IRA to Roth Coversion with a Simple IRA
A client wants to convert an IRA to a Roth IRA. However, he also has a contributory Simple IRA. For simplicity, let’s say the IRA is $1,000 and the Simple IRA is $9,000. His CPA is telling him they can do it without causing any basis in the Simple. In other words converting the full $1,000 and paying income taxes on the full conversion amount. My understanding of the rules was since the IRA represents 10% of his total “IRA” plans he would only pay taxes on 10% of the conversion and have a 10% basis in his Simple. Can you confirm or clarify? Also, if indeed my understanding is accurate, do you know where I can find the information to share with the CPA? Thank you for your guidance.
Permalink Submitted by Alan - IRA critic on Thu, 2013-12-12 19:45
Basis in an IRA comes from non deductible contributions. A SIMPLE IRA cannot be funded by non deductible contributions, so any basis would have to be in the other IRA. Once the SIMPLE IRA has met the 2 year holding period, a Roth conversion can be done either from the SIMPLE IRA or the other IRA. If there is no basis in either, whatever amount converted is fully taxable regardless of which IRA it came from. But if the client actually does have basis from non deductible contributions to the non SIMPLE account, the basis is pro rated with the total IRA values. Not sure if this answers your question.
Permalink Submitted by Todd Martin on Tue, 2013-12-17 00:46
Thanks for the response Alan. I always appreciate your expertise. Let me ask my question differently. A client makes non-deductible contributions to a contributory IRA, let’s say $5,000. They also have rollover IRAs and a Simple IRA with no basis (all pre-tax contributions). Can they just convert their non-deductible IRA contributions ($5,000) to a Roth without any tax liabililty? Since this was all after tax there would be no tax consequences regardless of the balances of their rollover IRAs or Simple IRA and now the conversion would grow tax free, is this correct? I thought I recall seeing that you had to take all IRAs (rollovers, Simple’s, SEPs, etc.) into the calculation if you were not doing a full conversion of all the balances. If they converted the $5,000 non-deductible IRA and had $15,000 in all other IRAs, how much taxes would they need to pay on the conversion if at all? Does that make sense?
Permalink Submitted by Alan - IRA critic on Tue, 2013-12-17 02:11
todd, all the non Roth IRAs must be included in the basis calculation on Form 8606 used to report a Roth conversion. That means that no matter which IRA account is used to fund the conversion, the tax effect is the same. If the total basis is 5k and the total value of all IRAs is 15k, then 5/20 of any conversion is non taxable. 15/20 or 75% will be taxed. If the IRA account that holds the 5k of non deductible contributions is converted, then 75% is taxable (3,750) and 1,250 is non taxable. That is the same result you would get if you took 5k out of the SIMPLE IRA and converted it since all non Roth IRAs are combined in the calculations. You could look at a Form 8606 and enter this or other scenarios to determine what the taxable amounts will be. A distribution taken that is not converted is taxed in the same manner as a conversion. So what you recall seeing is correct.