Tax Tips Blog

Rich asks: Just wanted to stop in here to get a clarification on my thinking regarding a recent stock transaction. Quite a few years ago, I had been holding stock in ZDNet (ZDZ) and that was acquired by CNet in October of 2000. For each share of ZDZ, I received 0.5932 shares of CNet stock. In 2007 I sold the CNet stock. If I am correct, I believe I would report the basis as the original purchase of ZDZ. As an example, consider the following: Bought 500 ZDZ @ $10.00 = $5000.00 Merger 500 ZDZ become 290 CNET Sold 290 CNET @ $5.00 = $1450.00 Transaction results in loss of $3550.00, is that correct? Or do I use the price from 10/17/2000 when my ZDZ became CNET stock? Thanks, Rich

My reply: I hate to be the one to tell you this, but the only person who can help you answer this question right now is the company involved in the transactions, namely CNet. They sent you paperwork back in 2000 which would explain how to compute your basis. If you no longer have that paperwork, you’ll have to call them, write them, do whatever it takes to get it from them.

There are seven different ways in the tax code to structure a corporate reorganization so that is it is for the most part tax-free at the time. Each method results in a slightly different tax result.

But corporations are not required to make their reorganizations tax-free. They could have used a taxable reorganization. The only way to know which method was used was to read the paperwork they sent you regarding the reorganization.

In short, this is why I inform my clients that they must keep up with their basis adjustments at the time of the split/merger/spinoff/dividend reinvestment, not years down the road when they sell it or gift it or it gets transfered through inheritance.

Best wishes,

Gina

Emily writes:My financial adviser suggested that I open a Roth IRA as a way of providing for my childrens’ educations, since I can take early distributions from my Roth IRA without penalty for qualified educational expenses. I thought that the same kind of distributions can be made from regular IRA’s (i.e. traditional, rollover, SEP, etc)? If so, is there something particularly appealing about using Roth IRA’s for this purpose, besides the fact that the distributions won’t be taxed? Thank you in advance, Emily

My response: Hello Emily, thanks for writing.

Time to jump up on to my soapbox before I get directly to your question….. I have clients who have spent all, or most, of their retirement assets in order to provide a “better education” for their children. They spared no expense when it came to their children’s education - extra years in school while the child “found themselves”; several colleges and trade schools because the child couldn’t decide on a “career”; and then there’s graduate school, law school, medical school, not to mention their child’s living expenses while in college.

You’re not doing yourself of them any favors if you find yourself without enough retirement funds because you spent it all on their college education. Unless of course you and your children have an understanding that what you’re actually purchasing is a better retirement - they understand and realize that they will be paying for your retirement - living costs, health care costs, vacations, whatever you need.

I’ve never seen a family work this way. Instead I’ve seen successful children who are too busy to realize their parents are now financially destitute and too blind to realize they are the cause. I’ve seen children with over 5 years of post high school education still living with their parents because they couldn’t find a job in their chosen field of study.

I know many bankers and not one of them will loan any money to a retired couple who can’t pay their medical bills, can’t afford their prescription drugs, has fallen behind on their second mortgage they took out for little “Jimmy” to get his Harvard degree, etc. How many times have you heard someone say, “I locked in a great rate on my retirement loan”? You can’t get a loan for retirement.

On the other side of that coin, your children can get low cost, tax deductible loans for education. What I’m trying to say is, it’s my personal opinion that you should have a plan that enables you to fully fund your own retirement BEFORE you even consider funding your child’s education. Now, I’ll jump off this box and try to answer the question I believe you were asking….

First, as you wrote, you can withdrawal funds “without penalty” from all IRAs. This does NOT mean “without paying taxes” - you may owe taxes on your withdrawals made for college education expenses. Even though taxes feel like a penalty, then aren’t.

Roth withdrawals are considered to be taken in the following order:

1. contributions,
2. then conversions,
3. then earnings.

The taxation of each kind of withdrawal is as follows:

• Contributions These are the annual contributions, currently limited to $4000 ($5000 for those 50 and older). These can be withdrawn at any time without tax or penalty.
• Conversions This is money converted from a traditional IRA. (And soon to be money going from a 401k directly to a Roth.) Conversions can be withdrawn any time free of income tax. Remember that the tax was paid at the time of conversion. But they will be penalized unless the money has been in the account for 5 years OR the IRA owner is over 59 1/2 (or is disabled or deceased). Each conversion has a separate 5 year holding period in the Roth IRA.
• Earnings Once contributions and conversions are withdrawn, what is left in the IRA is earnings. Earnings are subject to tax AND penalty unless the Roth has been open for 5 years AND the IRA owner is over 59 1/2 (or is disabled or deceased). The Roth IRA is considered to be opened as of Jan 1 of the year for which the first contribution (or conversion) is made. So if the first contribution to the Roth IRA happened on April 15, 2008 as a contribution for tax year 2007, the IRA is considered to be opened as of January 1, 2007.

In a Traditional IRA, it depends on whether the contributions are deductible or non-deductible. Contributions that are deductible are the same as gains on the account and must meet one of the early withdrawal provisions to be penalty free. If the contributions are non-deductible that portion of the withdrawal is considered a return of basis and not taxed again at withdrawal.

Please don’t rule out your other options of saving for your children’s education. It depends on your family situation and finances, but if you’re certain your children will be attending college a Section 529 plan may be a good option. Yes, you will be penalized if you do not use these funds for college education, but if you have multiple children, you can re-designate it from one child to another and you can even use it yourself.

That said, if you don’t feel a Section 529 plan (or even a Coverdell ESA), is the right option for your family, you may want to consider the risks that the tax rules for retirement savings accounts may change before it’s time to use the money.

Best wishes,

Gina

Brett asks:I bought a new car last year and I think I’ll get a larger deduction if I deduct my sales tax instead of my state income tax. When I calculate my sales tax deduction do I get to include all the sales tax I paid on my gasoline?

My reply: Hello Brett! Interesting question.

The tax on gasoline isn’t just one tax - it could be several different kinds of tax. First you have your Federal excise tax, then your State excise tax, then your general sales tax, your county and local sales tax, environmental fees and wholesale taxes.

State excise taxes are anywhere from about 8 cents a gallon to 33 cents a gallon. Federal excise taxes are about 18 - 20 cents a gallon. The actual sales tax on gas is anywhere from about 3% to maybe as high as 10% of the total retail price of the gas. Since this is rarely, if ever broken out, I would have to believe it would be extremely hard to go through all your receipts for the year and determine, based on where you purchased the gas, exactly how much of the taxes that you paid were actually sales taxes.

However, if you do decide to do that, the general sales tax on gasoline is potential deductible on your income taxes. It’s only deductible if you itemize your deductions, choose the option of taking your sales tax instead of your state income tax and use actual expense method of computing the sales tax and you qualify for the itemized deduction and your itemized deductions are not phased out and you’re not subject to AMT, etc.

Good question though.

Best wishes,

Gina