Tax Code Anomalies

Congress is getting ready to revise the U.S. tax code once again, and you can bet that the final version won’t subtract any pages from a document that now contains nearly 10,000 sections and two million words. Over the past 10 years alone, the tax code has been amended or revised over 4,000 times, with provisions covering pet moving expenses for people who lost their jobs, a deduction for clarinet lessons if it helps correct a child’s overbite, and a special carve-out for repairs for whaling boats—even though hunting whales is currently banned by the United States government.

And some of the provisions in the tax code are directly contradictory. Consider, for example, the limitations on high-income taxpayers who might want to contribute to Roth IRAs. With these tax-deferred accounts, you don’t get a deduction for the contribution, but all monies taken out of the Roth in retirement are tax-free. Under current law, joint filers with modified adjusted gross income (taxable income plus deductions for things like student loan interest and self-employment taxes) above $208,000 (singles above $140,000) are not allowed to make contributions to a Roth account.

But the tax code says that people at any income level CAN make contributions to a traditional IRA, up to $6,000 a year currently ($7,000 for people aged 50 and over) where the contribution amount is not counted as taxable income.

What’s the contradiction? The tax code specifies that people at any income level are eligible to make Roth conversions—that is, move money from their IRA into a Roth IRA—and count the money moved as income. So it’s possible, and relatively easy, for higher income individuals to make, contributions, say $500 a month, to their traditional IRA. Then their tax planner or financial advisor can move those traditional IRA contributions to a Roth account—and the taxation would be exactly the same as if the taxpayer had contributed to a Roth in the first place. (The strategy is known as a “back-door” contribution, which sounds vaguely sketchy but is actually perfectly legal.)

Every year, planning professionals and tax experts pore over the new tax provisions for contradictions and loopholes. This next tax bill, whenever it comes, will be no exception.

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