Why your Roth IRA distribution might not be taxable although your CPA reported income and penalty!

Why your Roth IRA distribution might not be taxable although your CPA reported income and penalty!

By Jeffrey Brooks, CPA, CFP, MBA for Jbrooks Wealth Advisors, PC, a Professional CPA and CFP Firm jeff@jbrookswa.com 602-687-9900 x101 Please consult with your professional tax CPA regarding your specific circumstances!

The great news is that a Roth IRA qualified distribution is not subject to tax or the 10% penalty on early distributions if the distribution is a qualified distribution which is five years AFTER the Roth IRA was established.

Let me repeat:

A qualified distribution is one made after the five-tax-year period beginning on the first day of the first year for which a Roth IRA contribution is made, if any of the following applies: [IRC 408A(d)(2)]

1) The taxpayer is at least age 591/2.
2) If a person was under 59 ½ years of age and the distribution is made in less than 5 years, the distribution is o.k. if the early distribution is due to the account owner’s death or disability.
3) The distribution is made to pay the costs (up to $10,000) of purchasing a principal residence for the taxpayer or certain relatives, if the person who is acquiring the home has not owned one in the last 24 months.

The five-year period begins on the first day of the first year to which a contribution relates, regardless of when it is actually made. Thus, a qualifying distribution can contain funds held in the Roth IRA for less than five years.

Here is an example: Bob opened a Roth IRA on March 15, 2008, making a contribution for the 2007 tax year. On January 15, 2012, at age 60, he withdraws the entire account balance, $30,000. This is a qualified distribution, not subject to income or penalty taxes. His five-year waiting period began January 1, 2007, the first day of the first tax year to which a Roth IRA contribution relates, and ended December 31, 2011.

What if Bob died age at 55? As long as the five-year test is met, a distribution after his death is nontaxable, regardless of his age when he dies.

Roth IRAs have more favorable basis recovery rules than traditional IRAs.

Roth IRA distributions are tax-free until all basis (that is, contributions) is recovered [IRC §408A(d)(4)]. In my example, you will see that if Bob only had held the IRA for four years, he would not be taxed until he recovered his original investment.

While basis from contributions to a Roth IRA can be withdrawn income and penalty tax-free at any time, distributions of basis attributable to funds converted from a traditional IRA or eligible employer plan are subject to penalty tax if withdrawn within five years of the conversion.

.To compute the basis-recovery portion of a distribution, all the taxpayer’s Roth IRAs are treated as a single account, but Roth IRAs are not aggregated with traditional IRAs.

Example #1: Darlene creates a Roth IRA by contributing $2,000 a year for five years. In this instance, regardless of Darlene’s age, up to $10,000 ($2,000 × 5) may be withdrawn from his Roth IRA tax-free.

Darlene’s Roth IRAs are worth $18,000. Darlene withdraws $14,000. $10,000 is tax free as long as Roth IRA account was started over 5 years ago. $4,000 is taxable.

Please let me know if you have any questions. Thank you very much! Jeff

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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