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.

Roth IRA Conversions - New Changes for 2010!

Prior to 2010, an individual could convert their Traditional IRA to a Roth IRA but only if their modified AGI did not exceed $100,0000. Now, as a result of a provision stuck deep inside a bill signed into law by George Bush back in May of 2006, ANYONE can convert their Traditional IRA to a Roth IRA regardless of their income. Roth conversion planning can provide an excellent opportunity from both an estate and income tax perspective and is worth considering by anyone with a pre-tax retirement account.

To convert or not often comes down to a numbers game; if you think tax rates are likely to go up in retirement then you should convert; if you think tax rates will go down, then you should not convert. While this is generally a good rule of thumb, there are other benefits to consider when deciding whether or not to convert. For example, converting to a Roth allows an individual to grow more wealth income tax free, provided that the individual can pay the tax on conversion with outside funds. Additionally, Roth IRAs are not subject to the required minimum distribution (RMD) rules, so the account will continue to grow tax-free during the lifetime of both spouses. At the death of the second spouse, the Roth IRA would then be subject to the RMD rules, but it would be based on the life expectancy of the beneficiary, which would maximize the stretch build-up period within the account. Even if you think that tax rates are likely to remain about the same in retirement and you do not expect to need the IRA as a major source of income to live on, the Roth conversion becomes practically a no-brainer.

Still not convinced? Well, converting is not an all or nothing deal. If you are at all uncertain or just want to hedge against future tax rates, you can choose to convert some of your Traditional IRA rather than all of it. And if you convert but then change your mind or your circumstances change, you are allowed to re-characterize any portion of the converted amount by the extended filing deadline of the return year in which you convert. You could even convert and set up several Roth IRA accounts by asset class and then re-characterize any accounts that have gone down in value back to a Traditional IRA.

There are many other nuances and strategies that you can implement when considering whether or not to convert some or all of your retirement accounts to a Roth IRA. Make sure as tax filing season approaches that you talk to your accountant and/or financial advisor to see how you can take advantage of the new law. Also, please feel to shoot me an email if you have any questions, chrisbenner@hotmail.com.