Last week’s blog post, The Ideal Roth IRA Conversion Candidate – Part 1, discussed two situations where it’s possible to convert a portion, and possibly all, of a traditional IRA to a Roth IRA while incurring minimal or no income tax liability attributable to the conversion. This week’s post presents two additional Roth IRA conversion “ideal candidates.”
As mentioned in last week’s post, all four situations, in addition to assuming availability of a traditional IRA, require preparation of an income tax projection, including calculation of potential exposure to alternative minimum tax, or “AMT,” to determine the amount of the traditional IRA that should be converted to a Roth IRA to achieve this result. The two situations that are the subject of this week’s post are as follows:
- Net operating loss
- Large charitable contribution deduction from establishment and funding of charitable remainder trust.
Net Operating Loss
If your deductions for a particular year exceed your income, which typically occurs from operating a business, you may experience a relatively rare tax phenomenon known as a net operating loss, or “NOL.” Generally, if you have an NOL, you are required to carry back the entire amount to the two years before the NOL year, unless you make an election to waive the carry back period, and then carry forward any remaining NOL for up to 20 years after the NOL year.
Your ability to use an NOL in a particular year is dependent upon the amount of your other income during the year. If you have an NOL, you may need to generate additional income to be able to utilize part, or all, of your NOL carry forward. If you are in this situation, an income tax projection should be prepared to determine the amount of traditional IRA you should convert to a Roth IRA to be able to utilize your NOL carry forward while incurring minimal or no income tax liability.
Also, if you have an NOL in the current year and are debating between carrying it back two years or making an election to relinquish the carry back period and instead carry it forward to next year, having a traditional IRA could be the deciding factor. While you may not be the ideal candidate for a Roth IRA conversion this year, the ability to offset income from a Roth IRA conversion with an NOL carry forward next year could prove to be quite beneficial.
Charitable Remainder Trust
Do you own any assets that you have been reluctant to sell because the sale would result in a large capital gain and sizeable tax liability? The establishment and funding of a charitable remainder trust, or “CRT,” is an income and estate planning technique that can be used to defer large capital gains while generating a large charitable contribution deduction in addition to providing portfolio diversification and an ongoing future income stream, making it a potent retirement income planning tool in the right situation.
The grantor of a charitable remainder trust is entitled to a charitable contribution deduction equal to the fair market value of the remainder interest of the property being transferred to the CRT. This deduction is limited to 30% of adjusted gross income (“AGI”), with the excess amount carried forward to future years. Given the size of the charitable contribution deduction resulting from establishment of a typical CRT, it isn’t unusual that a large portion of the deduction is unusable in the year of establishment of the CRT and must instead be carried forward.
If this is the case, an income tax projection should be prepared to determine the amount of traditional IRA that should be converted to a Roth IRA in the year of establishment of the CRT to generate additional AGI to free up an additional charitable contribution deduction that won’t result in an increase in income tax liability.
If you fall under one of the two scenarios above and it is projected that you will incur minimal or no income tax liability in connection with a partial or full Roth RIA conversion, you may be an ideal candidate for a Roth IRA conversion.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.