In this podcast, we sit down with our virtual CFO and host Tom Wadelton and Dave Danic, our Director of Tax to discuss about the BackDoor Roth IRA. Discussing what it is all about, how it can help companies and their tax filing, and carefully outlining the implications when utilized.
"And that's what financial planning is all about. (And) My strategy is little bit here, little bit there, you know, if, if everyone just had a strategy to - say, 'I'm going to eliminate a hundred thousand dollars of taxes', everyone would do it. Now, It's just taking little strategies and piecing them together to build wealth and save tax."- Dave Danic
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Tom Wadelton: So welcome to the Cleared Diagnostic Tax podcast. I'm Tom Wadelton. I'm one of the Virtual CFO's at Summit CPA Group. I'm joined by Dave Danic our Director of Tax Services. Dave, welcome to our podcast.
Dave Danic: Tom. Thanks for having me on the podcast. I appreciate it.
Tom Wadelton: So last time you told us it would never change, but the Build Back Better plan is like totally on target. And now we're saying, hey. Things have changed from that. Let's talk about one of the impacts.
Dave Danic: Yeah. Dirty little secret of tax planning, you can only work with the information we have. So last week or two weeks ago, we did a podcast on what's going on with the Build Back Better plan. It was supposed to be signed by December 26th or someday, and we said to be talking to clients about what they should be doing before year end before this is signed to take advantage of. And then President Biden yesterday says, Congress, you're not getting along well. So, we're going to delay Build Back Better to 2022. So what we're saying is, we can talk with our clients all day long with only the information that we have, and that's what's been so frustrating over the past three years is you get all these tax bills at the last minute that you don't know if they're going to sign. And then when they do sign, it's really late in the year. So I can say, I think you should accelerate some income into this year, assuming they sign the bill. So now we have some clients that said, well, I pushed some income into this year and now the tax bill isn't going to come.
Tom Wadelton: Right. So we're working on guidance we can give clients, right? We can't say exactly what's going to happen. Given what we're seeing there is some advice that we can give to people.
Dave Danic: Exactly. I mean even with the best information available 10 years ago, I didn't think Bitcoin was a good investment. That turned out to be wrong. So what can we do? One of the big things that we've been working on with our financial advisors and our business owner clients is something with called the backdoor Roth IRA. And that was one of the provisions that was going to be knocked out through Build Back Better. And it's a nice little strategy. It's a loophole. Let's call it for what it is, right? It's a legal loophole, but it's still a loophole. Why walk through the back door if I can walk through the front door? So, the theory is that if I make too much money I'm eliminated from contributing to a Roth IRA. A lot of our business owner clients fall into that category. And why do I want to do a Roth IRA? Well, the benefit of it is that I'm putting after tax money into it and it's growing tax free still. It's not subject to required minimum distributions when I reach an age and when I pull the money out it's not taxable either. So it's a really nice benefit, but that's why the IRS says we're not going to let high income people do it. But if I go through the back door, I make a contribution to a nondeductible IRA, and then I immediately convert it, that IRA balance to a Roth IRA, which is allowed, it's just some jumping through hoops, but allows me to get a balance of after-tax funds into this Roth IRA that's growing tax. It's really a nice benefit and a great way to diversify your pretax and post-tax retirement income.
Tom Wadelton: So essentially the conversion of a normal IRA to a Roth IRA, doesn't have the sort of income provision that would stop someone. If there is that the backdoor that you can do, right?
Dave Danic: Yeah. There's certainly some things that we want to talk about. I'd certainly recommend working with a financial advisor to have the accounts open for you. but the reason I'm harping on this right now, or I think why we want to talk about it is to say to clients to do your IRA backdoor Roth for 2021 before the end of the year. That's good stuff. So we get the benefits still allowed now. And then I also recommend you do the backdoor Roth early in 2022 for the 2022 tax year. The reason I think there's a little bit of hustle here is what happens if Build Back Better gets signed in early February of 2022 and they shut the backdoor? You will want to act fast.
Tom Wadelton: definitely a window there. You have time right before the end of 2021 to put it in.
Dave Danic: Yeah. You know, you hear a lot about this on the news like CNN, Fox News, you know, they talk about this loophole. That's an easy one to close. And while we talk and practice of it being pretty easy to do, you know, there are some pitfalls that I think we have to let our audience know about. And one of them is the prorate. So, what this rule means is that if I have existing traditional IRA balances if I convert some of it to a Roth IRA, what happens? Well, my pre-tax contributions, I need to pay tax on it this year. So for instance, if I take a hundred thousand dollars of a pre-tax IRA, convert it to a Roth, I pay tax on a hundred thousand dollars of it. That makes sense, right? I got the tax deduction of a hundred thousand dollars in previous years. So if I wanted to do a backdoor Roth IRA today, and I had an existing balance in all of my IRAs, all of my pre-tax IRAs, if I took my $6,000 contribution this year and then converted it to a Roth IRA I would have to prorate my balance of my pre-tax dollars and then pay tax on that. So I might be paying tax on $5,500 of the money that went to the Roth instead of zero from my IRA balances. So the way to get around that is to make sure you get your pre-tax traditional IRA balances out of those IRAs prior to doing the backdoor Roth IRA strategy. So my pre-tax balances are zero in my IRAs. So I've had some clients do this who say, by the way, I did a backdoor Roth. I said, how much is in your IRA at the end of the year? They said $50,000. I'm like, oh no, they are going to have to pay some tax on that conversion. So it's always good to get all of your simple IRA, SEP IRAs, traditional IRAs, and make sure you have those balances.
Tom Wadelton: Okay. So just to understand that. So to your person that had the a hundred thousand dollars in the IRA, if they say this sounds cool, I want to put $6,000, they have to consider that a hundred thousand dollars. It's sitting there.
Dave Danic: Right. Yeah. That's why I always ask who's your financial advisor? People have busy lives. If they've been in a career for 20, 30, 40 years you just have different retirement accounts floating around. I mean, we were talking with one of our CFO clients the other day, we were talking about some conversions. And he's like, what accounts do I have to get statements for? And where are they and who are they housed by? So. Yeah. It's certainly something I remember each tax season to ask.
Tom Wadelton: Right. And sometimes clients will ask us which accounts they have and things like that. It's very natural for people, especially those who are considered wealthy, it’s not that simple to just ask them what's their balance when they've got balances all over the place.
Dave Danic: Yeah. And one, what type of account is it? Two, is it a Roth IRA? A traditional IRA. A SEP? So things to consider with a financial advisor.
Tom Wadelton: So, if you're the tax person working with a client and their financial. It’s important to ask those questions so no one is surprised by a tax bill. So for anyone that is guiding a client, or for yourself, who has heard about these backdoors, time is really of the essence.
Dave Danic: We were telling people to do it already in 2021 before they close of the year. Now if it's going to push into early 2022, you can do a backdoor Roth IRA in January or December might as well, just front-loaded into January to make sure that we're being as safe as possible to take advantage of it. And that's what financial planning is all about. And my strategy is little bit here, little bit there, you know, if, if everyone just had a strategy to say, I'm going to eliminate a hundred thousand dollars of taxes, everyone would do it. No. It's just taking little strategies and piecing them together to build wealth and save tax.
Tom Wadelton: Yeah. But 10 years from now when that $6,000 is $60,000 and you can pull it out and it's not taxable that's a really nice opportunity.
Dave Danic: Yeah certainly something to look at and you know, we're going to. You know, we're sick of reading these updates on Build Back Better and the Tax department, but that is our job. We're ready for Congress to give a certainty for our clients. But this is one area where I think we have some momentum to provide some action. So that's good. Yeah.
Tom Wadelton: Yeah. It sounds like a good suggestion for people. Good. Well, thank you. It seems like a really good topic. Any final thoughts?
Dave Danic: No, we're all just going to keep reviewing what we need to, and advise our clients when it comes to changes in tax law and hopefully the IRS can catch up.
Tom Wadelton: We will hope so. Thanks for joining Dave. We will talk to everyone later.