Americans spend $1 billion annually in unnecessary state tax

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Americans spend $1 billion annually in unnecessary state tax

Postby Bob's not my name » Sun Nov 27, 2011 11:05 am

Decided on a new thread title after wading through a steaming pool of journalism on another, better advertised billion dollar giveaway.

I’m interested in how many states’ tax codes permit a deductible back door Roth, by which I mean dodging the state tax by making a deductible TIRA contribution and immediately converting to a Roth IRA without incurring state tax (so you get the best of both). A couple could save $300 - $1,000/year doing this on $4,000-$12,000 of IRA contributions, an immediate 5-9% return, depending on your state.

Illinois is the only state I know that allows this without an age or dollar limitation [edit: looks like Kentucky exempts conversions up to $41,000, which isn't much of a limit; edit2: Oklahoma looks good, too], but a cursory (read sloppy) review of state income tax instructions indicates that a number of other states allow this for $2,000 or $3,000 (each, so $4,000 or $6,000 for a couple) regardless of age, and some other states allow this if you’re over 55 or 60 or some similar pre-retirement age.

I want to emphasize that I am not a taxpayer in 49 of these states nor DC, and I obviously have not spent more than five minutes on each state’s tax form instructions, so I may very well be dead wrong in many instances. I will gratefully take corrections and additions and edit this first post accordingly in an effort to minimize the dissemination of bogus information. I haven’t finished looking at all states, but I thought I’d go ahead and start the thread and list all 50 states below so you can be a cog in the Mechanical Turk and check me on your state or help me out where I have a blank.

I’m ignoring here that many states provide big breaks for folks over 65. I know that some people continue to work past 65 and therefore may be able to do Backdoor Both. I want to focus on opportunities for the younger crowd.

The tax rate given in parentheses is a representative number for rough comparison only. I picked MFJ with state taxable income of $100,000 as the illustrative rate example, because a state taxable income of $100,000 may* roughly correspond to a federal AGI which puts the couple roughly in the middle of the deductible TIRA phaseout range ($92,000 - $112,000 for 2012), viz., eligible to contribute $4,000 or $6,000 deductible, combined. Higher income couples (up to about $200,000 gross) can still make deductible contributions to a spousal TIRA if one spouse is not covered by an employer plan, or (without income limit) to two TIRAs if neither is covered. However, these latter types will also be in high federal tax brackets, so leaving the deductible TIRA as such may make more sense. $100,000 state taxable income may* also roughly correspond to the top of the federal 15% bracket for a family with 2.3 kids and a mortgage.

*Most states allow pretty small deductions and exemptions, so state taxable income is often not far off federal AGI, especially if you’re adding back in things like municipal bond interest. I know this does vary widely. In any case, most state income taxes are flat or nearly flat (for example, the rate I cite for $100,000, or a rate less than 1% lower, kicks in at $50,000 or less – the only exceptions I saw were California, North Dakota, Ohio, and Vermont).

For those states with an income tax, the median and mean rate for MFJ with taxable income of $100,000 is about 6%, which surprised me – 6% is pretty significant if your federal bracket or LTCG/QD rate is only 15%. The mean and median rise to about 6.6% if you cherry pick the high tax cities and counties to represent each state.

I would also appreciate your help on the local taxes. I think it’s important to consider that NY is 6.85% but NYC is 10.45%, PA is 3.07% but Philly is 7.07%, MD is 4.75% but most counties bump that to 7.95%, etc. My numbers are again based on casual surfing, so corrections are welcome. In some cases the local tax is collected separately, such as by payroll deduction, and the Backdoor Both benefit is limited to the state tax, but in other cases the local tax is collected with and indistinguishable from the state tax. I don't know how NYC and Wilmington, for example, treat TIRA contributions and Roth conversions.

Alabama (5%, 6% in Birmingham) no Backdoor Both
Alaska none
Arizona (4.24%) no Backdoor Both (thanks Alan S)
Arkansas (7%, 7.7% in some school districts) Taxpayers over 59.5 can each exclude $6,000 of a TIRA conversion, so a couple can save up to $840/year with the Backdoor Both.
California (9.3%) no Backdoor Both (thanks Alan S)
Colorado (4.63%) Exempts $20,000 of IRA withdrawals and other pension income per taxpayer over 55 (or a taxpayer of any age who is a beneficiary due to death of the IRA owner), so a couple can save $556/year with the Backdoor Both.
Connecticut (5%) no Backdoor Both
Delaware (6.95%, 8.2% in Wilmington) Taxpayers over 60 can each exclude $12,500 of dividends, interest, capital gains, and IRA distributions, so Backdoor Boths could save a couple $764/year. It looks like taxpayers aged 59.5 but not yet 60 can each exclude $2,000 of a TIRA conversion (that is, there's a mismatch because a distribution at age 59.5 will not be coded as an early distribution, and therefore appears to be eligible for Delaware's $2,000 exemption for taxpayers under 60).
Florida none
Georgia (6%) Up to $70,000 of retirement income is exempt for a couple both 62 or over ($35,000 if only one is 62), so a full Backdoor Both is possible. A couple can save $720/year.
Hawaii (8.25%) no Backdoor Both
Idaho (7.8%) no Backdoor Both
Illinois (5%) Does not tax TIRA contributions or withdrawals, so TIRA is favored over Roth in higher brackets and a state-deductible back door Roth is possible for those eligible for a deductible TIRA. A couple can avoid $500/year ($600/year if over 50) of state taxes this way.
Indiana (3.4%, as high as 6.3% in some counties) no Backdoor Both
Iowa (8.98%, up to 10.8% in some school districts; 8.98% is effectively 7.6% because federal taxes are deducted -- thanks grabiner) Taxpayers 55 or older can exclude $6,000 each of IRA distributions, so a back door Roth from a deductible TIRA can save a couple $915/year in state taxes.
Kansas (6.45%) no Backdoor Both
Kentucky (6%, 8.25% in Lexington) Exempts $41,000 of retirement income, including conversions to Roth, so a couple could save up to $600/year ($720/year if over 50) with the Backdoor Both.
Louisiana (6%) no Backdoor Both
Maine (7.95%) $6,000/person exclusion covers 401k distributions but not IRA distributions
Maryland (7.95% including local taxes for most counties) no Backdoor Both
Massachusetts (5.25%) Taxes TIRA contributions but not 401k contributions, so 401k is favored over TIRA. No Backdoor Both.
Michigan (4.25%, 6.75% in Detroit) Had a $90,000 exemption for taxpayers over 59.5, but in 2012 that’s reduced to $40,000 and the age requirement is raised to 67 for persons born after 1952 (thanks to cheese_breath for explaining this). Still, today’s 59.5-year-olds can exploit this for their remaining working years to save $522/year in state taxes on a Backdoor Both. And of course they should convert more than this year’s contributions to make full use of the exemption.
Minnesota (7.05%) no Backdoor Both
Mississippi (5%) Non-early retirement plan distributions aren’t taxed, so Backdoor Both is allowed for taxpayers over 59.5.
Missouri (6%, 7% in Kansas City and St Louis) no Backdoor Both
Montana (6.9%) no Backdoor Both
Nebraska (6.84%) no Backdoor Both
Nevada none
New Hampshire none

New Jersey (5.525% excluding local taxes) Taxes IRA contributions and 403b contributions but not 401k contributions
New Mexico (4.9%) no Backdoor Both (thanks xerty24)
New York (6.85%, 10.45% for NYC residents and municipal employees, 7.5% in Yonkers) Per MarkNYC, taxpayers over 59.5 get to exclude $20K of IRA income, so a couple could save $822/year in state taxes on Backdoor Both ($1,254 NYC, $900 Yonkers). And of course they should convert more than this year’s contributions to make full use of the exemption. (thanks xerty24)
North Carolina (5.8%), for tax years prior to 2014 exempted $2,000 of TIRA conversions ($4,000 for a couple) regardless of age
North Dakota (3.44%) no Backdoor Both (thanks tfb)
Ohio (4.695%, 7.695% in Parma Heights) no Backdoor Both
Oklahoma (5.5%) Looks like there's a $10,000 exemption, so a couple can avoid $550/year ($660/year if over 50) with the Backdoor Both.
Oregon (9%, 9.69% in Portland) no Backdoor Both, but there appears to be an exemption for low-income 62-year-olds
Pennsylvania (3.07%, plus 4% payroll tax for Philadelphia and a 4% local tax on interest, dividends, and STCG) Taxes TIRA and 401k contributions, but exempts withdrawals from both after 59.5, so I guess for PA taxes everything's a Roth.
Rhode Island (4.75%) no Backdoor Both
South Carolina (7%) Exempts $3,000 of TIRA conversions ($6,000 for a couple) regardless of age, so a partially state-deductible back door Roth is possible for those eligible for a deductible TIRA (a couple can avoid $420/year of state taxes this way).
South Dakota none
Tennessee (6% on investment income only, including taxable interest, stock dividends, and mutual fund capital gains distributions, for singles with income over $33,000 and couples with income over $59,000)
Texas none
Utah (5%)
no Backdoor Both
Vermont (6.8%) no Backdoor Both
Virginia (5.75%) no Backdoor Both (thanks xerty24)
Washington none
West Virginia (6.5%)
no Backdoor Both
Wisconsin (6.5%) no Backdoor Both
Wyoming none
District of Columbia (8.5%)
no Backdoor Both

Backdoor Both as Emergency Fund
Further down in this thread you will see discussion of whether a Backdoor Both can serve as an Emergency Fund, as can a direct Roth contribution. It is well known that you can withdraw a direct Roth contribution (but not the earnings) for any reason without paying tax or penalty.

The short answer is: pretty much. The long answer is:

-- After the 5-year period starting with the first day of your tax year in which you converted, you can withdraw your converted amount without tax or penalty. For example, if you convert in November 2012, the 5-year period is satisifed on January 1, 2017.
-- Within that 5-year period, you can withdraw your converted amount without tax or penalty if any of the TIRA withdrawal exceptions apply (read on). For Backdoor Boths in Arkansas, Michigan, Mississippi, New York and Georgia, the 59.5 exception always applies, since you have to be that old anyway.
-- If none of the exceptions apply and you withdraw within the 5-year period, you will not owe tax but there will be a 10% penalty. For Backdoor Boths in Delaware, Illinois, Kentucky, Oklahoma, North Carolina, South Carolina, Colorado, and Iowa, you saved 5-8% going in, so your net penalty is 2-5%. Note, however, that the TIRA exceptions cover most major emergencies and life events:

-- 59.5
-- death
-- disability
-- unreimbursed medical expenses over 7.5% of AGI
-- medical insurance premiums after losing your job
-- higher education expenses for you, your spouse, your kids, your grandchildren, etc.
-- buying your first home after at least two years of not owning a home ($10,000 lifetime limit) for you, your kids, your parents, etc.
-- series of substantially equal payments
-- IRS levy
-- qualified reservist
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Re: Backdoor Both -- please contribute

Postby Alan S. » Sun Nov 27, 2011 3:32 pm

AZ - TIRA distributions are fully taxable at state level regardless of age, so no tax savings upon conversion.
CA - same as above
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Re: Backdoor Both -- please contribute

Postby saddle point » Sun Nov 27, 2011 5:14 pm

RI - no more itemized deductions as of 2011, so I assume the backdoor Both doesn't work.
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Re: Backdoor Both -- please contribute

Postby Bob's not my name » Sun Nov 27, 2011 5:17 pm

Hmm, but a TIRA contribution is not an itemized deduction. In any case I looked at the RI instructions and it doesn't appear that there's any adjustment to federal AGI with respect to IRA contributions or withdrawals.
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Re: Backdoor Both -- please contribute

Postby Bob's not my name » Sun Nov 27, 2011 6:00 pm

Added a few more states. It looks like Kentucky presents an excellent Backdoor Both opportunity.

Still have a blank next to about 20 states. Corrections also welcome.
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Re: Backdoor Both -- please contribute

Postby xerty24 » Sun Nov 27, 2011 7:18 pm

VA - looks like no backdoor benefits available.

More VA quirks -

1. They do allow you to exclude retirement income that was federally deductible but taxed by another state at the time, up to the amount of the contributions (kinda like an anti-MA treatment).
2. VA 529 contributions are unlimitedly deductible by people over 70, while those under 70 can do $4k/year
3. VA 529 distributions/refunds that would be federally taxable are not VA taxed
4. All you Congressional Medal of Honor recipients, move to VA and all your military retirement pay is tax free
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Re: Backdoor Both -- please contribute

Postby Alan S. » Sun Nov 27, 2011 7:20 pm

This list should also apply to all TIRA distributions for any purpose, not just those converted to Roth IRAs. If so, you could substitute the term "double tax free on state return" for "backdoor both". I think that term has been used to describe HSA accounts for which you get the deduction and generally take tax free distributions.

I expect that any states with a double tax free feature have a minimum age (like NY) under which there will be no double benefit, since these exceptions were generally adopted to attract retirees to the state or keep them from fleeing the state. But it will be interesting to see if any states turn up that offer this benefit to younger taxpayers.
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Re: Backdoor Both -- please contribute

Postby Bob's not my name » Sun Nov 27, 2011 8:13 pm

Alan S. wrote:This list should also apply to all TIRA distributions for any purpose, not just those converted to Roth IRAs. If so, you could substitute the term "double tax free on state return" for "backdoor both". I think that term has been used to describe HSA accounts for which you get the deduction and generally take tax free distributions.

I expect that any states with a double tax free feature have a minimum age (like NY) under which there will be no double benefit, since these exceptions were generally adopted to attract retirees to the state or keep them from fleeing the state. But it will be interesting to see if any states turn up that offer this benefit to younger taxpayers.
Yes, I agree, but this most commonly comes up -- or, rather, I bring it up -- when a new poster who is eligible for a deductible IRA is hammered with the "rule of thumb" to contribute to a Roth instead. Rather than fight that outright, I often point out that doing a backdoor Roth, if Roth is where you want to end up, will save quite a bit of money. I didn't hit on this myself, I stole the idea from bdpb.

Also, I've found in my reading that state rules on withdrawals are quirky -- I remember that one state (I forget which) doesn't exempt TIRA withdrawals to pay for college or medical insurance -- so I felt the broad question would be too great an undertaking (for me, anyway), and I chose to keep it narrowly on Roth conversions.

As for states without a minimum age, I believe these have none (but the latter two have dollar limits below the $5,000 contribution limit):

Illinois
Kentucky
South Carolina
North Carolina
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Re: Backdoor Both -- please contribute

Postby soaring » Sun Nov 27, 2011 8:30 pm

This link will tell you about each States sales tax and other tax info.

http://retirementliving.com/RLtaxes.html
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Re: Backdoor Both -- please contribute

Postby LadyGeek » Sun Nov 27, 2011 9:05 pm

soaring wrote:This link will tell you about each States sales tax and other tax info.

http://retirementliving.com/RLtaxes.html

That article is based on State Individual Income Tax Rates, from the Federation of Tax Administrators and is referenced in the wiki: State income taxes. Many states have tax ranges, so Bob's not my name assumptions are important.

I added this thread to the wiki: Backdoor Roth IRA

(FYI - Please fix the typo in the thread title (Both should be Roth) by editing the Subject line in Post #1.)

(Update 11-Jan-12: Removed wiki article link - will insert link from another wiki article - posted later in this thread).
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Re: Backdoor Both -- please contribute

Postby Bob's not my name » Sun Nov 27, 2011 9:16 pm

LadyGeek wrote:Please fix the typo in the thread title (Both should be Roth)
Bob's not my name wrote:That’s not a typo.
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Re: Backdoor Both -- please contribute

Postby LadyGeek » Sun Nov 27, 2011 9:21 pm

I misread your first paragraph - thanks (wiki corrected).
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Sun Nov 27, 2011 9:25 pm

I modified the title anyway to clarify the joke.
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Re: Backdoor Both -- please contribute

Postby tfb » Sun Nov 27, 2011 11:15 pm

Bob's not my name wrote:As for states without a minimum age, I believe these have none (but the latter three have dollar limits below the $5,000 contribution limit):

Illinois
Kentucky
Delaware
South Carolina
North Carolina

Thank you for doing the legwork. Think how many people in those states are contributing to a Roth IRA but are also eligible for a deductible IRA. The tax savings potential is huge.
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Mon Nov 28, 2011 6:02 am

About 15 states left. Corrections also welcome.
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Re: Backdoor Both -- have your cake and eat it too

Postby lrisius » Mon Nov 28, 2011 7:30 am

Hi,
I hadn't ever thought of this before-I understand the concept but have a couple of questions. I live in Illinois
1) Is there a thread somewhere that discusses the mechanics of this? I looked around some but wasn't able to find much. If someone can point me at a good thread, that would be wonderful.
2) How long do I need to leave it in the deductible IRA to make this work? Do I need to wait to recharacterize till after the first of the year or till after I file or can I do it immediately? Seems like if I did it immediately, the deduction and conversion would offset each other as far as income and I wouldn't get the benefit. I looked at my Illinois return from last year and it uses the AGI from the federal form and it appears they would cancel out in the federal AGI if done in the same year.
3) If the answer to #2 requires that I shift the income to next year for the federal return, I will need to watch how that affects our marginal tax rate since our taxable income is close to the line for our bracket. If done every year with the same amounts, this would cancel out after the first year, I guess.
Thanks!
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Mon Nov 28, 2011 7:38 am

lrisius wrote:Hi,
I hadn't ever thought of this before-I understand the concept but have a couple of questions. I live in Illinois
1) Is there a thread somewhere that discusses the mechanics of this? I looked around some but wasn't able to find much. If someone can point me at a good thread, that would be wonderful.
2) How long do I need to leave it in the deductible IRA to make this work? Do I need to wait to recharacterize till after the first of the year or till after I file or can I do it immediately? Seems like if I did it immediately, the deduction and conversion would offset each other as far as income and I wouldn't get the benefit. I looked at my Illinois return from last year and it uses the AGI from the federal form and it appears they would cancel out in the federal AGI if done in the same year.
3) If the answer to #2 requires that I shift the income to next year for the federal return, I will need to watch how that affects our marginal tax rate since our taxable income is close to the line for our bracket. If done every year with the same amounts, this would cancel out after the first year, I guess.
Thanks!
The mechanics of conversion would be the same as normal, e.g., just use the Vanguard forms. You should be able to convert the next day. See the instructions for Line 5. The contribution and conversion do cancel out in your federal AGI, but not in your Illinois taxable income.
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Re: Backdoor Both -- please contribute

Postby Bob's not my name » Mon Nov 28, 2011 3:17 pm

LadyGeek wrote:I added this thread to the wiki: Backdoor Roth IRA
I really appreciate the link, but it occurs to me that it would be more useful on the regular Roth page, since your typical Backdoor Roth reader is a high income taxpayer (>$200,000 MFJ) whose income exceeds the direct Roth phaseout and therefore also exceeds the spousal TIRA phaseout (which is the same) and the regular TIRA phaseout (which is much lower). The Backdoor Both trick is most useful to taxpayers who are already making direct Roth contributions and paying unnecessary state tax. These would typically be MFJ < $100,000.

About a dozen states are still blank. Contributions welcome. I'm getting the impression bogleheads aren't familiar with their states' instruction booklets. :(
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Re: Backdoor Both -- have your cake and eat it too

Postby xerty24 » Mon Nov 28, 2011 5:58 pm

New Mexico - no deductions or credits for IRAs different than Federal.

Bonus - if you're 100 years old by the end of the year, you're exempt from NM income tax. I knew I should have fudged my birth certificate by more than just a year or two.
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Mon Nov 28, 2011 7:29 pm

Thanks xerty. Ten left.
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Re: Backdoor Both -- have your cake and eat it too

Postby kd2008 » Mon Nov 28, 2011 7:46 pm

Oklahoma: Same as Federal deduction.

Also,

Each individual may exclude their retirement benefits, up to
$10,000, but not to exceed the amount included in the Federal
Adjusted Gross Income.


http://www.tax.ok.gov/it2010/511Pkt-10.pdf page 13
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Re: Backdoor Both -- have your cake and eat it too

Postby tfb » Mon Nov 28, 2011 8:02 pm

Bob's not my name wrote:Thanks xerty. Ten left.

ND - no adjustment = no Backdoor Both
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Mon Nov 28, 2011 8:15 pm

kd2008 wrote:Oklahoma: Same as Federal deduction.

Also,
Each individual may exclude their retirement benefits, up to $10,000, but not to exceed the amount included in the Federal Adjusted Gross Income.
Hmm. It looks like a Backdoor Both is allowed by this $10,000 exclusion. Am I wrong?
Each individual may exclude their retirement benefits, up to $10,000 ... The retirement benefits must be received from the following and satisfy the requirements of the Internal Revenue Code (IRC): ... an individual retirement account, annuity or trust or simplified employee pension under IRC section 408,
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Mon Nov 28, 2011 8:27 pm

Done. Corrections still welcome.

I believe NJ is like MA in making 401k preferable to TIRA, but PA is different in that it taxes both TIRA and 401k contributions, but doesn't tax withdrawals after 59.5.
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Re: Backdoor Both -- have your cake and eat it too

Postby tfb » Mon Nov 28, 2011 9:01 pm

Bob's not my name wrote:Done. Corrections still welcome.

Ohio provides a $25-200 tax credit. Requires that the person must be "retired" (not necessarily 100% retired). It looks like IRA distributions also count for this credit.
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Mon Nov 28, 2011 9:36 pm

OK, here’s a summation. There are five states where anybody can do this, and seven more where older working folks can. The average savings for a young couple in one of the six states are roughly equivalent to reducing your average ER by half a percent on a $100,000 portfolio.

I’ll say one more time that I am not a taxpayer in any of the following states, so my conclusions are based on skimming the states’ instructions.

Format is: State -- Annual savings both under 50/Annual savings both 50 or over

or, for states that only allow this for geezers: State -- Annual savings both 50 or over

Unlimited Backdoor Both
Illinois -- $500/$600
Kentucky -- $600/$720 (don’t know how local tax is affected)
Oklahoma -- $550/$660

No age limit but $6,000/couple limit
South Carolina -- $420/$420

No dollar limit for 55 or older
Colorado -- $556
Iowa -- $915 (don’t know how local tax is affected)

No dollar limit for 60ish or older
Arkansas -- $840 (don’t know how local tax is affected)
Delaware -- $764 (don’t know how local tax is affected)
Michigan -- $522 (don’t know how local tax is affected)
Mississippi -- $600
New York -- $822 ($1,254 NYC , $900 Yonkers)

No dollar limit for 62 or older
Georgia -- $720

Thanks again to contributors, and to bdpb for posting first about this (or maybe someone did before that).
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Re: Backdoor Both -- have your cake and eat it too

Postby JimInIllinois » Tue Nov 29, 2011 3:36 pm

So, if I have already made my 2011 Roth IRA contribution, can I recharacterize it to a deductible IRA and then convert it back to a Roth? Any gotchas?
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Tue Nov 29, 2011 3:53 pm

I think so but I'm not an expert on that stuff. You might want to start a new thread to get Alan S's guidance, or PM him directly.
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Re: Backdoor Both -- have your cake and eat it too

Postby JimInIllinois » Tue Nov 29, 2011 4:31 pm

It looks like this strategy would also be applicable (with greater rewards) to a 401(k)/(403(b)/457(b) plan that allows in-plan Roth rollovers. Anyone have a plan that allows such a rollover?
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Re: Backdoor Both -- have your cake and eat it too

Postby xerty24 » Tue Nov 29, 2011 4:52 pm

JimInIllinois wrote:So, if I have already made my 2011 Roth IRA contribution, can I recharacterize it to a deductible IRA and then convert it back to a Roth? Any gotchas?

You can do this recharacterize - it as a traditional contribution in the year you make it. I forget whether you have a delay before you can convert or not, check Pub 590.

JimInIllinois wrote:It looks like this strategy would also be applicable (with greater rewards) to a 401(k)/(403(b)/457(b) plan that allows in-plan Roth rollovers. Anyone have a plan that allows such a rollover?

401k plans are allowed to offer in-plan Roth conversions as of this year. My plan offered it, although I have not taken advantage of this (yet).
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Re: Backdoor Both -- have your cake and eat it too

Postby JimInIllinois » Tue Nov 29, 2011 5:06 pm

xerty24 wrote:
JimInIllinois wrote:So, if I have already made my 2011 Roth IRA contribution, can I recharacterize it to a deductible IRA and then convert it back to a Roth? Any gotchas?

You can do this recharacterize - it as a traditional contribution in the year you make it. I forget whether you have a delay before you can convert or not, check Pub 590.

There is a delay for converting recharacterized converted assets ("reconversion") but I don't see one for converting a recharacterized contribution.
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Re: Backdoor Both -- have your cake and eat it too

Postby xerty24 » Tue Nov 29, 2011 8:44 pm

Bob's not my name wrote:New York (6.85%, 10.45% for NYC residents and municipal employees, 7.5% in Yonkers) Per MarkNYC, taxpayers over 59.5 get to exclude $20K of IRA income, so a couple could save $822/year in state taxes on Backdoor Both (don’t know about NYC taxes). And of course they should convert more than this year’s contributions to make full use of the exemption.

Looks like NY is on to this loophole, or at least you'll have to plan ahead to use it. Observe that the NY exclusion applies to pension or annuity income of many types for those over 59.5 (SS is separately excluded), including deferred comp, IRA withdrawals, Keogh plans, and a variety of others (although not annuities bought directly with your own cash). However,

IT 150 Instructions, page 68 wrote:Qualifying pension and annuity income includes:
- periodic and lump-sum payments from an IRA, but not payments derived from contributions made after you retired;

Similar language applies to many other types of excludable annuity or pension income, i.e. that it may not be from contributions made after retirement. I'm not sure what they mean by "retired", nor do they give any ordering rules for which contributions are being withdrawn. Either way, it seems prudent to sock away as much pretax as you can in NY - $20k/year/person goes a long way and you can convert the amount you don't spend to a Roth each year once you're 60 instead (assuming the Federal conversion tax hit isn't too bad). Money you don't manage to convert and leave to your heirs still qualifies for this benefit up to your $20k/year max (assuming it did while you were alive), so that's one more bonus to keep in mind.

NYC and Yonkers follow NYS taxable income for their taxes, so anything that applies to the state should apply to these localities too.
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Tue Nov 29, 2011 9:28 pm

Awesome. Edited accordingly. Thanks.
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Re: Backdoor Both -- have your cake and eat it too

Postby Alan S. » Tue Nov 29, 2011 9:56 pm

NY has not updated Pub 36 to clearly define what they mean by an IRA contribution that is not derived from personal services. Alimony and spousal contributions are the only ones that come to mind. Further, qualified plan balances that are rolled to an IRA are also derived from personal services. The funds that are being converted were therefore derived from personal services (plus earnings thereon) with the limited exceptions noted above.

Accordingly, I would not hesitate to include Roth conversion income in the 20,000 exclusion. Taxpayer have been doing that without comment from the NY DOR.

I would take this approach with all states unless they specifically exclude Roth conversion income from their allowable retirement income exclusions.
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Re: Backdoor Both -- have your cake and eat it too

Postby chipmonk » Tue Nov 29, 2011 10:28 pm

Bob's not my name wrote:Oregon (9%, 9.63% in Portland) no Backdoor Both, but there appears to be an exemption for low-income 62-year-olds

Hmm... where did you get the extra 0.63% personal income tax for Portland? I've never heard of it before, but would sure be interested to know if it exists, since I live there :D
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Wed Nov 30, 2011 5:24 am

chipmonk wrote:
Bob's not my name wrote:Oregon (9%, 9.63% in Portland) no Backdoor Both, but there appears to be an exemption for low-income 62-year-olds
Hmm... where did you get the extra 0.63% personal income tax for Portland? I've never heard of it before, but would sure be interested to know if it exists, since I live there :D
Here: http://taxes.about.com/od/statetaxes/a/ ... -Taxes.htm
Oregon: The Tri-Met Transit District (includes Portland) assesses an income tax of 0.6318% and the Lane County Transit District (includes Eugene) assesses an income tax of 0.60%.
But it turns out that information is outdated:
http://trimet.org/taxinfo/ wrote:Payroll and self-employment taxes, which provide operating revenue for TriMet, are collected and administered by the Oregon Department of Revenue.
Effective January 1, 2011, the tax rate increased to .6918% ($6.918 per $1,000) of the wages paid by an employer and the net earnings from self-employment for services performed within the TriMet District boundary. Employers should apply the new rate with their reporting related to wages for the first quarter of 2011. Self-employed individuals should use the new rate when first reporting earnings for 2011.
The 2003 Oregon Legislature provided TriMet with the authority to increase the rate over 10 years to help pay for new transit service throughout the region. The rate increases annually by 1/100 of a percent.
I'll edit my first post to show the higher rate, but I can't reconcile this information with your statement. Possibly you live outside the TriMet zone? There's an interactive map and a list of zip codes at the site. If they've been taking 0.6918% out of your pay obviously you would have noticed.
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Re: Backdoor Both -- have your cake and eat it too

Postby tfb » Wed Nov 30, 2011 1:07 pm

Bob's not my name wrote:I'll edit my first post to show the higher rate, but I can't reconcile this information with your statement. Possibly you live outside the TriMet zone? There's an interactive map and a list of zip codes at the site. If they've been taking 0.6918% out of your pay obviously you would have noticed.

Sounds like it's levied on the employer, like employer's portion of FICA, FUTA, worker's comp, etc., which the employees don't see. Anyway it doesn't appear to be applicable to IRA withdrawals or Roth conversions.
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Wed Nov 30, 2011 1:16 pm

Yes, that appears to be the case, which is why it would be invisible to the employee (but not invisible to the self-employed):
The transit tax is imposed directly on the employer. The tax is figured only on the amount of gross payroll for services performed within the TriMet or Lane Transit Districts. This includes traveling sales representatives and employees working from home.

The following are exempt from transit payroll taxes:
Federal credit unions.
Public school districts.
501(c)(3) nonprofit and tax-exempt institutions (except hospitals).
Insurance companies (except domestic insurers).
Domestic service in a private home.

The following are exempt from LTD, but subject to TriMet taxes:
Public education districts.
Public special service and utility districts.
Port authorities.
Fire districts.
City, county, and other local governments.
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Re: Backdoor Both -- have your cake and eat it too

Postby chipmonk » Wed Nov 30, 2011 1:21 pm

tfb wrote:
Bob's not my name wrote:I'll edit my first post to show the higher rate, but I can't reconcile this information with your statement. Possibly you live outside the TriMet zone? There's an interactive map and a list of zip codes at the site. If they've been taking 0.6918% out of your pay obviously you would have noticed.

Sounds like it's levied on the employer, like employer's portion of FICA, FUTA, worker's comp, etc., which the employees don't see. Anyway it doesn't appear to be applicable to IRA withdrawals or Roth conversions.
Ah! Good to know I haven't been missing something or unknowingly cheating on my taxes. Thanks for clearing this up.
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Re: Backdoor Both -- have your cake and eat it too

Postby nhandy007 » Sun Dec 11, 2011 6:38 pm

Thanks to all who have contributed to documenting this strategy. It is an interesting idea that I would like to pursue. While reviewing some of the state tax instructions regarding retirement benefits, I see that the states commonly phrase their exception for the "receipt of retirement benefits from an individual retirement account." How does the rollover of a traditional IRA into a Roth IRA constitute the receipt of retirement benefits?
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Re: Backdoor Both -- have your cake and eat it too

Postby grabiner » Sun Dec 11, 2011 9:58 pm

nhandy007 wrote:Thanks to all who have contributed to documenting this strategy. It is an interesting idea that I would like to pursue. While reviewing some of the state tax instructions regarding retirement benefits, I see that the states commonly phrase their exception for the "receipt of retirement benefits from an individual retirement account." How does the rollover of a traditional IRA into a Roth IRA constitute the receipt of retirement benefits?


The conversion of a Traditional IRA to a Roth IRA is taxed the same as any other withdrawal from the Traditional IRA (but is not subject to penalty if done before age 59-1/2). Thus, if a state exempts Traditional IRA withdrawals from taxation (up to a limit or only for taxpayers of a certain age), it would normally also exempt conversions. You would have to check the individual state rules.
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Re: Backdoor Both -- have your cake and eat it too

Postby nhandy007 » Sun Dec 11, 2011 10:46 pm

Thanks for the clarification. I was trying to determine where I would take the deduction on last year's return. When I modified my IRA contributions to reflect this hypothetical scenario, TurboTax did not reduce my state taxes. I suppose I'll have to take the deduction manually.
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Re: Backdoor Both -- have your cake and eat it too

Postby Alan S. » Sun Dec 11, 2011 10:58 pm

Did you take a distribution? You would have to either take a distribution or do a conversion (which actually is a two part transaction of a distribution followed by a rollover) to realize the benefit. I would think that most states that exempt retirement income would do so in the form of a subtraction from income at the state level. I would check further before overriding the tax program.

With respect to the philosophy of the state allowing the subtraction for a conversion as well as a distribution only, the state is not losing revenue if you figure that without the conversion they would eventually be allowing the subtraction from the pre tax IRA. With a conversion, they just allow it sooner. Still, it is conceivable that there might be a couple states that excluded conversion income while allowing the deduction for ordinary distributions.
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Re: Backdoor Both -- have your cake and eat it too

Postby EmergDoc » Mon Dec 12, 2011 12:09 am

I just wanted to express appreciation to the OP for this thread. Nice work.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
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Re: Backdoor Both -- have your cake and eat it too

Postby nhandy007 » Mon Dec 12, 2011 12:23 am

Alan - No, I didn't take a distribution or execute a rollover in 2010. I was just using last year's return to see how TurboTax would treat the situation (Contribute $3000 to traditional IRA then rollover into Roth).
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Mon Dec 12, 2011 5:08 am

nhandy007 wrote:Thanks for the clarification. I was trying to determine where I would take the deduction on last year's return. When I modified my IRA contributions to reflect this hypothetical scenario, TurboTax did not reduce my state taxes. I suppose I'll have to take the deduction manually.
nhandy, if you're willing to share which state you're talking about I'd like to look at the form and instructions. I'm inferring South Carolina from the $3,000, but maybe that's an arbitrary number. Also, please confirm that you are eligible for a deductible TIRA under federal tax rules -- otherwise it doesn't work because your AGI isn't reduced. Well, that's not really accurate either. Typically the way state forms work is:
* If you only make a deductible contribution to a TIRA, your federal AGI is reduced and your state taxable income, being derived from your federal AGI, is also reduced (not true in MA, NJ, or PA).
* If you make a deductible contribution to a TIRA and convert the same amount to a Roth, your federal AGI is unchanged, but if you're in a state that allows the Backdoor Both, your state's adjustments to AGI include subtracting the Roth conversion.
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Re: Backdoor Both -- have your cake and eat it too

Postby nhandy007 » Mon Dec 12, 2011 12:18 pm

Hello OP,

First, thanks for putting in the time to research and explain this topic.

I file state taxes in North Carolina, and my income fails beneath the maximums for a TIRA. I plan to contribute to a Roth IRA this year, and thus I'm interested in this topic. I am a little concerned as to how to show this on my tax return, but I understand your logic.

I used TurboTax 2010 to modify last year's return so that instead of contributing $5k to the Roth, I contributed $2k to the Roth and $3k to the TIRA. I then rolled over the TIRA into the Roth, and my federal and state tax owed remained the same before and after the change. This left me wondering whether I should manually classify the $2k of TIRA as retirement benefits received.
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Re: Backdoor Both -- have your cake and eat it too

Postby Bob's not my name » Mon Dec 12, 2011 12:58 pm

nhandy007 wrote:instead of contributing $5k to the Roth, I contributed $2k to the Roth and $3k to the TIRA. I then rolled over the TIRA into the Roth
Well, first off, my reading of the NC form (see my OP) was that only $2k is exempted, not $3k, so your yin and yang are reversed.

Line 48 of form D-400 is where you should be able to exempt $2,000:
Line Instructions wrote:Retirement benefits also include amounts received from an individual retirement account or from an individual retirement annuity (IRA) ... Private Retirement Benefits. If you received retirement benefits from one or more private retirement plans other than federal, state, or local government retirement plans, you may deduct the amount included in federal taxable income or $2,000, whichever is less. Married individuals filing a joint return where both received such retirement benefits may each deduct up to $2,000 for a potential deduction of $4,000.
If you don't enter $2,000 on line 48 you're not going to see the effect.
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Re: Backdoor Both -- have your cake and eat it too

Postby nhandy007 » Mon Dec 12, 2011 2:19 pm

Yes, you're definitely correct - the exemption is $2,000. I referenced $3,000, because that's the minimum amount to open most Vanguard IRA's. Thanks for inserting the exerpt of the code covering this situation.
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Re: Backdoor Both -- have your cake and eat it too

Postby tfb » Mon Dec 12, 2011 3:38 pm

nhandy007 wrote:I used TurboTax 2010 to modify last year's return so that instead of contributing $5k to the Roth, I contributed $2k to the Roth and $3k to the TIRA. I then rolled over the TIRA into the Roth, and my federal and state tax owed remained the same before and after the change. This left me wondering whether I should manually classify the $2k of TIRA as retirement benefits received.

If you are only looking at the running meters in TurboTax after you made the changes, those numbers are not necessarily updated instantly. If you make a change to your federal return (Traditional instead of Roth, plus conversion), you will have "enter" the state return again and run it for the state tax number to update. As not-Bob suggested, run it to the end, print out that form and see what it shows.
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