The Joint Committee on Taxation has reported (JCX-18-98) on technical corrections with a March 31st markup scheduled by Senate Finance Committee Chairman Bill Roth.
I. DESCRIPTION OF TECHNICAL CORRECTIONS TO THE TAXPAYER RELIEF ACT OF 1997
C. Amendments to Title III of the 1997 Act Relating to Savings Incentives
1. CONVERSIONS OF IRAS INTO ROTH IRAS (SEC. 302 OF THE 1997 ACT AND SECS. 408A AND 72(T) OF THE CODE)
Present Law
[48] A taxpayer with adjusted gross income of less than $100,000 may convert a present-law deductible or nondeductible IRA into a Roth IRA at any time. The amount converted is includible in income in the year of the conversion, except that if the conversion occurs in 1998, the amount converted is includible in income ratably over the 4-year period beginning with the year in which the conversion occurs. /10/ Amounts includible in income as a result of the conversion are not taken into account in determining whether the $100,000 threshold is exceeded. The 10-percent tax on early withdrawals does not apply to conversions of IRAs into Roth IRAs.
[49] In general, distributions of earnings from a Roth IRA are excludable from income if the individual has had a Roth IRA for at least 5 years and certain other requirements are satisfied. The 5- year holding period with respect to conversion Roth IRAs begins from the year of the conversion. (Distributions that are excludable from income are referred to as qualified distributions.)
[50] Present law does not contain a specific rule addressing what happens if an individual dies during the 4-year spread period for 1998 conversions.
Description of Proposal
Distributions of converted amounts
Distributions before the end of the 4-year spread
[51] The proposal would modify the rules relating to conversions of IRAs into Roth IRAs in order to prevent taxpayers from receiving premature distributions from a Roth conversion IRA while retaining the benefits of 4-year income averaging. In the case of conversions to which the 4 year income inclusion rule applies, income inclusion would be accelerated with respect to any amounts withdrawn before the final year of inclusion. Under this rule, a taxpayer that withdraws converted amounts prior to the last year of the 4-year spread would be required to include in income the amount otherwise includible under the 4-year rule, plus the lesser of (1) the taxable amount of the withdrawal, or (2) the remaining taxable amount of the conversion (i.e., the taxable amount of the conversion not included in income under the 4-year rule in the current or a prior taxable year). In subsequent years (assuming no such further withdrawals), the amount includible in income under the 4-year will be the lesser of (1) the amount otherwise required under the 4-year rule (determined without regard to the withdrawal) or (2) the remaining taxable amount of the conversion.
[52] Under the proposal, application of the 4-year spread would be elective. The election would be made in the time and manner prescribed by the Secretary. An election with respect to the 4-year spread could not be changed after the due date for the return for the first year of the income inclusion (including extensions).
[53] The following example illustrates the application of these proposed rules.
EXAMPLE: Taxpayer A has a nondeductible IRA with a value of
$100 (and no other IRAs). The $100 consists of $75 of
contributions and $25 of earnings. A converts the IRA into a
Roth IRA in 1998 and elects the 4-year spread. As a result of
the conversion, $25 is includible in income ratably over 4
years ($6.25 per year). The 10-percent early withdrawal tax
does not apply to the conversion. At the beginning of 1999,
the value of the account is $110, and A makes a withdrawal of
$10. Under the proposal, the withdrawal would be treated as
attributable entirely to amounts that were includible in
income due to the conversion. In the year of withdrawal,
$16.25 would be includible in income (the $6.25 includible in
the year of withdrawal under the 4-year rule, plus $10 ($10
is less than the remaining taxable amount of $12.50 ($25-
$12.50)). In the next year, $2.50 would be includible in
income under the 4-year rule. No amount would be includible
in income in year 4 due to the conversion.
Application of early withdrawal tax to converted amounts
[54] The proposal would modify the rules relating to conversions to prevent taxpayers from receiving premature distributions (i.e., within 5 years) while retaining the benefit of the nonpayment of the early withdrawal tax. Under the proposal, if converted amounts are withdrawn within the 5-year period beginning with the year of the conversion, then, to the extent attributable to amounts that were includible in income due to the conversion, the amount withdrawn would be subject to the 10-percent early withdrawal tax. /11/
[55] Applying this rule to the example above, the $10 withdrawal would be subject to the 10 percent early withdrawal tax (unless an exception applies).
Application of 5-year holding period
[56] The proposal would also eliminate the special rule under which a separate 5-year holding period begins for purposes of determining whether a distribution of amounts attributable to a conversion is a qualified distribution; thus, the 5-year holding rule for Roth IRAs would begin with the year for which a contribution is first made to a Roth IRA. A subsequent conversion would not start the running of a new 5-year period.
Ordering rules
[57] Ordering rules would apply to determine what amounts are withdrawn in the event a Roth IRA contains both conversion amounts (possibly from different years) and other contributions. Under these rules, regular Roth IRA contributions would be deemed to be withdrawn first, then converted amounts (starting with the amounts first converted). Withdrawals of converted amounts would be treated as coming first from converted amounts that were includible in income. As under present law, earnings would be treated as withdrawn after contributions. For purposes of these rules, all Roth IRAs would be considered a single Roth IRA.
Corrections
[58] In order to assist individuals who erroneously convert IRAs into Roth IRAs or otherwise wish to change the nature of an IRA contribution, contributions to an IRA (and earnings thereon) may be transferred from any IRA to another IRA by the due date for the taxpayer's return for the year of the contribution (including extensions). Any such transferred contributions will be treated as if contributed to the transferee IRA (and not to the transferor IRA).
Effect of death on 4-year spread
[59] Under the proposal, in general, any amounts remaining to be included in income as a result of a 1998 conversion would be includible in income on the final return of the taxpayer. If the surviving spouse is the beneficiary of the Roth IRA, the spouse could continue the deferral by including the remaining amounts in his or her income over the remainder of the 4-year period.
Calculation of AGI limit for conversions
[60] The proposal would clarify that, for purposes of applying the $100,000 AGI limit on IRA conversions into Roth IRAs, the conversion amount (to the extent otherwise includible in AGI) is subtracted from AGI as determined under the rules relating to IRAs (sec. 219). Thus, for example, the AGI-based phase out of the exemption from the disallowance for passive activity losses form rental real estate activities (sec. 469(i)(3)) would be applied taking into account the amount of the conversion that is includible in AGI, and then the amount of the conversion would be subtracted from AGI in determining whether a taxpayer is eligible to convert and IRA into a Roth IRA.
Effective Date
[61] The provision would be effective as if included in the 1997 Act, i.e., for taxable years beginning after December 31, 1997.
2. PENALTY-FREE DISTRIBUTIONS FOR EDUCATION EXPENSES AND PURCHASE OF FIRST
HOMES (SECS. 203 AND 303 OF THE 1997 ACT AND SEC. 402 OF THE CODE)
Present Law
[62] The 10-percent early withdrawal tax does not apply to distributions from an IRA if the distribution is for first-time homebuyer expenses, subject to a $10,000 life-time cap, or for higher education expenses. These exceptions do not apply to distributions from employer-sponsored retirement plans. A distribution from an employer-sponsored retirement plan that is an "eligible rollover distribution" may be rolled over to an IRA. The term "eligible rollover distribution" means any distribution to an employee of all or a portion or the balance to the credit of the employee in a qualified trust. Distributions from cash or deferred arrangements made on account of hardship are eligible rollover distributions. An eligible rollover distribution which is not transferred directly to another retirement plan or an IRA is subject to 20-percent withholding on the distribution.
Description of Proposal
[63] Under present law, participants in employer-sponsored retirement plans can avoid the early withdrawal tax applicable to such plans by rolling over hardship distributions to an IRA and withdrawing the funds from the IRA. The proposal would modify the rules relating to the ability to roll over hardship distributions from employer- sponsored retirement plans in order to prevent such avoidance of the 10-percent early withdrawal tax. The proposal would provide that distributions from cash or deferred arrangements and similar arrangements made on account of hardship of the employee are not eligible rollover distributions. Such distributions would not be subject to the 20-percent withholding applicable to eligible rollover distributions.
Effective Date
[64] The proposal would be effective for distributions after December 31, 1998.
3. LIMITS BASED ON MODIFIED ADJUSTED GROSS INCOME (SEC. 302(a) OF THE 1997 ACT AND SEC. 72(T) OF THE CODE)
Present Law
[65] The $2,000 Roth IRA maximum contribution limit is phased out for individual taxpayers with adjusted gross income ("AGI") between $95,000 and $110,000 and for married taxpayers filing a joint return with AGI between $150,000 and $160,000. The maximum deductible IRA contribution is phased out between $0 and $10,000 of AGI in the case of married couples filing a separate return.
Description of Proposal
[66] The proposal would clarify the phase-out range for the Roth IRA maximum contribution limit for a married individual filing a separate return and conform it to the range for deductible IRA contributions. Under the proposal, the phase-out range for married individuals filing a separate return would be $0 to $10,000 of AGI.
Effective Date
[67] The proposal would be effective as if included in the 1997 Act, i.e., for taxable years beginning after December 31, 1997.
4. CONTRIBUTION LIMIT TO ROTH IRAS (SEC. 302 OF THE 1997 ACT AND SEC. 408A(c) OF THE CODE)
Present Law
[68] An individual who is an active participant in an employer- sponsored plan may deduct annual IRA contributions up to the lesser of $2,000 or 100 percent of compensation if the individual's adjusted gross income ("AGI") does not exceed certain limits. For 1998, the limit is phased-out over the following ranges of AGI: $30,000 to $40,000 in the case of a single taxpayer and $50,000 to $60,000 in the case of married taxpayers. An individual who is not an active participant in an employer-sponsored retirement plan (and whose spouse is not an active participant) may deduct IRA contributions up to the limits described above without limitation based on income. An individual who is not an active participant in an employer-sponsored retirement plan (and whose spouse is such an active participant) may deduct IRA contributions up to the limits described above if the AGI of the such individuals filing a joint return does not exceed certain limits. The limit is phased for out for such individuals with AGI between $150,000 and $160,000.
[69] An individual may make nondeductible contributions up to the lesser of $2,000 or 100 percent of compensation to a Roth IRA if the individual's AGI does not exceed certain limits. An individual may make nondeductible contributions to an IRA to the extent the individual does not or cannot make deductible contributions to an IRA or contributions to a Roth IRA. Contributions to all an individual's IRAs for a taxable year may not exceed $2,000.
Description of Proposal
[70] The proposal would clarify the intent of the Act that an individual may contribute up to $2,000 a year to all the individual's IRAs. Thus, for example, suppose an individual is not eligible to make deductible IRA contributions because of the phase-out limits, and is eligible to make a $1,000 Roth IRA contribution. The individual could contribute $1,000 to the Roth IRA and $1,000 to a nondeductible IRA.
Effective Date
[71] The proposal would be effective as if included in the 1997 Act, i.e., for taxable years beginning after December 31, 1997.
5. CONTRIBUTION LIMITATIONS FOR ACTIVE PARTICIPANTS IN AN IRA (SEC. 301(b) OF THE 1997 ACT AND SEC. 219(g) OF THE CODE)
Present Law
[72] Under present law, if a married individual (filing a joint return) is an active participant in an employer-sponsored retirement plan, the $2,000 IRA deduction limit is phased out over the following levels of adjusted gross income ("AGI"):
Taxable years beginning in:
Phase-out
Range
__________________________
_______________
1997
$40,000
to $50,000
1998
$50,000
to $60,000
1999
$51,000
to $61,000
2000
$52,000
to $62,000
2001
$53,000
to $63,000
2002
$54,000
to $64,000
2003
$60,000
to $70,000
2004
$65,000
to $75,000
2005
$70,000
to $80,000
2006
$75,000
to $85,000
2007
$80,000
to $100,000
[73] An individual is not considered an active participant in an employer-sponsored retirement plan merely because the individual's spouse is an active participant. The $2,000 maximum deductible IRA contribution for an individual who is not an active participant, but whose spouse is, is phased out for taxpayers with AGI between $150,000 and $160,000.
Description of Proposal
[74] The proposal would clarify the intent of the Act relating to the AGI phase-out ranges for married individuals who are active participants in employer-sponsored plans and the AGI phase out range for spouses of such active participants as described above.
Effective Date
[75] The proposal would be effective as if included in the 1997 Act, i.e., for taxable years beginning after December 31, 1997.
III. DIFFERENCES BETWEEN PROPOSED TECHNICAL CORRECTIONS CONTAINED IN THE CHAIRMAN'S MARK AND THE PROVISIONS OF TITLE VI OF H.R. 2676
2. Savings Incentives of the 1997 Act
[334] The Chairman's mark would modify the technical corrections relating to individual
retirement arrangements ("IRAs") in H.R. 2676 as passed by the House bill as
follows.
[335] Conversion of IRAs into Roth IRAs. -- In the case of conversions of IRAs into Roth
IRAs, the taxpayer would be able to elect whether to have the amount converted includible
in income in the year of the conversion (or the year of withdrawal if the conversion is
accomplished through a roll over) or ratably over 4 years. If an individual elects
application of the 4-year spread and withdraws amounts before the entire amount of the
conversion has been included in income, the amount withdrawn would be includible in income
(in addition to any amount required to be included under the 4-year spread). In no case
would the amount includible under this proposal exceed the amount converted. This proposal
would replace the additional 10-percent tax under H.R. 2676 for 1998 conversions. Under
the proposal, a new 5-year holding period for determining whether distributions from a
Roth IRA are qualified distributions would not apply to converted amounts. The proposal
would eliminate the rules in H.R. 2676 regarding separate accounts. The proposal would
also clarify calculation of adjusted gross income for purposes of applying the $100,000
adjusted gross income limit on individuals eligible to convert IRAs to Roth IRAs.
[336] Penalty-free distributions for education expenses and purchase of first homes. --
The Chairman's mark would modify the provision in H.R. 2676 as passed by the House
intended to prevent avoidance of the 10-percent early withdrawal tax in the case of
hardship distributions under qualified plans and similar arrangements by providing that
hardship distributions from qualified cash or deferred arrangements and similar plan are
not eligible rollover distributions (and not subject to 20 percent withholding). The
Chairman's mark would also modify the effective date of the House bill provision.
Footnotes:
/10/ If the conversion is accomplished by means of a withdrawal and a rollover into a Roth IRA, the 4-year rule applies if the withdrawal is made during 1998 and the rollover occurs within 60 days of the withdrawal. In such a case, the 4-year period begins with the year in which the withdrawal was made. For purposes of this discussion, such conversions are treated as occurring in 1998.
/11/ The otherwise available exceptions to the early withdrawal tax, e.g., for distributions after age 59-1/2, would apply.