Converting Traditional IRA to Roth IRA Tax Free - Posted by Lee (in Texas)

import · October 28, 2007, 10:26pm

Posted by Jimmy on October 31, 2007 at 05:59:23:

this one was so d@mned clever that it could not be wrestled to the ground by the IRS. They had to change the Treasury Regulations, which they did very quickly after this one surfaced.

This one was cooked up by some smart guys at Deloitte & Touche.

subject: super profitable S Corporation. wouldn’t work for any other taxpayer, because of a particular regulation applicable only to S Corps.

step 1: S corp establishes an ESOP (a type of employee benefit plan).

step 2: ESOP buys a chunk of stock in the S Corp, by taking out a bank loan. a so-called “leveraged ESOP”

step 3: as a condition of the loan, the existing key shareholders (who held all of the stock prior to the ESOP) had to pledge their stock as collateral, plus had to agree to stay with the company for the term of the loan (5 years). If they left the company before the expiration of the loan, they lost their shares.

note 1: this risk of losing shares is a “risk of forfeitire” under the tax rules. as such, these shares were no longer considered to be “vested.”

note 2: the brilliance: when an S Corp has vested and non-vested shares outstanding, taxable income is allocated ONLY to the vested shares. that’s right out of the tax regs. and the only vested shares (during the 5 year loan term) are owned by the ESOP. and an ESOP is a tax-exempt entity.

WOO HOO !! ALL OF THE TAXABLE INCOME FOR THE NEXT 5 YEARS IS ALLOCATED (but not paid–just allocated on a K-1) to an non-taxpayer.

the rub: if this one was done properly, and the company had a legitimate desire to carry on the ESOP indefinitely, the deal could be documented so that the voluntary forfeiture appeared to be reasonable.

The IRS was on this in a nano-second, because no one can keep a secret in this world.

import · October 28, 2007, 10:26pm

Converting Traditional IRA to Roth IRA Tax Free - Posted by Lee (in Texas)

Posted by Lee (in Texas) on October 28, 2007 at 22:26:18:

A guy I know told me he went to a seminar where the guru was telling everyone that he’s got a method that uses real estate, notes and options to, in effect, convert a self-directed traditional IRA to a self-directed Roth IRA tax free.

Apparently, there are multiple steps to the whole scenario, taking place over several different tax years. The net effect is you move your assets from a tax-deferred account to a tax-free account without incurring any tax liability for the “converted amounts.”

Of course, you can’t get this very secret and esoteric knowledge without coughing up the dough to attend the seminar. They can’t let this knowledge out to the Great Unwashed Masses or it will spoil the method for everyone of us who are deserving.

I’m not sure how it all works. My friend went to the guru’s seminar, and he still doesn’t really understand the concept well enough to explain it to me. (Or he won’t share it.) So I am turning to you guys.

It seems like a lot of B.S. to me, but what do I really know? Still, the idea is intriguing. What if you could design a strategy that accomplishes this? What could that save you in taxes?

Anyone understand how this might work?

Anyone been to the guru’s seminar who might want to spill the beans to those of us who won’t ante up the seminar fee for what might only be tax fraud?

I just gotta satisfy my curiosity, you know.

Lee (in Texas)

import · October 30, 2007, 8:30pm

Re: Converting Traditional to Roth Tax Free - Posted by Penny

Posted by Penny on October 30, 2007 at 20:30:23:

Rich and Jimmy hit the nail on the head. Also, not everyone is eligible to contribute to a Roth until 2010 when the income limit restrictions are removed.

So I would imagine the scammers will be out in full force as we get closer to that timeframe. There should be an entertaining display of creativity.

As Rich and Jimmy have very soundly pointed out, there is no free lunch. However, there are legitimate strategies around to minimize the taxes that would be paid on conversion. It depends on your income bracket, whether you currently have IRAs and whether you have made non-deductible contributions to an IRA in addition to deductible contributions, etc. for your personal situation. But this is something you should be working on now with your CPA if your income is too high to contribute to a Roth and you want to take advantage of the rules changes in 2010.

import · October 30, 2007, 5:57am

And Another Thing - Posted by Jimmy

Posted by Jimmy on October 30, 2007 at 05:57:42:

there will likely be a law firm involved, which will issue a “legal opinion” backing up the tax results.

these opinions often turn out to be worthless.

what you want is an indemnification from the promoter and the attorney. you’ll never get it, but ask anyway.

and if you really want to irritate the promoters, ask them why they have not sought a private letter ruling from the IRS. and I guarantee you they have not. the PLR process is a way to get the lawyers at the IRS head office to review a proposed transaction (somewhat anonymously–no taxpayer names are involved), to see if IRS counsel agrees with the tax lawyers opinion on the tax results. if the promoters are afraid to do this, then you can bet your boots they are relying on stealth to sneak the transactions through. and stealth will not help you when you get caught.

if the promoters REALLY believed the tax benefits they espouse were legitimate and would survive a full review by the courts, they would seek the PLR.

import · October 30, 2007, 5:46am

Look Out–A Fun Historical Example to Review - Posted by Jimmy

Posted by Jimmy on October 30, 2007 at 05:46:19:

I’ve been a tax lawyer since 1985. I’ve seen a number of very clever arrangements cooked up by very smart tax lawyers. often involves a series of steps which are inter-related and aimed at achieving a tax deferral or tax exclusion or fake tax loss. in the end, the courts unwind these things, put the promoters in jail, and hammer the taxpayers with back taxes, penalties and interest.

here’s one of my favorites. called BOSS (short for the “basis shift”). the lawsuits that followed this one ultimately took down a huge Chicago-based law firm.

time: January, 2000. client has sold a huge posotion in CSCO or SUNW or whatever. client wants big capital loss to offset, but does not want to a real economic loss. ok. here goes:

client takes 50K he realized from sale of stock and puts it in a brokerage acct.
client buys 50M worth of CSCO in that account.
client sells short 50M worth of CSCO. he now has offsetting postions in CSCO, plus 50M in cash.
client established another brokerage acct in name of newly created partnership.
client contributes the 50M long position to the pshp. in doing so, he gets a 50M “outside basis” this means his basis in the partnership interest in 50M.
the next day, he assigns the short position (which is a liability in his hands) to the same pship acct. here’s the brilliance of the deal. under partnership accounting rules, whan a pship takes on a partner’s liability, it is treated as a reduction in his outside basis. UNLESS the liability is considered to be a “contingent liability,” meaning one that can’t be calculated accurately. and a short position in a stock is a classic example of a contingent liability. so under the rules, there is no adjustment to his outside basis. voila. he has a partnership with zero net assets (the long and short posotions offset each other), but he has a 50M basis in the partnership !!
sell the 50M in CSCO to cover the short position. now there is nothing in the account.
close the account and terminates the partnership. the result is a 50M capital loss.
WOO HOO !!

bottom line: each step of this transaction was fine. but the courts can step back from this kind of deal, and collapse all the steps. “step transaction” is what the courts call it. because none of the individual steps wod have been taken without all the other steps, the court can disregard the sham.

the Chicago law firm that promoted this one would charge an outrageous fee for their participation and legal opinion. something like 15% of the tax savings. they made millions and million in fees. and ended up giving it all back. and the esteemed law firm went belly up

import · October 29, 2007, 4:28pm

Re: Converting IRA to Roth IRA Tax Free - Posted by Rich-CA

Posted by Rich-CA on October 29, 2007 at 16:28:19:

According to both my broker and CPA, you cannot convert a n IRA to a ROTH without incurring tax. Bottom line is IRA contributions are BEFORE tax and ROTH contributions are AFTER tax and to get from point A to point B you have to pass through the tax step.

import · October 30, 2007, 1:15pm

I like it - Posted by Rich-CA

Posted by Rich-CA on October 30, 2007 at 13:15:55:

I like stories like this. It points out that keeping things simple and honest helps keep a person from having to sleep with a gun under the pillow, a passport with fake name, and a wad of cash in case the agents break in during the night. Oh, and the trap door in the closet leading to the crawl space under the house - then out to the beat up motorcycle in the back.

I don’t like to see dishonesty rewarded, and here it is.