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I have invested some IRA money into privately held Internet companies that are scheduled to go public this year. If I decide to cash out some of the gains and take some of that money from my IRA, what are the issues with early withdrawal? Are cost basis, short-term/long-term capital gains an issue? I know there will be a 10% penalty. But how do I calculate the total tax bite? -- Tim Braman
We have previously
reported that you can't contribute "property in-kind" -- like stocks and options -- to your IRA. But the IRA itself can buy and sell securities if the plan's administrator will allow it. Once the securities are in there, you can take them out.
If you withdraw assets from your IRA before age 59 1/2, you will owe taxes on the withdrawal at your ordinary income tax rate, which could be as high as 39.6% on the federal front. And unless you're withdrawing the money for higher education, a first-time home purchase or to cover medical bills, you will also owe a 10% early withdrawal penalty. So, worst case, nearly half of your withdrawal could go to the government -- and that's not taking state taxes into account.
If you really need the money, it might make sense to withdraw the shares before they go public, suggests Martin Nissenbaum, national director of personal income tax planning at
Ernst & Young
. You'll still owe the early withdrawal penalty, and the value of the shares still will be taxed at your ordinary income rate. But presumably they'll be worth a lot less before they go public.
Once the shares are withdrawn, you must hold them for a year in order to get the preferential 20% long-term capital gains rate. At that point, you'll be taxed on the difference between the shares' value the day they were withdrawn and the day they were sold.
But here's a way to get IPO profits out of your IRA tax- and penalty-free: You can make a temporary tax-free withdrawal from your IRA if you return the same amount to the account (or another IRA) within 60 days. So pull the shares out before the IPO and put them in your taxable account. Then just be sure to return the fair market value of that pre-IPO withdrawal before the 60 days are up. Any IPO gains can remain in your taxable account.
You can only use this 60-day loan once a year.
If your adjusted gross income is $100,000 or less, you might want to consider converting your IRA to a Roth IRA. That way, you can withdraw all the money tax-free in five years, as long as the account remains open that long and you are age 59 1/2 when you withdraw the money.
Granted, you'll owe tax on the entire IRA balance when you convert it to a Roth. But if you do it before the companies go public, the account balance, hopefully, will be much lower. (For more on IRA conversions, see our
Roth IRA Reporting Guide.)
I am a member of an investment club. The partnership had short-term capital gains and incurred expenses during 1999. Where should the expenses like phone calls, postage and margin interest be reported on Form 1065 -- on page 1, as an ordinary loss, or on Schedule K, as other deductions? -- Kuldeepak Acharya
An investment club is formed when a group of friends, neighbors, business associates or others pool funds to invest in shares of stock or other securities, according to the
Research Institute of America
. Since your club is a partnership, securities are purchased in the name of your club. And as a partnership, it is required to file
-- U.S. Partnership Return of Income
The investment club's gains and losses are reported on Form 1065, which is similar to Form 1040 for individuals. It also has lines for reporting expenses incurred during the taxable year for postage, stationery, safe deposit box rentals, bank charges, fees for accounting and investment services, rent and utility charges.
In addition, the partnership should send you a
-- Partner's Share of Income, Credits, Deductions, etc.
for your share of the underlying portfolio. If you put in 20% of the initial capital, then 20% of the profits and expenses will show up on your Form K-1, says Nissenbaum. Each time new members are admitted to the club, the allocation must change.
A partnership is a pass-through entity. That means everything reported on Form K-1 will flow to the other parts of your return. Any gains or losses on your Form K-1 will be reported on your
-- Capital Gains and Losses
. Any expenses the club incurred will flow to
-- Itemized Deductions
, and will be treated as miscellaneous itemized deductions. In some cases, the deductions will have to exceed 2% of your adjusted gross income to be deductible.
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.