Roth IRA's - A Simple Strategy to Work Around the AGI Limits

In 2010, the rules changed for Roth IRAs (see previous post) where now anyone with a Traditional IRA may convert a portion or all to a Roth regardless of their Adjusted Gross Income. This is all good and fine for those of us who have Traditional IRAs to convert, but what about the rest of us who just have their company 401(k)s and make too much money to contribute to a Roth?

Well, there's a little known aspect about Traditional IRA contributions in that ANYONE can make them, regardless of their income level provided they have earned income equal to or higher than the contributed amount. Your income level only determines the deductibility of the contributions for the year that those contributions were applied to, not whether or not you can contribute at all.

Thus, an individual who is not eligible to contribute to a Roth can still contribute to a Traditional IRA, albeit a nondeductible one. The individual can then immediately convert their contributed amount to a Roth IRA. There are certain basis rules that apply if you have other Traditional IRA balances that could make all or part of the conversion taxable, but if you have those you probably would not do this until you had fully converted the other balances first.

Strategy in Action - An example:

Joe makes too much money to contribute to a Roth, but still wants to save after tax dollars for retirement. He has no traditional IRAs, but does have a 401(k) at work. To accomplish his goal, Joe could open a traditional IRA and contribute the maximum allowed amount, and then direct his trustee to convert the balance the following day to a Roth IRA. Thus, Joe now has a Roth IRA via the conversion rule now allowed even though he doesn't qualify to contribute to a Roth.

This may seem like a lot of hoops to jump through but administratively it is not too difficult and the tax savings are plentiful. If you are up to the task, your retirement could be all the richer for investing in a Roth!

Never Pay State Income Taxes Again!

Georgia taxpayers have an excellent opportunity to reduce their tax burden by purchasing income tax credits rather than paying the tax directly. There are several state income tax credits that can be acquired by individual taxpayers, but the most widely available credits in Georgia are the film and low income housing credits. These credits can be purchased at a significant discount while still satisfying the total underlying liability owed.

The film and low income housing credits each work in different ways. To acquire low income housing tax credits (LIHTCs), the taxpayer would purchase partnership unit(s) equivalent to the amount of state income tax credit they need. Thus, if a taxpayer wants to satisfy an expected $100,000 state income tax liability, they would acquire a partnership unit(s) equal to $100,000 of credit. Taxpayers will often do this because they can acquire the credit at a discount. For example, if LIHTC credits are available for 75 cents on the dollar, that individual could contribute $75,000 to the partnership in exchange for a partnership interest equal to $100,000 of credit instantly saving them $25,000. So why the free lunch?

The state of Georgia grants LIHTC credits to builders to incentivize the construction of low income housing. Rather than waiting to take the credit themselves, the builders typically monetize the credit through brokers who form LLCs where individuals/corporate entities can "purchase" the credits by acquiring LLC unit(s) equal to the desired credit amount. The credit then passes out to the individual investor on their K-1 and the individual then claims the credit on their tax return. However, LIHTC credits are not totally without risks; if some or all of the low income housing project(s) the LLC is invested in loses its status as a low income housing project, the credit could be recaptured and the individual member of the LLC would be liable to pay the credit back. The period of "recapture" can also last up to 15 years. The better low income credit LLCs will dilute their risk by investing in several low income housing projects and by seeking indemnification from the builders, but some risk ultimately still remains regardless. Additionally, any unused portion of the credit will only carry forward for three years at which point any unused portion is lost.

On the other hand, the film credit is a "certificated" credit. The taxpayer does not enter into a partnership to acquire the credits but purchases the credit directly from the owner of the credit (most commonly through a broker). As an incentive to have more movies made in Georgia, the state has granted the "film credit" to producers of movies for up to 30% of certain qualifying expenditures made in Georgia. The movie producer typically prefers to monetize the credit immediately and sells them in the open market at a discount. Individuals then acquire the credits and claim them on the applicable year's tax return. These credits are usually somewhat more "expensive" than low income housing credits, but are generally considered safer and thus cost more. These credits are also subject to recapture if the expenditures are not actually made or fraudulently represented as made. Any unused portion of the film credit is carried forward five years at which point any unused portion is lost.

Any year where a taxpayer has a liquidity event and/or a high liability expectation, acquiring either of these types of credits could be a great opportunity to minimize their state tax burden. These credits are not totally without risk so taxpayers should carefully consider those risks before investing. The federal income tax treatment is also still unsettled regarding whether or not a state income tax deduction is allowed, and further if a gain should be recognized on the discounted portion of the credit. Talk to your tax advisor to see if an investment in Georgia credits could be a good fit for your facts and circumstances.