Would you believe that electronic tax filing nightmares continue to trickle in? We'll take a look at one this week. We'll also discuss how to set up an IRA for a child working abroad and how to take advantage of a 401(k) that has tanked.
In addition, we've got a big math problem for you this week. Only we're not talking simple algebra. This problem involves the wash sale rule.
Keep sending your questions, with your full name, to
Too Many Attachments
A few weeks ago you wrote that "you can't just e-file your gross numbers and attach a detailed trade schedule to your Form 8543-OL." But I did just that! How can I correct this mistake? -- Ola Situ
At this point, there is most likely no harm in attaching something to
- U.S. Individual Income Tax Declaration for On-Line Services Electronic Filing
, says Eddie Feinstein, vice president of electronic services at
. But, on the flip side, it's probably not going to do you any good either.
The purpose of Form 8453-OL is to have your signature included with your electronically filed return. The form was not intended to be used for supporting information, but a few documents, primarily W-2s and medical forms, were approved as attachments.
So what will happen with the attachments you submitted? "I have no idea," says Feinstein. No one does because this process is still in its infancy. The
Internal Revenue Service
just might ignore them. Either way, you won't be penalized for attaching too many things.
But if the IRS needs documentation to support the numbers in your tax return, you very well may get a notice requesting this information. You may have attached that information to Form 8453-OL, but remember, some IRS employee may have thrown it out.
So just humor the Service and send it all again.
Hopefully, the IRS will work these kinks out. Many professional tax preparers did not e-file this year because their clients had complicated returns that could not be sent electronically.
IRAs for Overseas Kids
Can you please give me some information regarding contributions for a daughter's IRA if she is living and working outside of the U.S. I would like to hire her as an independent contractor. Then she would have earned income within the U.S. to contribute to her IRA. I would pay her to do research for me. Will the IRS accept this as earned income eligible to be invested in her IRA? -- Paul Rogland
If you hire your daughter to do legitimate work, she can open an IRA for herself, says Nick Morrow, foreign tax specialist at
, a New York accounting firm.
If you pay her to do research, she will have earned income for U.S. purposes, notes Morrow. It does not matter that whether those services are performed in the U.S. or overseas. It's still considered to be U.S. income. Then she can contribute to an IRA. "It's the perfect thing to do," says Morrow.
Be aware that hiring her as an independent contractor may not be as straightforward as it seems, as far as U.S. tax law is concerned. See the IRS'
Web site for more on the difference between an employee and contractor.
Turning a 401(k) Loss Into a Gain
I want to roll over a 401(k) from a previous employer into an existing traditional IRA. If I roll over the 401(k) at current levels I will incur a loss. After the rollover, I would then like to convert this (recently enlarged) existing IRA into a Roth IRA. This rollover will create tax consequences as the existing traditional IRA has posted a gain based on current levels. Is there any way to use the potential loss on the conversion of the 401(k) against the gains to be incurred on conversion from traditional IRA to Roth IRA? -- Ryan Randall
I'll assume you meet the $100,000 adjusted gross income limitation that is required before you roll your IRA to a Roth.
Then the only way to take advantage of the loss in your 401(k) is to immediately get it all into the Roth, says Dee Lee, a certified financial planner and author of
The Complete Idiot's Guide to 401(k)s
. And do it quickly.
I hesitate to say that your 401(k) loss is a good thing, but it is an indirect blessing. First roll the money into an IRA, then you can roll it to a Roth IRA. In most cases you can do both rollovers simultaneously, notes Lee. Then you will owe tax on the entire amount you rolled from the IRA to the Roth. If the value of the account is down because your investments have been in the toilet, the amount you will owe tax on also will be lowered.
(I know that's not much consolation for your tanking investments, but the glass is always half full here at the Tax Forum.)
And why should you do this immediately? Because you don't know what the market is going to do tomorrow, says Lee. So your loss might be gone. And your tax bill will jump.
Here's more good news. In the event your investments fall even lower, you have one shot to roll your assets back to an IRA and pretend the Roth never happened, reminds Lee. Then when you roll the money back again to the Roth, the account will be worth even less, thereby reducing your tax bill even more.
Hey, it's something.
Wash Sale Exercise
Let's do a math problem. Just like you did in algebra class, only this one involves the wash sale rule. Reader
sent us a sequence of events and wanted to know where and when the wash sale sneaks in. So I called wash sale guru Ted Tesser, a certified public accountant in Boca Raton, Fla., and author of
The Trader's Tax Survival Guide
, to help us out.
Let's walk through Frank's trades step by step:
1. Purchase 200 shares of XYZ on May 12 at $21 per share.
2. Purchase 200 shares of XYZ on July 7 at $16.
At this point, the cost basis of these 400 shares is $7,400.
3. Purchase 400 shares of XYZ on July 28 at $11.
The cost basis is now $11,800.
4. Sell 400 shares of XYZ on Aug. 7 at $14.
"This is a wash sale since a purchase of the same stock occurred within 30 days of sale," says Tesser.
Frank grossed $5,600 on this sale. To determine which lot of shares he sold, we'll use the first-in-first-out method. (Remember you do not need to use this method when deciding which lots of shares to sell. You can specifically identify which lots to sell. Just be sure to keep good records.)
The purchase of the first 400 shares cost $7,400. So, thanks to the wash sale rule, the loss of $1,800 ($7,400 - $5,600) is disallowed and is added to the basis of the next lot.
"Being consistent, it would make the basis of your next 400 shares (Step 3) $6,200," notes Tesser. How'd we get that number? Frank's basis in Step 3 was $4,400. Adding in the disallowed loss of $1,800 raises the basis to $6,200.
5. Sell 100 shares of XYZ on Sept. 16 at $14.
There's no wash sale here because there was no purchase 30 days before or after the sale. "So you can recognize some of that loss you carried forward," notes Tesser.
Frank's overall cost basis on the remaining 400 shares is $6,200. But because he only sold 100 shares and not the whole lot, he now needs to figure out the basis of each individual per share. So he must divide the $6,200 by the 400 shares. That gives him a basis of $15.50 per share.
He sold 100 shares at $14, so he created a $150 loss ($1,400 - $1,550). And since there's no wash sale, he can take the full amount as a loss on his tax return.
6. Purchase 400 shares of XYZ on Nov. 26 at $9.
7. Purchase 400 shares of XYZ on Dec 3 at $8.
8. No sales or purchases in January 1999.
At this point, Frank's hasn't sold anything else, so there are no more wash sale issues -- for now.
Whew. That was tough. Now get out and enjoy the weekend.