The IRS just gave guidance that a “nondeductible” IRA may still be converted into a Roth IRA. We have had our concerns that the new tax codes might have changed the IRS interpretation.
Until 1997, taxpayers over a certain level of income were no longer able to deduct their IRA contribution. Many advisors thought that the rule was that the higher income earner could not open an IRA, which was incorrect. Note, that they were still able to make the contribution but simply lost the ability to deduct them.
Why would anyone open an IRA that they could not deduct? Well, it still allowed tax-deferred growth after it was opened. It was a “tax-deferred annuity” that could be invested in any way that an IRA could be invested. With the creation of a Roth IRA (1997) and the Roth conversion rules that developed afterward, the planning community spared no time in putting two and two together. Now we could convert the “excess” IRA contribution that had never been deducted into a Roth IRA. The future growth would be “tax-free” instead of “tax differed”. Some refer to this as a “Back-Door Roth”. This allowed a way for Roth contribution for people who would previously not have been allowed to contribute.
With some of the changes in the new tax code, the planning community wondered if that ability had been forfeited. The ruling came down in favor of allowing that to continue.
So, at least that part of the planning race is over until 2025!
The changes to the tax code have left bits and pieces like this for clarification that will take years to decipher. Even grander in scope are new sections of the code like 199A, and new terms of art like “QBI” (Qualified Business Income) that will need to be further defined. That endeavor will take so much time that several years of business returns will be filled without reliable guidance, so battles over letter audits will likely continue until 2025 and after. Then, it all sunsets and goes away. We are back to the 2017 tax code. Right about the time we actually understand what we’re doing and reframe our business tax practices.
What should the Trump tax code be nicknamed? “Finish Line 2025”! Or, “The Constant Confusion of the American Taxpayer Act”.
So, if you have never used a tax planning firm in the past and have just used tax preparation firms, you may want to rethink that. If you need proof, consider that H&R Block just announced the closing of 400 offices and their stock has dropped significantly in value as a result.