Monthly Archive: February 2015

California Tax Planning Part 2 – Estimated Tax Payments for High Income Taxpayers

High income taxpayers have two sets of estimated tax payment rules that apply to them – federal rules and California rules.  Under the federal rules, high-income taxpayers have to pay in the lesser of 2 numbers in equal installments before the end of the tax year:

(1) 90% of the current year’s liability; or

(2) 110% of the previous year’s liability (non-high income taxpayers use 100% instead of 110%).

However, under California law, high income taxpayers with more than $1 million of AGI must pay in 90% of the current year’s liability, as these taxpayers are ineligible for the prior-year safe harbor.  Furthermore, unlike federal, California taxpayers must front load their estimated tax payments in the 1st and 2nd quarters (30% and 40% in each, with the remaining 30% due in the 4th quarter).

It may seem simple, but I find that many tax preparers are not adequately (or at all) instructing their clients about their responsibility to pay estimated tax payments.  Failure to pay in your estimated tax payments results not only in big tax bills in tax season, but also non-deductible penalty payments.  With bank savings account interest rates hovering around next to nothing, it is a no-brainer to pay in your estimated taxes as required and avoid penalties in tax season.

Backdoor Roth IRA’s

Reading President Obama’s recently released budget proposal for 2016 is like reading a tax attorney’s playbook – many of the good tax savings ideas are in there, except the President wants to end them!  One such proposal is to limit Roth conversions to pre-tax dollars.  While I don’t expect any serious tax reform bills to be signed into law anytime soon, it is a good idea to familiarize oneself with existing “loopholes” in order to maximize tax savings while available.

What is it?  A “backdoor” Roth IRA conversion refers to contributing after-tax money to a traditional IRA and then converting that traditional IRA into a Roth IRA.  The reason for undertaking this convoluted procedure is that while contributions to a Roth IRA are limited based upon income levels, contributions to a traditional IRA are not, although the ability to obtain an income tax deduction by contributing to a traditional IRA is limited by income.  Thus, a backdoor Roth IRA allows an indirect contribution to a Roth IRA when a direct contribution would not otherwise be allowed.  No income tax is owed on the conversion of the original contribution dollar amount (since the traditional IRA contribution was, in this scenario, non-deductible) and the money can grow tax free in the Roth IRA.  Furthermore, Roth IRA’s do not have required minimum distributions and are not subject to income tax upon receipt.

What would President Obama’s proposal accomplish?  Roth IRA conversions would be limited to pre-tax contributions (and earnings thereon) to traditional IRAs, so this loophole would effectively be closed.  The ability to convert pre-tax dollars in a traditional IRA would still be available, but income taxes will be incurred by the conversion.

Strategy: If this retirement savings/wealth accumulation strategy sounds interesting, get started.  If you wait, you could miss out if tax reform is ever implemented.  It is important to note, however, that there are pitfalls to any tax minimization strategy, and this one is no different.  Consult your tax advisor prior to making the conversion to determine the tax effects, especially if you have other pre-tax retirement accounts.

401(k) Loans and mortgage interest expense

Most people think of their 401(k) as a “hands off” asset that can’t be touched until retirement.  Although this is sound strategy for retirement planning, the 401(k) can be a source of short-term funding that will continue to grow despite being withdrawn now for other purposes.  Depending upon your plan policies, 401(k) participants can take a loan from their accounts in an amount up to $50,000 (limited to 50% of your account value) at a 3.25%-5.25% interest rate without recognizing the loan amount as income (as would otherwise happen upon receiving a distribution from a 401(k)).  This means that although retirement account assets have been diverted away from the account for 5 years and the participant has lost out on 5 years worth of stock market appreciation (or losses), there has been a guaranteed 3.25-5.25% per year return by simply paying the loan back.  And since the 401(k) is yours when you retire, you are paying yourself back by simply shuffling money from one pocket to another.

What if you could turn the otherwise non-deductible 401(k) loan into a tax deductible loan by securing the loan with a deed of trust on your residence?  That would be the best of all possible worlds – guaranteed returns of 3.25%-5.25%; paying oneself instead of someone else; and deducting the interest paid for a tax benefit.   It is possible, but unfortunately, only in very limited situations, such as for non-key employees.  Furthermore, tax deductions for interest is limited to interest accrued on non-elective deferrals (i.e. appreciation in the account or employer-deposited amounts). However, if you fall into this small category of individuals, the results can be worthwhile, as illustrated below.


  1. Non-key employee;
  2. 401(k) with a significant non-elective deferral balance;
  3. $50,000 of student debt at a 8% interest rate (which is entirely or partially non-deductible, depending upon income level); and
  4. Also owns a home.

If this person were to take a $50,000 loan from the 401(k) at a 3.25%-5.25% interest rate and secure the loan with a Deed of Trust on the home, this person could deduct the interest expense on the $50,000 401(k) loan and save 2.75% – 4.75% (the difference between 8% and 3.25%-5.25%) on the interest rate over the life of the loan.  Furthermore, by securing the 401(k) loan with a Deed of Trust, the 5 year repayment period can be extended, thus reducing the monthly payment.


Although this seems like a no brainer, there are many potential issues with this plan to consider (other than the issue presented above relating to key employees and elective deferrals) and you should consult your tax adviser prior to taking out a 401(k) loan.  For example, all of the benefits (such as forbearance and deferment) of having public student loans disappear when you pay them off with the 401(k) loan.  Furthermore, itemized deductions can be limited based upon your income levels and home equity debt is limited by the Alternative Minimum Tax.  Lastly, if the stock market has a gangbuster year, you could miss out on significant appreciation.  On the flip side, though, if the stock market has a bad year, you will have had a good year simply by paying yourself interest.


How to avoid repaying the 2008 first-time homebuyer credit

If you purchased a home in 2008 and took a first-time homebuyer credit on your 2008 tax return, you know that this credit is really more like a loan – you have to pay it back in $500 increments over 15 years.  You likely also know that if you sell your home before the 15 years is up, that you have to repay the loan on your tax return in the year of the sale.  But did you know that if you sell your home for a loss (as adjusted by closing costs and the unpaid amount of the loan) that you don’t have to repay the loan?  If you are selling your home for a loss or near breakeven, then this could be a ~$5,000 windfall for you.  If you are contemplating selling your home in 2015, this windfall could help make selling for a loss a little easier to bear.


Flashback to 2014: IRA Transfers to Charity – Why you should start planning for year-end charitable transfers now.

If you had blinked, you would have missed it – nontaxable IRA transfers to charity were approved and then expired within a 2 week period this last December.  Since it seems that every year Congress re-authorizes expired tax breaks, my guess is that we will see a repeat in 2015 and taxpayers will again have a limited window to transfer IRA assets to charity.  If you are charitably inclined and in a higher tax bracket, you should take this strategy into account for your 2015 charitable planning.

What is it?  An IRA to charity transfer is a direct distribution of up to $100,000 from an IRA account to an eligible charity.  The only catch is that the IRA account holder must be 70 1/2 or older.  The provision authorizing this procedure expired on December 31, 2013, but in December, 2014, the expiration date was extended to December 31, 2014.  This means that taxpayers that made an IRA to charity transfer anytime in 2014, even if it was not good law at the time, are entitled to reap the tax benefits of the transfer.

What are the tax benefits?

  1. The transfer qualifies as the required minimum distribution, meaning any amount transferred reduces the amount that would otherwise be required to be withdrawn and recognized as income.
  2. The amount transferred does not count as income, but there is no deduction for a charitable contribution.
  3. Lower income is almost always a good thing from a tax perspective – lower marginal tax rates, avoidance of the Medicare surtax on investment income, lower taxation of social security benefits, and avoidance of income-based itemized deduction and exemption phaseouts.

So what should I do?  You have 2 options – you can assume that the provision will be extended again and make the transfer now, or you can wait until the end of the year to see what happens.  If the provision is not extended and you make the transfer now, you will be in no worse position so long as you don’t transfer more than your required minimum distribution. If you wait and see and the provision is not extended, then you may have to squeeze all your planned charitable contributions into the end of the year.