Small Business Jobs Act and Notice 2009-68
[b]Small Business Jobs Act[/b]
As you may know, the Senate could not get the Tax Extenders bill passed (a bill that included a provision to allow IRA owners to make tax-free distributions for charitable purposes). As a result, it seems a deal was struck to allow the Small Business Jobs Act…a bill passed by the House back in March…to come to the Senate floor for debate.
One of the offsets has me puzzled:
[i][b]Allow Rollovers from Elective Deferral Plans to Roth Designated Accounts. [/b][/i]The bill would allow 401(k), 403(b), and governmental 457(b) plans to permit participants to roll their pre-tax account balances into a Roth account. The amount of the rollover would be includible in taxable income except to the extent it is the return of after-tax contributions. If the rollover is made in 2010, the participant can elect to pay the tax in 2011 and 2012. Plans would be able to allow these rollovers immediately upon enactment.
MY COMMENT: I think this may finally address the issue of which method to use when rolling a mix of pre-tax and after-tax dollars from a qualified employer retirement plan to a Roth IRA. As you know, the IRS has stated that the preferred method is to do an indirect rollover (60 day rollover), whereby a mandatory 20% withholding is applied. However, custodians have insisted they are comfortable transacting a direct rollover, whereby pre-tax dollars transfer to a Traditional IRA and after-tax dollars transfer to a Roth IRA simultaneously. We’ll see if this bill clarifies this ambiguity. But, maybe this provision just makes it mandatory for employers who offer qualified employer retirement plans to offer as well a Roth IRA option within their current employer plan…like a Roth 401(k).
I would be interested in your interpretation.
Thanks,
Doug
Permalink Submitted by Alan Spross on Wed, 2010-06-30 18:29
Doug,
I don’t see any connection between those two issues. The new provision just allows Roth conversions within QRPs where this was not previously possible. Earlier reports on this provision referred to limitations on these conversions to “otherwise distributable assets”. This proposal may also reflect the elimination of income limits for conversions which would have triggered many recharacterizations in the past. QRPs have never had to deal with recharacterizations like IRA custodians, and it remains to be seen what will happen if an employee wants to recharacterize one of these QRP conversions due to market losses, inability to pay the taxes, etc.
Also, with respect to isolation of basis, I am not aware that the IRS has made any recommendation. Tax attorneys have come up with the indirect rollover as a partial solution to isolating basis because Sec 402(c)2 includes an ordering rule that indicates an employee completed rollover is deemed to be composed of pre tax funds before any after tax funds. The debate, unresolved by 2009-68 is whether the same rules can apply to direct rollovers or not. 402(c)2 does not comment on direct rollover ordering rules which leaves the pro rating process in place when a direct rollover is done.
The new proposal is a direct rollover from the pre tax QRP to the designated Roth QRP. Therefore, it appears that after tax contributions would be pro rated with the pre tax amounts as described in 2009-68. If the pre tax account held 20% in after tax contributions, then 80% of any full or partial conversion would be taxable. This would also bring into play the need for a 5 year conversion holding period for QRP conversions to prevent employees from converting and then distributing funds to get around the penalty.
There are probably several reasons for this provision, but it appears one obvious one is that it will allow QRPs to retain assets, particularly after separation from service. But the prime driver is that the conversion taxes generated by these QRP conversions is being applied as an offset to the budget deficits resulting from other provisions in the Jobs Act. I wonder when Congress is going to figure out that accelerated revenue in the short term equals lost revenue in the long term and short term stimulus becomes part of long term deficits that could depress the economy for longer periods of time.
We may be seeing a trend toward Roth conversions as taxpayer friendly options that increase tax revenue. Maybe we will have another conversion campaign in 2013 that allows taxes to be spread over 3 or 4 years. That would produce another flow of tax revenue that would otherwise drop off in 2013.
Permalink Submitted by [email protected] on Wed, 2010-06-30 20:21
Alan,
Thanks for the clarification.
Doug