Roth IRA versus traditional IRA: which is better for you?
Roth IRAs tend to get a lot of hype, and for good reason: Because you pay the taxes upfront, your eventual withdrawals (assuming you meet the age and holding-period requirements—more on these below) are completely tax-free.
While we like “tax-free” as much as the next person, there are more times than you would imagine when a traditional IRA will put more money in your pocket than a Roth would.
Making the Decision on What’s Best
Example. Say that your tax rate is 32 percent and that you will invest $5,500 a year in an IRA and earn 6 percent interest. Should you put the $5,500 a year into a Roth or a traditional IRA?
Say further that neither you nor your spouse is covered by a workplace retirement plan, so you can contribute the $5,500 a year without worry because it’s under the contribution limits.
If you invest the $5,500 in a traditional IRA, you create a side fund of $1,760 ($5,500 x 32 percent).
On the side fund, you pay taxes each year at 32 percent, making your side fund grow.
Roth contributions are not deductible; this means no side fund, so your annual investment remains at $5,500.
For the Roth, your marginal tax rate at the time of your payout doesn’t matter because you paid your taxes before the money went into the account. The whole amount is now yours, with no additional taxes due.
But for the traditional IRA, your current tax bracket matters a great deal. You have taken care of the taxes on the side fund annually along the way, but the traditional IRA (both growth and contributions) is taxed at your current marginal tax rate at the time you cash out.
The table below shows you how this looks with tax rates
On April 11, likely after you filed your tax return, the IRS updated its Section 199A frequently asked questions (FAQs) by increasing the number of questions and answers from 12 to 33. The IRS often publishes FAQs on its website to help educate you on various tax law provisions. Section 199A is no different: the IRS has been updating its FAQ website with additional questions and answers on the new qualified business income (QBI) tax deduction.
We noted three of the FAQs that help fill in some holes in the final Section 199A regulations but will cause problems for many taxpayers. In fact, there will be taxpayers who will need to file amended tax returns because of the FAQs.
FAQ 29: QBI Subtractions for Partnerships
In this FAQ on partnerships, the IRS hints at the following:
FAQ 32: QBI in Final vs. Proposed Regulations
In FAQ 32, the IRS clearly states that the definition of QBI is the same in both the proposed and the final regulations. Since the definition was clarified in the final regulations, this was a surprise to many.
And what this means is that you reduce QBI by the self-employed health insurance deduction, the one-half of self-employment tax deduction, and the qualified retirement plan deductions.
FAQ 33 Has to Be Wrong
FAQ 33 states that an S corporation shareholder who owns more than 2 percent may have to reduce QBI at both the entity (S corporation) and the shareholder (1040 tax return) levels.
We don’t agree with the double subtraction indicated in IRS FAQ 33, for three reasons:
Website Is Not an Authority
If you don’t like the positions taken on the IRS’s FAQ website, then there’s one silver lining: FAQs don’t constitute an authority for tax return positions.
If you need further assistance with the IRS FAQs, don't hesitate to contact us. Book your Business Consultation Today.
What rules apply for purposes of the new 20 percent deduction under Section 199A when you rent an office or other building to your personally owned C corporation?
Neither the IRS nor lawmakers specifically address self-rental to a C corporation.
But the Section 199A regulations are clear: rental activities that rise to the level of a Section 162 trade or business qualify for the Section 199A deduction.
The new Section 199A tax deduction can be confusing. If you would like to discuss your rentals with me, click the link below to schedule an appointment for a Business Consultation
When you rent a bedroom or two or 20, you first examine Section 280A of the tax code to determine whether your bedroom rental is:
When exempt from Section 280A, your bedroom rental faces four tax code sections:
As you can see, bedroom rentals travel a torturous path. Contact us, we will set a time to review your bedroom rentals to achieve the best results.
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Spencer Accounting Group, LLC does not provide investment, tax, legal, or retirement advice or recommendations in these blogs. The information presented here is not specific to any individual's personal circumstances.
Keana Spencer is an Accountant, Entrepreneur, and Educator to her clients, with a strong passion. Keana has over 10 years of experience and through her practice, she is a source of knowledge and strategies to her clients.