Multiple Roth Transfers; Internet Taxation and LLC Taxation

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, November 1, 1998

Copyright 1998 Robert L. Sommers, all rights reserved.

Question:  May I transfer retirement funds between my IRA and Roth without restriction?

Answer: No. IRS has issued rules, effective November 1, 1998, permitting a "reconversion" only once in each of the tax years 1998 and 1999. A reconversion usually involves three transfers: (1) from the original IRA to a Roth; (2) from the Roth back to the old IRA; and (3) finally from the IRA back to the Roth. However, if you have made multiple transfers prior to November 1st will not be penalized. Transferring between these two retirement plans still permits some tax planning, but includes the risk of fluctuating stock market values.

The multiple conversion technique became popular with the recent drops in the stock market. Investors could minimize their taxable gain on the IRA to Roth transfer, by timing the transfer at the lowest IRA value. Those who converted prior to the market's decline might have then reconverted to an IRA and then made another Roth transfer at yet a even lower value.

For example: If you transferred your original IRA to a Roth when the IRA was worth $10,000 but now is worth only $8,000, you may switch back to the old IRA in an attempt to time the market to fund your Roth at an $8,000 or lower valuation. Note: For tax purposes, excess reconversions (more than one per year after November 1, 1998) are ignored, not penalized.

If you convert to a Roth but later are ineligible because your adjusted gross income exceeds $100,000, you may reconvert to an IRA by the due date of your tax return, including extensions, regardless of the new one-conversion rule.

Question: I am based in California and will be selling goods via the Internet. Do I have to pay state income taxes outside California?

Answer: No. The Internet Tax Freedom Act (due to become law soon) contains a 3-year ban on any new taxes on Internet sales and services. The law generally follows the tax scheme applicable to mail order businesses: Consumers will pay sales tax on Internet purchases only if the seller has a substantial physical presence (usually an office or employees) within the consumer's state of residence.

For example, if a customer buys a jacket from a clothing store located in San Francisco, the merchant must charge 8.5% sales tax. If that same jacket is purchased through the Internet from a company in New Hampshire, only New Hampshire customers will be taxed, because the company is physically there.

Question: My brother and I formed a California Limited Liability Company (LLC) for our auto parts business. Are we liable for employment taxes on the distributions?

Answer: Yes. An LLC is a hybrid entity: It has limited liability like a corporation, but it is usually taxed as a partnership (the members are taxed directly on the income). Similar to partnerships, LLC members may participate either actively (akin to general partners) or passively (akin to limited partners). Limited partners generally do not suffer employment taxes on their distributions.

Note: Employment taxes involve two segments: (1) Old Age Survivors and Disability Insurance fund which is 12.4% of the first $68,400 of net earnings from self-employment in 1998; and (2) Medicare, which is 2.9% without income limitation. The latter accounts for most of the tax planning.

An LLC may be managed by its members (comparable to a general partnership), or the members may select one or more managers (comparable to a limited partnership). When managers are appointed, the non-managing member's interest resembles a limited (thus passive) partnership interest and, logically, should receive the same exemption from employment tax as do limited partners.

Unfortunately, for employment-tax purposes, IRS has declined thus far to treat passive participants in an LLC in the same manner as limited partners of a traditional limited partnership. Congress is due to address this important issue.


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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**