California and Federal Laws Are Now in Sync on IRA Conversions Made in 1998
Q: I have converted my individual retirement account to a Roth IRA. I know that by doing it this year, my federal tax obligation will be spread over four years, but I don’t understand exactly how that is to be done. Please explain.
Also, does the California Franchise Tax Board honor the same four-year period for 1998 IRA conversions?
A: For 1998 IRA conversions to Roth IRAs, you will simply declare 25% of the converted IRA amount as ordinary income on your tax return. For example, let’s say that this year you convert a $50,000 IRA on which no taxes have ever been paid. You would declare $12,500 as income on each of your tax returns for 1998, 1999, 2000 and 2001.
However, if you convert an IRA on which taxes already have been paid on any part of the amount, be sure to exclude that amount from the total on which taxes are owed.
For example, if you have a $50,000 IRA that includes $10,000 on which taxes have already been levied (because your IRA contributions were not tax deductible when you made them), the taxable portion of your IRA conversion would be $40,000, or $10,000 for each of the four years over which you will spread the tax if you convert your IRA this year.
The good news is that California has adjusted its state tax laws to be in sync with the federal law on IRA conversions made in 1998. However, be advised that there are many instances in which state and federal tax laws are not alike as a result of the sweeping federal tax law changes approved by Congress last year.
Perhaps the most important difference still remaining between federal and California tax laws pertains to capital gains tax rates. With the exception of the sale of a personal residence, in which state law does follow the new federal law exempting up to $500,000 of gain from taxation, California still taxes capital gains as ordinary income up to the maximum state tax rate of 9.3%.
Some state legislators have indicated an interest in adopting more favorable tax treatment for capital gains. However, the old state law definitely still applies to the 1997 tax returns that are due by midnight Wednesday. Any new legislation would affect only subsequent tax years.
Q: I intend to sell my home and move out of state. Now I hear that the state will assess me a 3.3% tax on the proceeds. Can this possibly be true?
A: The “3 1/3" law to which you refer is, indeed, a fact. But it’s not as sweeping as you’ve been led to believe, nor does it affect residential property. So, at the outset, you’ve got nothing to worry about.
But let’s explain this feature of state tax law for those who might be affected. Beginning in the late 1980s, the state Legislature imposed a withholding tax of 3.3% on the sale of income or investment property in California by landowners whose last known address was out of state. The goal was to ensure that the state gets its fair share of any profits generated by such transactions.
The reasoning is that once taxpayers have money withheld from their proceeds, they are likely to make the required filing with the state Franchise Tax Board. If taxpayers reside out of state, California authorities have only a limited reach. But if money is withheld at escrow, the state can claim its share.
Apparently, the law works. A Franchise Tax Board spokesman reports that tax-filing compliance has soared. Out-of-state residents whose California property sale will produce a loss or who have other legitimate reasons for not owing the state any tax from the sale of their property may petition the Franchise Tax Board for a waiver from the withholding.
A modified waiver is also available if the 3.3% withholding tax is greater than the amount of tax the property owner would otherwise owe. Any waiver petitions must be filed before the sale becomes final. To request a waiver form, call (916) 845-4900.
Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail firstname.lastname@example.org