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- IRA Deductions Are Available to More Taxpayers. In 1998, the thresholds
at which IRA deductions are phased out will be higher than they were in 1997. Thus, some
taxpayers who could not deduct their contributions in 1997 or received only partial
deductions in 1997 should qualify for deductions (or larger deductions) in 1998 and later
years. The thresholds are discussed further in Chapter 6.
- Rules on IRA Contributions by Spouses Are Eased. An important
restriction on IRA contributions has been removed for 1998 and later years. In earlier
years, an individual who was not an active participant in an employer-sponsored retirement
plan could not make a deductible IRA contribution if the individual’s spouse was an
active participant. That restriction no longer applies, provided that the spouses’
joint income is less than $150,000. The phaseout is discussed further in Chapter 6.
- Penalty-Free Withdrawals from IRAs for Higher Education Expenses and First-Time
Homeownership Are Now Available. In 1998, for the first time, the 10-percent
additional tax on early withdrawals from IRAs is waived for withdrawals used to pay
qualified higher-education expenses or for qualified first-time home buyers. These
withdrawals do continue to be subject to regular income tax, however. The withdrawals are
discussed further in Chapter 6.
- Roth IRAs and Education IRAs. These new tax-advantaged savings vehicles
have become available in 1998. They are discussed in detail in Chapter 6.
- Elective Deferrals of Partners and Self-Employed Individuals. In 1998,
partners who participate in section 401(k) plans will be able to receive matching
contributions on their own contributions on the same basis as employees of the
partnership. (Under prior law, matching contributions made for partners counted against
the maximum annual dollar limit on the partner’s 401(k) contributions ($10,000 in
1998). Matching contributions of employees who are not partners have not been counted
against this limit.)
These rules may make it more attractive for a partnership to sponsor a 401(k) plan.
However, they don’t change the maximum amount that can be allocated to any employee
(including a partner) under other qualified plan limits, or the maximum contribution that
may be deducted.
A similar provision applies to SIMPLE plans. (SIMPLE plans are discussed in Chapter 3.)
- Roth IRA Conversions -- Tax Break for Those Receiving Mandatory Minimum
Distributions. Effective for tax years beginning after 2004, this year’s
legislation modifies the definition of adjusted gross income for purposes of determining
eligibility to convert a regular IRA into a Roth IRA. Under current law, only taxpayers
with AGIs of $100,000 or less are eligible to convert a regular IRA into a Roth IRA. The
1998 legislation modifies the definition of AGI for this purpose by excluding required
minimum distributions from IRAs. As a result, retirees or individuals who have reached age
seventy and one-half will not have to include the mandatory minimum distributions from
IRAs in their AGIs to determine whether they are eligible to convert an IRA into a Roth
IRA.
- New Clarifications on IRAs. For the most part, the 1998 legislation
confirmed existing informal IRS positions or understandings among tax practitioners. For
example:
Perhaps most important in the short term: Contributions to an IRA (and the resulting
inside build-up) can now be transferred from any IRA to another IRA by the due date for
the taxpayer’s return for the year of the contribution (including extensions). The
transfer must include all of the earnings on that distribution. This means that a taxpayer
can contribute to a Roth IRA early in the year and then unwind that contribution (or
conversion) if it later turns out that the contribution or conversion will be a problem
for the taxpayer. (A contribution might be a problem, for example, if the taxpayer’s
income for the year turned out to exceed the $100,000 limit for making a contribution to a
Roth IRA.)
Regarding the limits for deductible IRA contributions for an individual whose spouse is an
active participant in a pension plan (when the contributing individual is not): The
legislation clarifies that it is the IRA of the nonparticipant for which a contribution
deduction is allowed.
Regarding the five-year holding rule for Roth IRAs: It is now clear that the five-year
period begins with the year for which a contribution is first made to a Roth IRA. A later
conversion would not start the running of a new five-year period.
Regarding the four-year spread of income resulting from conversions of IRAs into Roth
IRAs: The rules are modified to prevent taxpayers from receiving premature distributions
from such a conversion while retaining the benefits of four-year income inclusion. In the
case of Roth conversions to which the four-year income inclusion rule applies, income
inclusion would be accelerated with respect to any amounts withdrawn before the final year
of inclusion.
The application of the four-year income spread is now elective. However, an election with
respect to the four-year spread cannot be changed after the due date for the return for
the first year of the income inclusion (including extensions).
If converted amounts are withdrawn within the five-year holding period beginning with the
year of the conversion, to the extent the withdrawals can be attributable to amounts that
were includible in income due to the conversion, the amount withdrawn would be subject to
the 10-percent early withdrawal tax.
Ordering rules now apply to determine which amounts are withdrawn if a Roth IRA contains
both conversion amounts (possibly from different years) and other contributions. Regular
Roth IRA contributions are deemed to be withdrawn first; then converted amounts (starting
with amounts first converted) would be deemed withdrawn. Withdrawals of converted amounts
are treated as coming first from converted amounts that were includible in income.
It is now clear that an individual may contribute up to a total of $2,000 a year to all
the individual’s IRAs combined. For example, suppose an individual is not eligible to
make contributions to a deductible IRA because of the income limits, but is eligible to
(and does) contribute $1,000 to a Roth IRA. The individual could also make a $1,000
contribution to a nondeductible IRA. (The $2,000 ceiling on total retirement IRA
contributions does not limit any contributions to education IRAs.)
- Parking and Transit Benefits: A New Option. Employers can offer
employees the option of electing cash compensation in lieu of any qualified transportation
benefit, or a combination of benefits, beginning in 1998. Qualified transportation
benefits include employer-provided transit passes, parking and vanpooling. Thus, no amount
is includible in income or wages merely because the employee is offered the choice of
cash, or merely because the employee is offered a choice among qualified transportation
benefits. Up to $175 per month (for 1998) of employer-provided parking and up to $65 per
month (for 1998) of employer-provided transit and vanpool benefits are excludable from
gross income.
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Tax Guide
