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Q: I need advice on closing out a Roth account by the end of the year to claim losses. I have invested $17,000 over the years and the account balance is now about $13,000. I have capital gains from stocks that I owned myself so I can use all of the capital loss. It is my understanding that if I completely close out the Roth to claim the loss that I will have no problem with taking the money out before age 59 1/2. Is that true?
A: The age 59 1/2 issue will not matter because you have $17,000 of basis in your Roth account so that you will not have any gains from the distribution. A “nonqualified” Roth distribution may create income only when the distribution exceeds your basis.
The 10 percent penalty tax for premature distributions, those taken before age 59 1/2, applies only to the taxable portion of the distribution. Since you have no taxable portion, you also have no concern about the penalty tax.
Roth accounts produce only ordinary income or ordinary loss. While funds are held within the Roth, investment gains are not taxed but any losses produce no tax benefit.
Nonqualified distributions from a Roth may create taxable income. Qualified distributions are not taxed. But when the amount withdrawn is less than the invested basis, a loss may be realized.
Like most people, you are familiar with capital losses as coming from investment-type assets. But remember that you are asking about a Roth account, which produces only ordinary gains and losses.
So if you close out the Roth by the end of the year, and have a $4,000 loss, the loss realized is ordinary rather than capital. So it cannot be used to offset your capital gains from taxable accounts.
Instead the loss is classified as a miscellaneous itemized deduction. So it must be added to other such deductions, and you get a tax benefit only if the aggregate of those deductions exceeds 2 percent of your adjusted gross income (AGI).
If your AGI is, say, $100,000, then the $4,000 loss produces a $2,000 net tax benefit if you itemize deductions. However, none of the deduction is allowed if you happen to be subject to the alternative minimum tax (AMT) in 2012 because miscellaneous itemized deductions are never allowed for the AMT.
Q: I think most people consider my wife and me to be “high” income We both have professional jobs and earn about $165,000 of salary. But we have 2 young children in a private Christian school and a large mortgage, and are very close to the line each month with our expenses. We are not “rich” by any standard and I am terrified that Congress will target people like us for added taxes that we cannot afford to pay. Do you really believe that the Democrats will stick to targeting people making more than $250,000 and leave me alone?
A: Well it seems that everyone wants “crystal ball” answers these days, and no one can really guarantee anything. I will give an opinion that tax rates will rise only for those with income above $250,000 (or $200,000 for singles).
But there are many other tax changes that are automatically set in place as of the first day of 2013 that can adversely affect you, perhaps even more than the small increase in rates being discussed for the high income.
First, you will lose the 2 percent payroll tax exemption at the end of this year. Second, there may be many expiring tax benefits that you have used to reduce your tax bill that will not be reinstated. Without looking at your tax returns, I can’t tell how these expiring benefits will affect you.
Third, perhaps the biggest problem is the AMT exemption, which has been “patched” annually by Congress to raise the exemption above the basic $45,000 set for married taxpayers.
The patch allowed a $74,450 exemption in 2011. With two children, property taxes, and a significant state income tax bill, you may have been subject to AMT in past years. If so, it will get a lot worse with a $45,000 exemption and if not, the lower exemption may create an AMT problem beginning this year.
James R. Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.<br>
