the phase-out is between $117,000 and $132,000. Once the upper end of the range is reached, no contribution is allowed for the year.
However, those AGI limitations can be circumvented by what is frequently referred to as a back-door Roth IRA. Here is how a back-door Roth IRA works:
- First, you contribute to a traditional IRA. For higher-income taxpayers who participate in an employer-sponsored retirement plan, a traditional IRA is allowed but is not deductible. Even if all or some portion is deductible, the contribution can be designated as not deductible.
- Then, since the law allows an individual to convert a traditional IRA to a Roth IRA without any income limitations, you now convert the non-deductible Traditional IRA to a Roth IRA. Since the Traditional IRA was non-deductible, the only tax related to the conversion would be on any appreciation in value of the Traditional IRA before the conversion is completed.
Potential Pitfall – There is a potential pitfall to the back-door Roth IRA that is often overlooked by investment counselors and taxpayers alike that could result in an unexpected taxable event upon conversion. For distribution or conversion purposes, all of your IRAs (except Roth IRAs) are considered as one account and any distribution or converted amounts are deemed taken ratably from the deductible and non-deductible portions of the traditional IRA, and the portion that comes from the deductible contributions would be taxable.
This may or not may affect your decision to use the back-door Roth IRA method but does need to be considered prior to making the conversion.
There is a possible, although complicated, solution. Taxpayers are allowed to roll over or make a trustee-to-trustee transfer of IRA funds into employer qualified plans if the employer’s plan permits. If the rollover or transfer to the qualified plan is permitted, such rollovers or transfers are limited to the taxable portion of the IRA account, thus leaving behind the non-taxable contributions, which can then be converted to a Roth IRA without any taxability.
Please call Dagley & Co. if you need assistance with your Roth IRA strategies or need assistance in planning traditional-to-Roth IRA conversions.
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