Tax-free Roth conversion in 2010…?
I just heard a caller to a radio talk show question whether a Roth conversion could be done in 2010 without paying any income tax on it. Unfortunately, the show’s host did not give a deterministic answer to the question.
Can anyone here answer that question, and/or possibly give a link to more info regarding any conditions, limits or details that would apply…?
Thanks,
Gerry.
Permalink Submitted by Alan Spross on Wed, 2009-03-25 02:51
The caller was half right. With a 2010 conversion, you do not pay any income tax for 2010, but instead you report half the conversion amount in 2011 and the other half in 2012. Therefore, the tax payment is only deferred, not eliminated. This feature of deferred taxation is only available on conversions done in 2010. In addition, for ALL years after 2009, the income limit for conversions and the married filing separate limit are gone. That means that anyone with a TIRA balance can convert starting in 2010. The deferral is an incentive to convert and generate taxable income for the US Treasury.
If the taxpayer wants to, they can opt out of the deferral and report the entire conversion on their 2010 return. This choice would be better for someone wanting to convert small amounts every year to keep the income from increasing their tax bracket, and thus the cost of the conversion. If you defer the 2010 income, you effectively lose the use of your lower bracket for any conversion income in 2010. Then, you have to convert smaller amounts in 2011 and 2012 to keep the income in those years from increasing the marginal rate. A taxpayer must choose either deferral or 2010 reporting for all conversions done in 2010, they cannot defer one and fully report the other.
The financial press has been pushing making non deductible TIRA contributions for those whose income is too high for regular Roth contributions. They can then convert those amounts to a Roth in 2010 and the portion coming from the non deductible contributions would be converted tax free.
Permalink Submitted by David Spellman on Thu, 2009-03-26 15:39
Am I correct in thinking, then, that one can be making contributions to a non-deductible IRA with no limits — and then convert it to a Roth IRA with no limit? You’d have the tax liability of the gain that year (or 50/50 in 2010 and 2011), but all growth moving forward would be tax-free.
Is that correct?
Permalink Submitted by Alan Spross on Thu, 2009-03-26 22:46
Yes, that is basically correct.
The income limits for regular Roth contributions remain in place and only get minor inflation increases. Therefore, higher income taxpayers may never qualify to make regular Roth contributions. But as long as they have earned income, they can make non deductible TIRA contributions and report them on Form 8606. They can then convert the account in full every year, with only the amounts in excess of the basis being taxable. In the Roth the earnings would eventually become fully qualified after 5 years from the first contribution and also upon reaching 59.5.
2010 is only different in that the conversion income is reported half in 2011 and half in 2012 (not 2010 and 2011), OR the taxpayer can opt out of the deferral and report it all for 2010.