Why does the government want to know the value of my IRAs?
By Karin Price Mueller
NJMoneyHelp.com for NJ.com
States can't take back taxes on retirement accounts if you move away.
Q. My wife and I are both seniors who are retired. Several years ago, our tax preparer wanted to know the total value of our combined IRAs for our New Jersey return. When I asked why, she said it was because if we moved to a state such as Florida where there is no state income tax, New Jersey would seek to claw back state income taxes on IRA money that was earned in New Jersey. Is that correct?
-- Retired
A. It's against federal law for any state to claw back taxes on money earned in that state if the taxpayer moves to a tax-free state.
But there are valid reasons why your tax preparer will want to know the total market value of your IRA accounts, specifically, they're needed to make calculations for your Required Minimum Distributions (RMDs).
Let's go back for a moment.
We frequently talk about basis when we are talking about income taxes.
Basis is the amount you have invested in something like a stock, a bond or your house. When you sell or withdraw something, you do not pay taxes on your basis, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.
He said traditionally, IRA contributions had zero basis for federal income tax purposes. People would make tax deductible contributions to their IRA or they would roll over 401(k) or 403(b) accounts into their IRAs.
New Jersey has never allowed a tax deduction for IRA or self-employed pension accounts, Kiely said, so the amounts in these accounts usually had no federal basis but they did have basis for state income tax purposes.
So when you make your first IRA withdrawal, how do you deal with your tax basis for New Jersey purposes?
Kiely said New Jersey has two methods to deal with tax basis for IRAs.
The first is the Three-Year Rule.
"The Three-Year Rule allows you to take out your tax basis first if you will take out your entire basis within 36 months of taking your first IRA distribution," he said. "To do this, you need to know how much is in all your IRA accounts, what your total basis is and how much you are planning to take out each month or year."
If you will have taken out your entire basis within 36 months, the withdrawals are tax-free until your basis is exhausted. Then your withdrawals are 100 percent taxable, he said.
If you will not have taken out your entire basis within 36 months from the date of your first distribution, you must use the General Rule Method.
"Under this method, part of your withdrawal is taxable and part of it is not," Kiely said. "The portion that is not taxable is the ratio of your tax basis to the market value of all your IRAs."
He said this calculation must be done every year you take money out of your IRA.
Kiely offered this example: Assume you have $50,000 of basis in your IRA and a market value of $500,000. If you then withdraw $10,000 from your IRA, $1,000 (10 percent) will be tax-free and $9,000 will be taxable. The next year your remaining basis will be $49,000 and let's assume the market value is $493,000 ($500,000 - $10,000 + $3,000 market gains). Your basis is now 0.099 percent. A $10,000 withdrawal will be $993 tax-free and $9,007 taxable.
So to answer your question, either you or your tax preparer needs to know the total market value of all your IRAs, plus the unrecovered basis, so you/they can make the required calculations, Kiely said.
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Karin Price Mueller writes the Bamboozled column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Sign up for NJMoneyHelp.com's weekly e-newsletter.