Tax Tips: January/February 2023

Now may be the time for a Roth conversion

If you’ve watched the value of your retirement accounts shrink in recent months, there may be a silver lining: It’s an ideal time to convert your IRA or 401(k) plan into a Roth account. Roth IRAs and Roth 401(k)s offer many attractive benefits, including tax-free withdrawals of earnings and contributions and no required minimum distributions when you reach age 72. When you convert a traditional account into a Roth account, the amount you convert is fully or partially taxable in the year of conversion. But doing a conversion when the value of your account has dipped generally minimizes the overall tax hit.

Rising interest rates boost interest in certain estate planning vehicles

High interest rates favor certain estate planning vehicles over others. For example, charitable remainder annuity trusts (CRATs) are more effective when interest rates are high. Why? Because their performance is tied to an IRS-prescribed interest rate called the Section 7520 rate. A CRAT pays the donor income for life or a term up to 20 years, after which its remaining assets are given to charity. When you contribute assets to a CRAT, you’re entitled to a charitable income tax deduction (subject to applicable limits) equal to the present value of the charity’s remainder interest. A higher Sec. 7520 rate equates with a higher value for the remainder interest — and a bigger tax deduction.

Qualified personal residence trusts (QPRTs) also perform better as interest rates increase. On the other hand, grantor retained annuity trusts (GRATs), charitable lead annuity trusts (CLATs) and intentionally defective grantor trusts (IDGTs) tend to do better when interest rates are low.

Sales tax nexus inquiry letters: Handle with care

Most states impose sales tax collection obligations on out-of-state businesses that have a nexus, or connection, with the state. Nexus may be based on 1) a physical presence in the state (brick-and-mortar outlets, for example) or 2) an economic presence in the state (usually based on a particular sales level).

In an effort to determine whether out-of-state businesses are subject to their sales tax laws, many states send out “nexus inquiry letters” to businesses they believe may have a nexus with the state. If your business receives one of these letters — which are often in the form of a questionnaire — handle your response carefully. Typically, these questionnaires consist primarily of yes/no questions that can make it difficult to convey the nuances of your company’s activities in the state. To avoid inadvertently triggering further inquiry or even a sales tax audit, consult your tax advisor before responding. Consider preparing a letter describing your activities in lieu of the questionnaire, if permitted.

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