Optimizing Taxes: Backdoor Roth IRA Contributions

This unique strategy becomes available if your 401(k) plan allows you to roll over an IRA account into the 401(k) plan. Normally, single people making over $120,000 a year and married people filing taxes jointly making over $189,000 a year are limited in their ability to contribute to a Roth IRA (the income numbers are based on your Modified Adjusted Gross Income). By using the backdoor Roth IRA strategy, a highly compensated individual can contribute to a non-deductible IRA and convert it to a Roth IRA. The problem is that any Roth conversions must be done pro-rata across all IRA accounts. This means that, if you have a deductible IRA in addition to a non-deductible IRA being funded, any conversion of IRA money would be taken from both pre- and post-tax IRA accounts pro-rata. This creates a tax on the distributions from the deductible IRA where otherwise there would be none. 

To avoid this additional taxation, you could potentially transfer the deductible IRA money into your 401(k) and then convert the new non-deductible IRA contributions to a Roth IRA without creating a taxable distribution.

TAXABLE BENEFITS, TAX AND THE SELF-EMPLOYED

TAXABLE BENEFITS

There are a number of employee benefits offered by companies that are taxable on the employee as a benefit in kind. These include:

§  private medical insurance;

§  payments for expenses that have not been wholly, exclusively and necessarily incurred in the performance of relevant duties of the employee;

§  payment of telephone rental charges and private telephone calls;

§  the cost of luncheon vouchers above 15 pence per day.

We emphasize that the basic principles of benefit taxation are not clear cut and that it is always advisable to get a ruling from the Inland Revenue on any specific new benefit under consideration. In addition, it is important to ensure that employees are fully aware of the tax liabilities on their benefits in kind.

 

TAX AND THE SELF-EMPLOYED

The income tax position for individuals depends largely on whether they are employees and their income is taxable as employment income or whether they are taxable under Schedule D. (Some employees, eg professionals who teach and write for fees but have either a full- or a part-time contract, may be both.) It is now very difficult to have a contract with a 'self-employed person' if he or she works more or less full time for one 'client'. There are a number of tax cases that have debated this point. However, the basis of being self-employed is generally dependent upon a number of factors. Guidance is available from the Inland Revenue to help decide whether an individual is an employee or is self-employed.

EMPLOYER AND EMPLOYEE TAXATION

Deductibility of Premiums
Employer contributions to the Social Security and Medicare programs are tax deductible for federal income tax purposes. Any employee contributions are paid with after-tax dollars. Self-employed persons can deduct one-half of their Social Security tax as a business expense. In addition, Part B premiums are treated the same as other premiums for individual medical expense insurance and may be deductible.

Taxation of Benefits
Benefits received in the form of monthly income under Social Security are partially subject to income taxation for some Social Security recipients. To determine the amount of Social Security benefits subject to taxation, it is necessary to calculate modified adjusted gross income, which is the sum of the following:

- The taxpayer's adjusted gross income (disregarding any foreign income and savings bond exclusions)

- The taxpayer's tax-exempt interest received or accrued during the year

- One-half of the Social Security benefits for the year

If the modified adjusted gross income is $25,000 or less for a single taxpayer ($32,000 or less for a married taxpayer filing jointly), Social Security benefits are not taxable. If the modified adjusted gross income is between the base amount and $34,000 ($44,000 for a married taxpayer filing jointly), up to 50 percent of the Social Security benefit is includable in taxable income. If the modified adjusted gross income exceeds $34,000 ($44,000 for a married taxpayer filing jointly), up to 85 percent of the Social Security benefit is includable in taxable income. The exact amount of the taxable Social Security benefit is determined by complex formulas that are beyond the scope of this discussion.

Medicare benefits and any lump-sum Social Security benefits are received tax free.