Many people are wondering what ended up in the final version of the tax bill and how it affects IRAs and other accounts. First, a brief civics lesson is in order. In the United States Constitution, Article I, Section 7, Clause 1 states that “All Bills for raising Revenue shall originate in the House of Representatives; but the Senate may propose or concur with Amendments as with Amendments as on other Bills.” In this case, the House of Representatives proposed the tax bill, and then the Senate passed amendments to the proposed bill. Since the proposed bills were not identical, a conference committee was established to work out the differences between the two versions of the bill. Once reconciled, the modified version of the bill goes back to the Senate and the House of Representatives to be voted on in its final form. If the final bill is passed by both chambers, the bill goes to the President to be signed into law or vetoed. The reason this is significant is that confusion often arises when one chamber proposes a change which does not match the proposal in the other chamber. Until the final version of the bill is negotiated and passed by both chambers of Congress, there is no way to tell what changes were actually made.
With that bit of background, let’s discuss what changes did, and just as importantly what did not, get passed in the final version of the tax bill. First of all, with regard to the Coverdell Education Savings Account (CESA), no changes ended up being made. The House bill had several proposed changes to the CESA, including provisions to disallow any additional contributions to a CESA after December 31, 2017, and allowing a CESA to be rolled into a qualified tuition program (a Section 529 plan). The Senate amendments had no changes proposed to the CESA. Both the Senate and the House had provisions to modify Section 529 plans. In the final version of the tax bill, the Senate amendment prevailed. For distributions made after December 31, 2017, Section 529 plans may not distribute more than $10,000 in expenses for tuition incurred during the taxable year free of tax. Any excess distributions received by the individual are treated as a distribution subject to tax under the general rules of Section 529. The definition of higher education expenses was expanded to include certain expenses incurred in connection with a homeschool.
Both the House bill and the Senate amendments proposed identical changes to the Roth conversion and recharacterization rules. The proposal was to disallow any recharacterization of a contribution to one type of IRA into the other type of IRA (a Roth IRA contribution to a traditional IRA contribution or the reverse). For example, if you made a contribution to a Roth IRA and later discovered that you made too much money to qualify for a contribution, you would not be permitted to recharacterize that contribution. However, in the conference committee a change was made which allowed the recharacterization of a contribution to one type of IRA into the other type of IRA, but did not allow a recharacterization of a Roth conversion contribution. In other words, the recharacterization rules remain the same except for Roth conversions. Beginning January 1, 2018, once a Roth conversion takes place, it may not be reversed (or recharacterized). As a result, much more thought must go into a Roth conversion decision in 2018 and future years. Significantly, no changes were made to the Roth conversion rules which allow high income earners to contribute to a traditional IRA and immediately convert that contribution into a Roth IRA. This is known colloquially as a ‘back door’ Roth contribution.
Finally, a change was made to the rules for Unrelated Business Income Tax (UBIT). Under the previous regulations, an organization that operates multiple unrelated trades or businesses aggregates income from all such activities and subtracts from the aggregate gross income the aggregate of deductions directly related to the trades or businesses. As a result, an organization was able to use a deduction from one trade or business to offset income from a different unrelated trade or business, thereby reducing unrelated business taxable income. However, the tax bill added a new provision (Section 512(a)(6)), which requires an organization to compute its unrelated business taxable income separately with respect to each trade or business and without regard to the specific $1,000 deduction generally allowed under Section 512(b)(12). The organization’s unrelated business taxable income is the sum total of the amounts (not less than zero) computed for each separate unrelated trade or business, less the specific $1,000 deduction. Beginning in 2018, a net operating loss deduction will only be allowed with respect to the trade or business from which the loss arose. As a result, an organization may not use a deduction from one trade or business to offset income from a different trade or business for the same taxable year. Fortunately, net operating losses from a taxable year beginning prior to January 1, 2018 that are carried forward to a taxable year beginning on or after that date are not subject to the rule, and can be used to offset unrelated business taxable income.
The final bit of good news is that the rules for inherited IRAs did not change in the tax bill. Given the power of an inherited Roth IRA, particularly if that account is self-directed, this is really great for those who have one and know how to work it.
- Quincy Long is a Certified IRA Services Professional (CISP), a Texas attorney, and is President of Quest IRA, Inc., with offices in Houston, Dallas, and Austin, Texas. He may be reached by email at Quincy.Long@QuestIRA.com or by calling 855-FUN-IRAS (855-386-4727). Nothing in this article is intended as tax, legal or investment advice.