Question

5. Dave, age 32, loses his job in a corporate downsizing. As a result of his termination, he receives a distribution of the balance in his § 401(k) account of $20,000 ($25,000 − $5,000 Federal income tax withholding) on May 1, 2018. Dave’s marginal tax rate is 24%. a. What effect will the distribution have on Dave’s gross income and tax liability if he invests the $20,000 received in a mutual fund? b. Same as part (a) except that Dave invests the $20,000 received in a traditional IRA within 60 days of the distribution. c. Same as part (a) except that Dave invests the $20,000 received in a Roth IRA within 60 days of the distribution. d. How could Dave have received better tax consequences in part (b)

Please consider changed from TCJA 2017

Answer 1

Part A

The distribution will have following effects:

Gross income = $25000

Tax liability =$6000 (25000*24%)

Part B

Due to above, there will be partial roll-over treatment. Effects will be as follows :

Gross income = $5000 (amount not invested)

Tax liability = $1200 (5000*24%)

Part C

Due to above, again there will be a partial roll-over treatment. Effects will be as follows :

Gross income = $25000

Tax liability = $6000 (25000*24%)

Part D

if David had contributed $25,000 in place of $20,000 to the traditional IRA, surely he could have received better tax consequences. Gross income could have made $0 and thus no tax liability with the help of complete rollover treatment.