By Laura Saunders
Yesterday, the Tax Blog answered your IRA conversion questions on a range of topics: applying a conversion, suspended distributions, maximizing your contributions and use of your converted funds. The Wall Street Journal’s Tax Report columnist Laura Saunders reached out to Ed Slott, CPA, IRA expert and host of www.irahelp.com, for some more answers to her readers’ most pressing questions.
Q: If a taxpayer converts several IRAs in one year, can he or she defer the 2010 taxes on one account but not the others?
Ed Slott: No. Either the Roth conversion income is reported under the two-year deal — half in 2011 and half in 2012 — or the entire amount is reported in 2010.
But a married couple may be able to simulate reporting Roth conversion income over the three years, if both spouses have IRAs or retirement plan funds they converted in 2010. Because IRAs are individual accounts, each spouse can elect a different method. One spouse can convert and elect to report all of the conversion income in 2010 and the other spouse can use the two-year option. Because all of the Roth conversion income will be reported on the same tax return (if they file married jointly), they can simulate a three-year payout this way.
Q: Is the adjusted gross income limit of $100,000 for converting traditional IRAs to Roth IRAs unique to 2010, or does the limit extend into 2011 and beyond?
ES: The $100,000 income limitation for Roth IRA conversions is permanently repealed for 2010 and beyond. However, the deferral of 2010 Roth conversion income into 2011 and 2012 is only available for 2010 Roth conversions. Conversions income from 2011 and later years will be included as income in the year of the Roth conversion.
Q: Are both the conversion income and tax due carried forward to 2011 and 2012, or only the tax due? If the income and tax due are carried forward, a greater monthly premium due for Medicare Part B would result because it is based on annual income. If the income is split between two years, there may be no increase in the Part B premium.
ES: It’s the income that’s split and deferred into 2011 and 2012 — not the tax — at the rates that will be in effect in those years. Any other items affected by increased income (like Medicare Part B premiums or other tax deductions or credits), could be affected in 2011 and 2012 if you choose this two-year option.
Q: Do some conversions trigger an alternative minimum tax that negates the benefits of conversions? I suspect that this could affect many retirement-age IRA holders like me, who have had assets accumulate over many years.
ES: In its simplest terms, the AMT is a second taxation system calculated on every tax return to see if it applies. If the tax under the AMT would be higher than the regular tax, you have to pay the AMT instead. If the regular calculation is higher, the AMT does not apply because Uncle Sam gets a higher tax out of you under the regular system.
The AMT typically hits taxpayers whose deductions are high relative to income. Adding Roth conversion income to a tax return can push you into paying the AMT if you’re close to triggering it. But if you are already subject to AMT, then adding Roth conversion income can actually pull you out of the AMT when the regular tax would be higher.
Getting hit with the AMT is not necessarily a bad thing if you know to plan for it ahead of time. The actual top tax rates under AMT (26% and 28%) are lower than the top income tax rates under the regular tax system (35%). If you know that a Roth conversion will push you into AMT, then, if you can, try to postpone to the following year so you don’t lose them to AMT and pile more income (like Roth conversion income) into the year, as it will be taxed at lower AMT rates.
If the Roth conversion income pulls you out of AMT and into the regular tax system, then traditional tax-planning strategies apply — meaning that you should accelerate deductions and defer income where possible. When AMT applies, you should do the opposite — accelerate income (like Roth conversion income) and defer deductible items where possible.
Remember that a Roth conversion can be undone (re-characterized) until Oct. 15 after the year of the conversion. There is no risk in converting to a Roth IRA (if you deem conversion a good choice for all other reasons) and then see if it pushes you into or pulls you out of the AMT. If you are subject to the AMT, you may even decide that this will be the year to put your Roth conversion income in: It could be taxed at lower rates than under the regular tax system. Remember, too, that you can undo just part of your Roth conversion to bring your income to the perfect amount for you.
This is definitely something you’ll want to run by your CPA.