Changes to the law regarding Roth IRAs
We are an elderly couple and we cashed several 1964-1965-1966 Series "E" government bonds. The interest amounts to over $7,000. We have been told that the interest can be treated as capital gain. I disagree. I am sure such interest must be treated like all other interest, however it is not taxed by the State of Indiana. Am I correct?
Trust your instinct on this one. The Series "E" bonds are issued at a discount when you make your original investment, which means that when you purchase one of these bonds, you pay less than the face value for the bond. When you cash the bond, you receive the face value. The difference is interest. Over the years in which you hold the bond, you have the right to report the annual increase in redemption value of the bond as interest income. Alternatively, you may choose, as you have done, to wait until you redeem the bond, then report the entire difference between your purchase price and the redemption value as interest income. Either way, the income is interest to you. Report this interest on your Schedule B along with any other interest income you may have. And, as you noted, Indiana will not tax this interest income.
Continuing Confusion over the Roth IRA
On a Roth IRA conversion performed in 1998, is the conversion income to be spread over four years, or is it the tax on that income, as computed on the 1998 tax return, that is spread over four years? If it is the amount that is spread over four years, I will remain in the 15% tax bracket. If I am taxed on the full conversion amount in 1998, my tax obligation greatly exceeds the 15% level. Then, even if this tax is spread over four years, the attractiveness of the advantages of a Roth IRA are severely diminished.
As you point out, there can be a great difference between reporting the income of a Roth conversion over four years, versus calculating the tax in 1998 and dividing the tax amount over four years. Fortunately, the Roth continues to be an attractive alternative to a regular IRA when it comes to making the four-year election.
The way it works is, you may convert amounts from an ordinary IRA to a Roth IRA if your adjusted gross income for the year does not exceed $100,000 and your filing status is not married filing separately. If you choose to make this conversion in 1998, you have the option of paying tax on the entire conversion in 1998 or reporting the income from the conversion ratably over four years. If you choose the four-year method, you will include one-fourth of the conversion amount in your income on your 1998 tax return, one-fourth of the income on your 1999 tax return, one-fourth on your 2000 tax return, and one-fourth on your 2001 tax return.
This means that only one-fourth of the conversion amount will be added to your income during each of the four years, and, therefore, your tax rate will remain lower than it would if you had to compute the entire tax in the first year, then pay the tax over four years.
What are the complications resulting from a transfer back to a traditional IRA, in the event that a person. s income now appears that it will exceed the $100,000 limit, but the value of the Roth IRA account is below its original transfer value as a result of the recent stock market decline?
If you determine that you will not meet the requirements for a conversion to a Roth IRA and you reconvert your funds from the Roth back to a traditional IRA, you will transfer any related income or loss associated with the funds back to the original IRA with no tax consequences.
For example, if you converted $50,000 in securities to a Roth IRA in May, 1998, and now find that your adjusted gross income (without including the IRA conversion amount) is expected to exceed $100,000, you may reconvert the entire Roth account back to your original IRA. If the securities in the account are now only worth $45,000, you do not need to come up with the additional $5,000 when you send the account back to your IRA. Instead, the loss of $5,000 carries back to the IRA along with the securities in the account. Likewise, if your Roth account increased in value between May and October, and you reconvert the funds to your original IRA, you will reconvert the income in the account as well.