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Hi,

I am thinking out loud here and am posting on the off chance that someone familiar with how the MO income splitting for married couples works could let me know if my thinking is way off base.

In Tax Year 2006 (yes, I try to think ahead), it is likely my wife will not have any earned income. In MO, if a couple files MFJ, deductions are apportioned to each spouse according to percentage of overall income and then tax is figured separately for each spouse. Tax brackets increase 1% for each $1,500 of income, topping out at 6% (so 1% for the first $1,500, 2% for the second $1,500, and so on to a top rate of 6% on all income above $7,500). Clearly, it would be advantageous to shift income from the working spouse to the non-working spouse, at least until both spouses are in the 6% bracket. Since there are unlimited gifts between spouses, we are already preparing to put as much of our income-producing assets as possible in her name.

Now, we will also be within the range to make deductible Traditional IRA contributions. I know we can contribute to her Traditional IRA in the form of a spousal contribution. I am thinking that since she will have no earned income, my income must be the source of the contribution. If we then immediately roll that over to a Roth, I am thinking that that will be counted as her income since it is her IRA that is being rolled-over.

The effect as I see it (excepting more stringent limitations on penalty-free withdrawls which is not an issue to us) would essentially be the same as if we made a spousal Roth contribution directly, except that the $4,000 would be counted as her income rather than mine for MO income tax purposes.

Does anyone (especially anyone familiar with MO state income tax) see any flaws in my thinking here?

Thanks,
B+C
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I am thinking out loud here and am posting on the off chance that someone familiar with how the MO income splitting for married couples works could let me know if my thinking is way off base.

In Tax Year 2006 (yes, I try to think ahead), it is likely my wife will not have any earned income. In MO, if a couple files MFJ, deductions are apportioned to each spouse according to percentage of overall income and then tax is figured separately for each spouse. Tax brackets increase 1% for each $1,500 of income, topping out at 6% (so 1% for the first $1,500, 2% for the second $1,500, and so on to a top rate of 6% on all income above $7,500). Clearly, it would be advantageous to shift income from the working spouse to the non-working spouse, at least until both spouses are in the 6% bracket. Since there are unlimited gifts between spouses, we are already preparing to put as much of our income-producing assets as possible in her name.

Now, we will also be within the range to make deductible Traditional IRA contributions. I know we can contribute to her Traditional IRA in the form of a spousal contribution. I am thinking that since she will have no earned income, my income must be the source of the contribution. If we then immediately roll that over to a Roth, I am thinking that that will be counted as her income since it is her IRA that is being rolled-over.

The effect as I see it (excepting more stringent limitations on penalty-free withdrawls which is not an issue to us) would essentially be the same as if we made a spousal Roth contribution directly, except that the $4,000 would be counted as her income rather than mine for MO income tax purposes.

Does anyone (especially anyone familiar with MO state income tax) see any flaws in my thinking here?


Yes, it is flawed. If you convert the Traditional IRA contributions to a Roth IRA, the contribution is not deductible and the conversion is not reported. In other words, it appears on your Federal return exactly as if you made the contribution directly to the Roth IRA. See the instructions for Form 1040, line 15 and Form 8606.

Ira


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Yes, it is flawed. If you convert the Traditional IRA contributions to a Roth IRA, the contribution is not deductible and the conversion is not reported. In other words, it appears on your Federal return exactly as if you made the contribution directly to the Roth IRA. See the instructions for Form 1040, line 15 and Form 8606.

Thank you. This would be deemed a recharacterization then? I figured this was too easy to work.

I have skimmed through the instructions and my understanding is sort of vague. Is it possible to accomplish something similar to what I want through a rollover of IRA assets from previous years' contributions (she has a stockpile of old Traditional IRA contributions and 403(b) contributions that could be used) or would those be deemed to be simply recharacterizations also?

I hope that is clear...

--B+C
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I have skimmed through the instructions and my understanding is sort of vague. Is it possible to accomplish something similar to what I want through a rollover of IRA assets from previous years' contributions (she has a stockpile of old Traditional IRA contributions and 403(b) contributions that could be used) or would those be deemed to be simply recharacterizations also?

I hope that is clear...


Unfortunately, yes. Too bad the answer won't be as clear. If all of her past IRA/403(b) contributions were pre-tax (that is, deductible when made), then the answer is easy. All amounts converted to a Roth IRA will be taxable income to her in the year of conversion. If I understand MO taxes correctly, the first $6000 of conversion income will be tax-free. This doesn't reduce the taxes on your income or divert some of it to your wife, but it does allow you to get money into the Roth for her. Whether that's a good thing or not really depends on your long-term expectations -- will you be in a higher tax bracket in retirement than you are now, will you need to draw on your IRA in retirement, do you plan to leave your IRA to your heirs, etc.

However, if any of her previous contributions were after-tax dollars, a typical conversion will be partly taxable and partly tax-free. You'll need to complete Form 8606 to work out the details. This could lead to an interesting set of circumstances. Contribute $4000 to her traditional IRA pre-tax and then convert $4000 to Roth IRA. I don't remember what the ordering sequence is... whether you just consider the $4000 current year contribution and eliminate both the deduction and conversion income, or whether part of the conversion cosists of after-tax dollars leaving a net deduction on the federal return.

Ira
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Unfortunately, yes. Too bad the answer won't be as clear. If all of her past IRA/403(b) contributions were pre-tax (that is, deductible when made), then the answer is easy. All amounts converted to a Roth IRA will be taxable income to her in the year of conversion.

They are all pre-tax and I assumed this would be the case.

If I understand MO taxes correctly, the first $6000 of conversion income will be tax-free. This doesn't reduce the taxes on your income or divert some of it to your wife, but it does allow you to get money into the Roth for her. Whether that's a good thing or not really depends on your long-term expectations -- will you be in a higher tax bracket in retirement than you are now, will you need to draw on your IRA in retirement, do you plan to leave your IRA to your heirs, etc.

I see your point. I may have been trying to be too clever.

FTR, how do you arrive at the conclusion that the first $6,000 would be (MO) tax-free? My understanding is that it would get lumped in with other income and, since her other income is small, would just get taxed at rates below the top bracket. I fully admit I might be missing something obvious here.

However, if any of her previous contributions were after-tax dollars, a typical conversion will be partly taxable and partly tax-free.

Thankfully, we don't have to deal with this.

Thank you very much for your help and your time.

--B+C
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FTR, how do you arrive at the conclusion that the first $6,000 would be (MO) tax-free? My understanding is that it would get lumped in with other income and, since her other income is small, would just get taxed at rates below the top bracket. I fully admit I might be missing something obvious here.

... from a very quick look at Form MO-A, Part 3. But, I may have misinterpreted the calculation sequence.

Ira
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... from a very quick look at Form MO-A, Part 3. But, I may have misinterpreted the calculation sequence.

Ah, I see. Thank you. Since my wife and I are both in our 30's, it never even occured to me to look for this.

--B+C
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... from a very quick look at Form MO-A, Part 3. But, I may have misinterpreted the calculation sequence.

Ah, I see. Thank you. Since my wife and I are both in our 30's, it never even occured to me to look for this.


It surprised me as well. First state I've seen with a general pension exclusion for the under 60 crowd.

Ira

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