Editor's note: TSC is doing reader Mike Bauer's tax return to illustrate how tax laws apply to real people. On Wednesday, we introduced Bauer and his family and spotlighted his Form 1040. Thursday, we showed you how Bauer handled the conversion of his IRA into a Roth IRA and the refinancing of his mortgage. Friday, we saw how he reported his trading activities on Schedule D. Today, we answer reader questions, and Tuesday, join series author Tracy Byrnes and Martin Nissenbaum of Ernst & Young for a Yahoo! Chat at 5 p.m. EST.
Many thanks to reader
to dissect his tax return this week. Mike bared it all to help us educate our readers, and for that we commend him. We hope it was helpful.
At one point he said he was "having fun," and with that,
has reached a pinnacle. We made taxes fun for someone. How many Web sites out there can make that claim?
Today, Tax Forum delves further into some of the issues that came up as a result of our examination of Bauer's tax return. We've got more on the wash sale and the Roth IRA and an inquiry about child care deductibility.
Any other questions? Send them to
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Form 8606: To Sign or Not to Sign
Many of you wrote questioning the signing of
- Nondeductible IRAs
. Do you have to or not? If you file the form with your tax return, you do not have to sign it, though it won't hurt if you do. If you open a Roth IRA (or convert a traditional IRA to a Roth) but you are not required to file a tax return, you would have to send the form on its own with your John Hancock at the bottom.
Out of the Position, No Wash Sale
If I buy and sell 100 shares of Cisco (CSCO) - Get Report on Monday for a $200 profit and buy and sell 100 shares of Cisco for a $150 loss on Tuesday, I would post both the $200 profit and the $150 loss for a net profit of $50. I've closed out both positions, so I can take both the profit and loss, right? -- Jay McElroy
There's no wash sale issue here, provided you are completely out of the position and do not repurchase that same security within 30 days of the last sale at a loss, says Richard Shapiro, an
Ernst & Young
securities tax partner in New York.
The key here is whether there's an open position. If everything is closed out at year-end, there is no reason to disallow the loss.
What's the Basis in My IRA?
I am trying to do my tax returns on TurboTax software and I am stuck on my IRA basis for 1997 and earlier years. What exactly is this? I read the instructions on the 1040 booklet and the instructions on TurboTax and I am more confused than before. My understanding of the basis is that it is based on contributions I made to my IRAs prior to 1998. -- Pradeep Audho
If you have been making deductible contributions to your IRAs throughout the years, your IRAs don't have any basis. You will owe tax on the entire fair market value.
If you made any nondeductible contributions to an IRA, your basis is the sum of those nondeductible contributions over the years. Technically, you should've been reporting these nondeductible contributions over the years on Form 8606, notes Clarence Kehoe, partner and director of employee benefits at
Anchin Block & Anchin
But if you have more than one IRA, your basis calculation is not that straightforward. You have to consider all your IRAs together. Then your basis in one IRA is equal to the percentage of your total bases, divided by the total fair market value of all your IRAs.
Here's an example: Let's assume you have three IRAs. Over the years you made nondeductible contributions to two of them totaling $50,000. But the fair market value of all three IRAs is $500,000. So your basis in each IRA is equal to 10% (50,000 divided by 500,000) of its fair market value, says Kehoe.
If you decide to convert just one of your IRAs to a Roth, then 10% of the fair market value of that IRA will be considered as your basis and should be reported on line 15 on Form 8606.
Converting a Nondeductible IRA
Last April, I set up a 1997 nondeductible traditional IRA which I then fully converted to a Roth IRA in 1998. Since I didn't deduct the original amounts from my 1997 taxes, does that mean that I won't have to pay tax on the conversion? If that's the case, how does that get reported on the Form 8606? This form asks me for the distribution amount and the basis. Should I put $2,000 for both, giving me a taxable amount of zero? -- David Swainson
If you converted a completely nondeductible IRA to a Roth, you would not owe any tax on the conversion, says Martin Nissenbaum, national director of personal income tax planning at
Ernst & Young
. You paid it already.
I am assuming this is your only IRA. If it's not, you'll have to do a bit more work when calculating your basis in the IRA. (See Pradeep's question above.) Assuming this is it, then your basis in your IRA is the sum of your total contributions.
On line 14 of Form 8606, you'd first report the amount you were moving to the Roth. Then on line 15, you'd fill in the same amount, indicating that the whole IRA was nondeductible. Your total on line 16 would then be zero.
Day Care Deductibility
My son, age 6, is in kindergarten. Since both parents work he attends the after-school program. During summer vacation, I plan to send him to his grandparents in India. They are neither U.S. residents nor dependent on me. Can I claim the cost of my son's travel to India and the expense I incur for his care abroad as dependent care expense? -- Paresh Gada
Nice try. Unfortunately for all working parents, the costs associated with getting your child to and from day care are not deductible, says Nick Morrow, foreign tax specialist at
in New York. That includes taxi fares, gas and bus tokens and, I'm sorry to say, airplane tickets.
My Son's Eligible for the Roth
My son earned approximately $1,400 in his summer job and another $1,000 in interest and dividend income for 1998. He's completed the 1040A for his return and I'm still taking him as a deduction for 1998. Can my son establish a Roth IRA for 1998 for the money he earned in 1998 ($1,400)? In my reading of the regulations, he appears to qualify. However, I do not. Does that inhibit my son's ability to establish a Roth? -- Bob Schreiber
It does not matter that you do not qualify for the Roth. If your son does, he's free to contribute.
You are correct in noting that an individual must have earned income to be eligible for the Roth IRA. (Earned income consists of wages, salaries, tips, other employee compensation and an individual's net earnings from self-employment.) So his interest and dividends do not count toward his eligibility. He can contribute only up to his summer job wages of $1,400.
If your son is under the age of majority in your state, you will have to establish a custodial account for him. That means when you open the Roth IRA on his behalf, you will be the custodian of the account until he reaches the age of majority.
The next hurdle is to make sure the fund family you select allows minors to open Roth IRAs. Call your favorite fund family or check out a previous
Tax Forum for a few suggestions.
TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.