2010 Roth conversion
A couple of scenarios with several questions within as follows (hopefully not too much for one post);
1) In a case where I’ve purposefully had a high earned income client funding a Traditional IRA with non-deductible contributions for the past several years in anticipation of the favorable 2010 Roth conversion rules can I have them make a final 2010 maximum contribution to the Traditional IRA just prior to the 100% conversion to the Roth IRA? What if the total ‘basis’ happens to exceed the FMV at the time of conversion? If their 2010 income is down relative to what they might expect in 2011 & 2012 can they choose to report the income (if any) all in 2010 instead of spreading it out?
2) In another case where I’ve done similar planning now this client has the opportunity to roll out his old 401(k) before the end of this year (2009). The 401(k) is 100% pre-tax dollars and the FMV dwarfs the current Traditional IRA where there is ‘basis’ by about a 7:1 ratio. Can I do the full Traditional to Roth IRA conversion early in 2010 before any rollover and then rollover the 401(k) a week or so later? Will this allow me to fully exhaust the basis in the relatively small Traditional IRA without having to convert any of the 401(k) balance too or will I need to give stronger consideration to waiting on doing the 401(k) rollover until 2011 so there is no confusion?
Permalink Submitted by Alan Spross on Tue, 2009-08-11 00:59
1) Yes, the 2010 regular TIRA contribution can be made prior to the conversion. It will add to the prior basis reported on Form 8606. If the FMV is less than the 8606 basis at the time of conversion, client will qualify for a misc itemized deduction based on total closure of all TIRA assets. This will be subject to the 2% of AGI floor. All TIRA, SEP and SIMPLE IRAs must be closed to qualify for this deduction. A taxpayer can either report 2010 conversions deferred to 2011 and 2012 or opt out of that and report the entire amount of 2010 conversions in 2010 income. Of course, if the basis exceeds the FMV at conversion, there will be no taxable income to either defer or report currently.
2) Your final statement is what would need to happen unless the client qualifies to convert the TIRA in 2009 under the 100,000 modified AGI limitation. Then the 401k rollover could be done in 2010. It will not work to do the 401k rollover shortly after the 2010 conversion because the Form 8606 used to report the taxable amount of the conversion is based on year end 2010 values adjusted for earlier distributions and conversions. This would cause the % of basis in the TIRA to be diluted by the 401k rollover and the tax free portion of the conversion would be reduced by 6/7.