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  • 'Cash Flow:' A column by Albert Crenshaw
  •   Roth IRA Holders Might Cut Taxes

    By Albert B. Crenshaw
    Washington Post Staff Writer
    Saturday, September 5, 1998; Page G01

    Taxpayers who converted their traditional individual retirement accounts to new Roth IRAs earlier this year may be able to repeat the transaction to take advantage of the stock market plunge and reduce the taxes they owe on capital gains, some accountants studying the new law and regulations have concluded.

    In fact, these accountants said, IRS regulations may allow taxpayers to reverse a conversion to a Roth IRA repeatedly until they file their 1998 returns, which could be as late as next October. In effect, this would allow a taxpayer to time the market in an attempt to realize the lowest possible capital gain on which taxes must be paid.

    "This really could help a lot of people out that are in these rollovers," said John R. Ziegelbauer of the Washington office of Grant Thornton, a big national accounting firm.

    And, Ziegelbauer added, "Now is the time to do something. If people don't learn about this until next month it could be too late" because the market could have gone back up.

    Roth IRAs differ from traditional ones in that they are funded exclusively with nondeductible dollars, but no income tax is levied on the growth or distributions. By contrast, when money is withdrawn from a traditional IRA it is taxed at ordinary income rates.

    Taxpayers may convert their traditional IRAs to Roth IRAs, but all the accumulated gains become taxable in the year of conversion. For conversions done in calendar 1998, however, taxes may be spread over four years to ease the burden.

    The amount of the gain within an IRA that is invested in stocks depends, obviously, on market performance. A conversion done near the market peak in July would likely result in much higher tax than one done last week. A taxpayer who made a July conversion would now be looking at paying taxes on gains he or she no longer has.

    The opportunity to redo the conversion and reduce the capital gains tax results from a change in the law that was intended to protect taxpayers from falling into a trap when they switched.

    Because there are income limits on Roth conversions, and because people don't always know before year-end what their income will be for the year, there was fear that some taxpayers would make the conversion and then be penalized for being over the income limit, which is $100,000 of adjusted gross income.

    Under a technical correction provision in the Internal Revenue Service Reform Act passed earlier this year, taxpayers are allowed to undo their Roth conversions, thus avoiding the trap. However, there don't appear to be any limits on the number of times a taxpayer may convert and unconvert up until the time his or her tax return is due, including extensions.

    An IRS spokesman said, "There is nothing in the law or regulations to prevent it." He did caution, though, that the proposed regulations are not final and could change. They will be the subject of a public hearing Dec. 10.

    Thus, Ziegelbauer said, taxpayers who have already converted when their portfolios were worth more can reverse the transaction and then reconvert at the lower value. Or they could convert now for the first time, if they have not done so before.

    Then the taxpayers can wait and watch. If the market never goes any lower, they have lowered their taxes as much as possible. If the market does continue down, they can repeat the process to catch the new lower value.

    There is some debate as to whether such moves are really permitted. Some accountants said they were wary of that interpretation, though they would not rule it out.

    "They are really, really confusing regulations," said Althea Day of the accounting firm PricewaterhouseCoopers.

    The IRS "might take a liberal view of this," said Stephen R. Corrick of the Washington office of Arthur Andersen, since a different interpretation might expose taxpayers to the trap that Congress had meant to close.

    "I'd like it if it came out favorably, but I wouldn't tell a client today that I know that it works," he said.

    And there may be practical obstacles. A spokesman for the Vanguard Group of mutual funds said his firm will permit shareholders who have genuinely made an error to switch back once, but will not permit multiple conversions.

    However, T. Rowe Price will "serve the customer's wishes," a spokeswoman said.

    Ziegelbauer noted that taxpayers may convert and unconvert until they file their returns -- which with extensions could go into October 1999. However, the right to spread the taxes over four years applies only to conversions made in calendar 1998.

    If the market goes lower after Jan. 1, 1999, taxpayers will need to weigh the additional tax savings they might realize from another conversion against the value of being able to spread the burden over four years. In any case, taxpayers in this situation would want to keep their returns open as long as possible to see what the market does, Ziegelbauer said.

    Conversions are not limited to 1998. Conversions done in later years could also be undone and redone up to the filing of the return, Ziegelbauer said.

    © Copyright 1998 The Washington Post Company

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