The Joint Committee on Taxation released a report, Description of Chairman's Mark of the "Tax Technical Corrections Act of 1997", which includes significant Roth IRA provisions. If passed by Congress, the following changes would apply 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
[26] 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. /6/ The 10-percent tax on early
withdrawals does not apply to conversions of IRAs into Roth IRAs. The 5-year holding
period for converted amounts begins from the year of the conversion.
[27] 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 within 5 years
[28] 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 (i.e., before the lapse of 5 years) while retaining the benefits of 4-year income
averaging and the nonpayment of the early withdrawal tax.
[29] Under the proposal, if converted amounts are withdrawn within the 5-year period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that were includible in income due to the conversion the amount withdrawn would be subject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 (1) the 10-percent early withdrawal tax, /7/ and (2) in the case of conversions to
which the 4-year income inclusion rule applies, an additional 10-percent tax. /8/ Any
withdrawal from a Roth IRA which contains converted amounts (called a "Roth
Conversion IRA") within the 5-year period beginning with the year of the conversion
would be deemed to come first from the amounts that were includible in income as a result
of the conversion.
[30] To assist in applying these rules, it is anticipated that appropriate forms will be
developed to clearly differentiate Roth Conversion IRAs from other Roth IRAs and, for
taxpayers who make conversions in more than one year, to differentiate Roth Conversion
IRAs for different years so that taxpayers will be able to easily maintain separate IRAs
for conversion amounts for each year in which a conversion is made and to facilitate
reporting with respect to such IRAs by trustees and custodians.
[31] Special rules would apply in the event that separate Roth IRAs are not maintained. In
the case of a Roth IRA which contains conversion contributions and other contributions or
conversion contributions from more than one year, the 5-year period begins with the most
recent taxable year for which a conversion contribution was made. /9/ For purposes of
determining the amount of a withdrawal attributable to amounts includible in income due to
a conversion, all Roth IRAs with the same 5-year holding period would be aggregated.
[32] 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).
[33] The following example illustrates the application of the 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. 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. (It is anticipated that when A opens the account, it will be designated as a
1998 Roth Conversion IRA.) At the beginning of 1999, the value of the account is $110, and
A makes a withdrawal of $45. $25 of the withdrawal is treated as attributable entirely to
amounts that were includible in income due to the conversion. Upon withdrawal, the $25 is
not includible in income, nor is the 4-year income inclusion affected. However, the $25 is
subject to the 10-percent tax on early withdrawals (unless an exception applies) and an
additional 10-percent tax to recapture the benefit of the 4-year income inclusion. The
remaining $20 of the distribution would not be includible in income nor subject to the
early withdrawal tax because it would be considered as a return of contributions under the
ordering rule generally applicable to Roth IRAs. Subsequent withdrawals would be subject
to the ordering rule generally applicable to Roth IRAs.
Effect of death on 4-year spread
[34] 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.
Effective Date
[35] 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
[36] 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
[37] 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 to an IRA in order to prevent such avoidance of the 10-percent early withdrawal tax.
The proposal would provide that distributions from cash or deferred arrangements made on
account of hardship of the employee are not eligible rollover distributions and may not be
rolled over to any IRA. Such distributions would not be subject to the 20-percent
withholding applicable to eligible rollover distributions.
Effective Date
[38] The proposal would be effective as if included in the 1997 Act, i.e., for taxable
years beginning after December 31, 1997.
3. LIMITS BASED ON MODIFIED ADJUSTED GROSS INCOME (SEC. 302(a) OF THE 1997 ACT AND
SEC. 72(t) OF THE CODE)
Present Law
[39] 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
[40] 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
[41] 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
[42] 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 [sic] individuals filing a joint return does not exceed certain limits. The limit
is phased for out for [sic] such individuals with AGI between $150,000 and $160,000.
[43] 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
[44] 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
[45] 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
[46] 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:
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
[47] 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
[48] 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
[49] The proposal would be effective as if included in the 1997 Act, i.e., for taxable
years beginning after December 31, 1997.
Footnotes:
/6/ 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.
/7/ The otherwise available exceptions to the early withdrawal tax, e.g., for distributions after age 59-1/2, would apply.
/8/ This additional tax is intended to recapture the benefit of deferring the income inclusion of the converted amounts. The converted amounts would still be includible in income under the 4- year rule; that is, there would be no acceleration of the income inclusion.
/9/ This same rule would apply for purposes of determining whether a distribution from a Roth IRA is a qualified distribution.