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PAYING THE TAX ON A ROTH CONVERSION
ESTIMATED TAX RULES WHEN INCOME INCREASES


The March issue of Ed Slott's IRA Advisor Newsletter goes into detail on this subject. Below are several key points to consider when dealing with the impact of a Roth conversion on estimated tax payments.

  • A client can avoid an estimated tax penalty by setting up "protective" payments of 100% (110% for those earning over $150,000) of the prior year's tax liability paid equally in each quarter.
  • A Roth conversion may increase a client's income for one or more years, forcing them to make estimated tax payments when they normally do not have to.

For a more detailed analysis of this subject, check out the March issue of the newsletter.



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Inside Ed Slott's IRA Advisor Newsletter

Paying the Tax on a Roth Conversion

Estimated Tax Rules When Income Increases

  1. Will my Client Need to Make Estimated Tax Payments?
  2. What is the Estimated Tax (Underpayment) Penalty?
  3. How to Avoid an Estimated Tax Penalty - Safe Harbor Methods
  4. Which Estimated Tax Safe Harbor Method to Use
  5. The Estimated Tax Impact of a Roth Conversion
  6. Using the 2010 Roth Conversion Two-Year Payment Deal (the Default Provision)
  7. The 2013 Estimated Tax Dilemma
  8. Electing out of the Roth Conversion Default Provision
  9. 3 Tricks to Help Avoid an Underpayment Penalty
  10. Advisor Action Plan

2010 Retirement Plan Contribution Limits

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CAN'T MAKE A ROTH CONTRIBUTION... THINK AGAIN

It is 2010. In China, it is the year of the tiger. In the US, it is the year of the Roth conversion. Everyone with an IRA can do a Roth conversion this year and many plan participants can also do a conversion. The income limits and tax filing restrictions are permanently repealed. However, the income limits for making a Roth contribution remain in place. The ability to make a Roth contribution phases out for individuals married/filing jointly between $167,000 and $177,000. For a single individual the range is $105,000 - $120,000 and if you are married/filing separate the range is $0 - $10,000.

But all is not lost. Any individual with earned income can make an IRA contribution and then, the very next day if they want to, convert that contribution to a Roth IRA.

Generally, that IRA contribution will be after tax. But the conversion to the Roth IRA will not be income tax free if the account owner has other IRA accounts. IRS Form 8606 must be used to report an after-tax contribution and it is used again whenever there is any distribution from any IRA, including SEP and SIMPLE IRAs, of the account owner. You cannot convert just the after-tax amount, even if it is in a separate IRA.

The distribution or the conversion will be subject to the pro-rata rule. For a 2010 distribution you take the 2010 year-end balance in all IRAs and divide that into the total after-tax amount in all IRAs. The resulting percentage is used to determine the amount of the distribution that will not be taxable. (It's really a little more complicated than that.) You can find Form 8606 on the IRS website at www.irs.gov. On the left hand side of the screen, click on 'Forms and Publications'.

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PRIVATE LETTER RULING 201005057:

A taxpayer we will call Sam Smith was employed at Warehouse A and participated in their company plan. She eventually moved on to another warehouse plant but maintained her retirement savings in Warehouse A. Sam talked to representatives from her new employer and decided to roll the funds directly from her current retirement plan to her new company plan.

In order to accomplish this, Sam received a check payable to her new company, FBO Sam.

Representatives of her new company plan would accept the check as drawn provided it was endorsed as 'for deposit only' by a principal of her new company. Sam held onto the check until a time past 60 days after she made the initial withdrawal from her former company plan at which time it was deposited into the new company plan. Up to that point, Sam stated that the withdrawal amount had not been used for any other purpose.

For the calendar year of the withdrawal from the Warehouse A plan, Sam received a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit- Sharing Plans, IRAs, Insurance Contracts, showing the distribution from the former company plan. Box 7 (Distribution Code(s)) of Form 1099-R was coded 'G' to indicate a direct rollover to a qualified plan.

Sam asked IRS to waive the 60-day requirement with regards to the distribution from her former company plan.

IRS responded that the 60-day rule was NOT an issue. IRS noted that Sam never received a distribution subject to the 60-day rollover requirement. She took a company plan distribution in the form of a 'direct rollover,' of amounts due to her from contributions and earnings from her former company plan. The distribution check was given to Sam, BUT made out to her new company, FBO Sam Smith. Therefore, the check was NOT payable to Sam. She lacked control over the check and could not have disposed of it. Form 1099-R supported this conclusion.

IRS ruled that Sam's receipt of the distribution was a direct rollover and was therefore not subject to the 60-day rollover requirement.



Q: My IRA was converted to a Roth in 2009. An RMD is required in 2010. A portion of the 2009 conversion is recharacterized in 2010. What amount is the 2010 RMD based on?

A: The required minium distribution for 2010 is based on the value as of 12/31/09. Since you are doing a partial recharacterization, you will have to do 2 net income calculations, one for the recharacterization and one to determine the 12/31 value. The formula for this calculation can be found in IRS Publication 590.




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