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Author: kse4 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75335  
Subject: a real SEP pickle Date: 3/16/1999 12:05 AM
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The short version: My spousal unit and I both took jobs in Hong Kong. His is a 3-year contract, mine a 1-year. He's a college prof., I design web sites. Never having had to deal with contract positions before, we turned to (local smalltown) professionals for advice and ended up establishing SEPs for ourselves in the US, to which we've been wiring $$ monthly. We did this through Edward Jones. From Sept. to Dec. '98 we deposited $4000, and at least that much since.

Now a tax consultant here in Hong Kong informs us that we are, strictly speaking, employees, not contractors and are therefore not entitled to SEPs. (Actually, we're not entitled to any retirement plan at all, best we can figure. Spouse gets a 15% gratuity at the end of 3 years, but otherwise the U. here makes no provision for retirement. This is the rule, not the exception, in Hong Kong.)

So I have two questions for all you brilliant minds out there: Do we owe a fat penalty on the money we've put aside so far? I mean, we have to undo the SEPs altogether, but since we're not yet accountable for 1998 taxwise... (we are paying estimated taxes, though. Have to, from here on out.)

Secondly, what would you do in our situation? We are each entitled to the $70,000 overseas income exemption, so we can sock big $$'s away, but nothing we invest will have the lovely advantage of tax-free growth. We've been told we're not eligible for IRAs, either. And, we're still subject to Hong Kong income tax, which is pretty much a flat 15% on top of what's taxed by the U.S.

Needless to say, we've never had to build our own retirement structure before and we haven't gotten good advice from any professional so far. No one seems to know what to make of our situation.

Anyone care to take a bite of this pickle?
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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9183 of 75335
Subject: Re: a real SEP pickle Date: 3/16/1999 5:02 PM
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Greetings, Kse4, and welcome. You wrote:

<<The short version: My spousal unit and I both took jobs in Hong Kong. His is a 3-year contract, mine a 1-year. He's a college prof., I design web sites. Never having had to deal with contract positions before, we turned to (local smalltown) professionals for advice and ended up establishing SEPs for ourselves in the US, to which we've been wiring $$ monthly. We did this through Edward Jones. From Sept. to Dec. '98 we deposited $4000, and at least that much since.

Now a tax consultant here in Hong Kong informs us that we are, strictly speaking, employees, not contractors and are therefore not entitled to SEPs. (Actually, we're not entitled to any retirement plan at all, best we can figure. Spouse gets a 15% gratuity at the end of 3 years, but otherwise the U. here makes no provision for retirement. This is the rule, not the exception, in Hong Kong.)

So I have two questions for all you brilliant minds out there: Do we owe a fat penalty on the money we've put aside so far? I mean, we have to undo the SEPs altogether, but since we're not yet accountable for 1998 taxwise... (we are paying estimated taxes, though. Have to, from here on out.)>>


Uh, oh. You have offended the IRS to such an extent that you will now forfeit the balance in the SEP, your house, your car, and your first-born child. Unless, that is, you take steps now to rectify the situation. You have until April 15 following the tax-year of contribution to remove those funds and the earnings from the SEP. The situation may not be as bad as it appears on the surface, but that depends on what happened in 1998.

You say you only contributed $4K last year. With $2K for you and $2K for your spouse, that's the amount that could have been put into a traditional IRA. As long as both of you did not participate on any single day in a qualified retirement plan through work (i.e., 401k or company pension plan), then those contributions would also be fully deductible. They're definitely deductible for 1999. Thus, as I see it (and I hasten to add that this must be discussed with your tax advisor), you could have Edward Jones change your SEP accounts to traditional IRAs for you and for your husband. If that can't be done, then close the SEP and take everything. Then make a traditional IRA contribution of $2K each for 1998 before April 15 for you and your hubby. Declare any earnings on the SEP as income and pay the 10% early withdrawal penalty. Deposit another $2K in the same traditional IRA for 1999. Any earnings atttributable to those deposits will be declared as income for 1999 and will also be assessed the 10% penalty. The worst that will happen will be the 1998 contributions cannot be deducted and will have to be declared as income along with the earnings thereon. The 1999 contributions definitely can be deducted. So, talk with your tax advisor and with Edward Jones so all can get done by April 15.


<<Secondly, what would you do in our situation? We are each entitled to the $70,000 overseas income exemption, so we can sock big $$'s away, but nothing we invest will have the lovely advantage of tax-free growth. We've been told we're not eligible for IRAs, either. And, we're still subject to Hong Kong income tax, which is pretty much a flat 15% on top of what's taxed by the U.S. >>

I'm puzzled why your tax advisor says you are not eligible for an IRA. You file a tax return, and you have earned compensation. Thus, there's something here I don't understand because that's all that's required. Ask your advisor for details because if that indeed is true, then the IRA route I suggested above won't work for the 1999 SEP deposits. They definitely will for 1998, though, if you had W-2 or 1099 wage income of at least $4K.

Regards….Pixy


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Author: Wavelength One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9224 of 75335
Subject: Re: a real SEP pickle Date: 3/17/1999 11:03 PM
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<<<Secondly, what would you do in our situation? We are each entitled to the $70,000 overseas income exemption, so we can sock big $$'s away, but nothing we invest will have the lovely advantage of tax-free growth. We've been told we're not eligible for IRAs, either. And, we're still subject to Hong Kong income tax, which is pretty much a flat 15% on top of what's taxed by the U.S. >>>

<< I'm puzzled why your tax advisor says you are not eligible for an IRA. You file a tax return, and you have earned compensation. Thus, there's something here I don't understand because that's all that's required. Ask your advisor for details because if that indeed is true, then the IRA route I suggested above won't work for the 1999 SEP deposits. They definitely will for 1998, though, if you had W-2 or 1099 wage income of at least $4K >>


Pixy:
The problem is the fact that they are using the overseas income exclusion. Thus, they are not paying US income taxes on up to $70k each of the income they are earning while employed overseas. For the IRA's, this is not considered earned income since it is not subject to US income taxes. They'd need to have $4k of earned income which is not included in this $70K exclusion in order to qualify for a full IRA. (the things you can learn by hanging out with Roy on the Tax board... :) )

Wavelength

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Author: kse4 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9230 of 75335
Subject: Re: a real SEP pickle Date: 3/18/1999 3:43 AM
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Let me just weigh back in here on my own pickle's behalf.

Wavelength, I'd be a little more careful of that Roy fellow on this tax thing. Actually, Pixy was right to be dubious about us not being eligible for IRAs--turns out we are eligible, overseas exclusion or not. Gotta let my tax advisor in on this, too. (And why am I paying her....?)

It's all there in IRS Pub 590. IRA eligibility is based, not on AGI, but on "modified" AGI--which is pretty much the same as Gross Income, because it means adding back to AGI most of the deductions that made it "adjusted" to begin with, including excluded overseas income.

This lends itself to some nice conundrums. Like, for 1998, since my spousal unit (hereafter SU) was covered by a retirement plan at work for half the year, we are not entitled to IRA deductions because our joint modified AGI is > $60K. But for 1999 we will be eligible for the full deductions, even though our incomes are more than double the previous year's, because in HK neither one of us is covered by a retirement plan. The basis of my original complaint turns out to be a blessing in disguise.

HOWEVER, a Roth is a different story. For 1998 I may not contribute to a Roth because even though I had $6000 in income in the last six weeks of '98, it was foreign income cancelled out by whatever percentage of the foreign exclusion I'm entitled to for a portion of that year. That is, for 1998 I had no taxable compensation--this also excludes me from traditional IRA eligibility in 98, but I qualify for a trad IRA as a spouse with no taxable compensation. (what? no, it's true--check it out)

But my SU can contribute fully to a Roth for 1998 because our MODIFIED AGI will be less than $150K. By that same measure, for 1999 and thereafter neither one of us qualifies for a Roth at all.

Notice here that my husband's eligibility for a traditional IRA in 1998 is precluded by his modified AGI (that is, AGI with the foreign exclusion added back in) even though his foreign excluded income does not meet the definition of "taxable compensation". In other words, money that does not count towards his eligibility for an IRA (you're entitled to an IRA if you have taxable compensation, aren't over a certain age, etc. etc.) DOES COUNT towards pushing him over the limit of eligibility for an IRA deduction. Gotcha!

Hence the "pickle."
Speaking of which:
I did a little research about my own earlier question (the misinformed SEP contributions). Also according to IRS Pub 590 (and various forms I've downloaded), if I withdraw both the SEP contributions and their earnings before our tax filing date (overseas filers get an automatic 2-month extension :-) ) and include both in gross income, all will be forgiven EXCEPT we'll owe a 10% tax penalty on the earnings since the inception of the SEP. (that's 10% on top of the tax on the earnings as a portion of gross income.)

Isn't this fun?

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Author: kse4 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9231 of 75335
Subject: Re: a real SEP pickle Date: 3/18/1999 4:25 AM
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A thousand thanks, TMFPixy. You didn't solve my problem but you got me going in what I THINK is the right direction. You wrote:
------------
Thus, as I see it (and I hasten to add that this must be discussed with your tax advisor), you could have Edward Jones change your SEP accounts to traditional IRAs for you and for your husband. If that can't be done, then close the SEP and take everything. Then make a traditional IRA contribution of $2K each for 1998 before April 15 for you and your hubby. Declare any earnings on the SEP as income and pay the 10% early withdrawal penalty. Deposit another $2K in the same traditional IRA for 1999. Any earnings atttributable to those deposits will be declared as income for 1999 and will also be assessed the 10% penalty. The worst that will happen will be the 1998 contributions cannot be
deducted and will have to be declared as income along with the earnings thereon. The 1999 contributions definitely can be deducted.
---------------------
What I've discovered:

Better than pulling funds out of the SEPs, we can simply have them RECHARACTERIZED before our tax due date. Since we'd already put aside a traditional IRA for me and a Roth IRA for him in '98 (I left that out, didn't I?), the '98 contributions into the SEP and their earnings can be recharacterized as a nondeductible IRA, with no penalties at all.

As for what we've put in thus far in '99, $2000 of his SEP contributions can be recharacterized as a deductible IRA and the remainder as a nondeductible IRA. All my SEP contributions can be recharacterized as a traditional IRA and topped up from other funds. (We're ineligible for Roths in '99.)

Your reply made me go pull out the documentation. Even my broker hasn't suggested this yet, but I'm fairly certain it'll work because the IRS treats SEPs just like IRAs.

What thinkst thou? (and the rest of youse guys)? Will this turkey fly? Or should I be floating this proposition on the Tax message board?

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 9238 of 75335
Subject: Re: a real SEP pickle Date: 3/18/1999 10:30 AM
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Kse4 writes:

<<What I've discovered:

Better than pulling funds out of the SEPs, we can simply have them RECHARACTERIZED before our tax due date. Since we'd already put aside a traditional IRA for me and a Roth IRA for him in '98 (I left that out, didn't I?), the '98 contributions into the SEP and their earnings can be recharacterized as a nondeductible IRA, with no penalties at all.

As for what we've put in thus far in '99, $2000 of his SEP contributions can be recharacterized as a deductible IRA and the remainder as a nondeductible IRA. All my SEP contributions can be recharacterized as a traditional IRA and topped up from other funds. (We're ineligible for Roths in '99.)

Your reply made me go pull out the documentation. Even my broker hasn't suggested this yet, but I'm fairly certain it'll work because the IRS treats SEPs just like IRAs.

What thinkst thou? (and the rest of youse guys)? Will this turkey fly? Or should I be floating this proposition on the Tax message board?>>


Kudoes to you for your persistence, and brava to your tax advisor for digging deeper! It sounds as if you're gonna make it. And, as you've discovered, the SEP is nothing more than a special type of traditional IRA.

I suggest you do run the tactics through Roy aka TMF Taxes just to get a second expert opinion. It never hurts. And tell him Pixy sentcha. :-P

Regards….Pixy


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