Mandatory State Tax Witholding from IRA Conversion to Roth
In 2019, a client of mine under age 50 (who is a resident of CT) converted his non-deductible Traditional IRA to a Roth IRA to accomplish a “Back Door Roth”. As of Jan 1, 2019, The State of CT instituted a mandatory state tax withholding of 6.99% on all distributions from pensions, annuities, IRA’s, etc for residents with income is above a low threshold. As a result, state taxes were withheld on the conversion.
My question is….when he files his tax return next year to report the 2019 conversion and if he gets the state withholding back in a refund, is he able to contribute that state income tax withholding back to the Roth IRA? If so, would it be considered a 2020 contribution? So essentially if I am understanding this correctly, if he makes a $6,000 non-deductible IRA contribution every year beginning in 2020 and converts each one to a Roth, only about $5,580.60($6,000-6.99%) of each contribution will actually be able to be contributed to the Roth IRA each year?
Besides moving to a different state, is there a remedy? Thank you.
Permalink Submitted by David Mertz on Thu, 2019-03-14 19:37
By the time he gets the tax refund from the state is will be too late to complete the conversion of the amount withheld for taxes. To complete the conversion of the portion withheld for taxes he must substitute other monies and complete the conversion contribution by the 60th day following the date of the distribution from the traditional IRA.
Permalink Submitted by [email protected] on Thu, 2019-03-14 21:47
If I am understanding you, if as a result of his original conversion….$500 (for example) was withheld for state taxes, he will have to contribute $500 of his own money into the non-deductible IRA and then just bank his refund when it comes several months later. Correct?Is the 60 day time frame you mentioned only related to the 60-day rollover rule? Not sure how that applies if he will do a direct rollover when he converts from IRA to Roth IRA. That still doesn’t answer my question….if he does all of this, won’t the $500 (in this example) also be subject to state taxes when he converts it to a Roth?Thanks.
Permalink Submitted by Alan - IRA critic on Thu, 2019-03-14 23:34
No. The $500 of his other money must be contributed to the Roth IRA as a conversion contribution within 60 days of the date of the first distribution, or 60 days from the receipt of that first distribution if the funds were distributed to him instead of directly to the Roth IRA. When he files his CT return for 2019, he will get credit for the amount withheld. He will also be able to report a full conversion on Form 8606 if he can complete the rollover to the Roth IRA within 60 days. Does CT allow withholding to be declined if the TIRA distribution is non taxable and no taxes would be due in the first place?
Permalink Submitted by David Mertz on Fri, 2019-03-15 00:37
Permalink Submitted by Alan - IRA critic on Fri, 2019-03-15 03:12
The taxpayer can file a CT Pension withholding certificate (CT W4 P) and opt out of withholding on partial distributions. The legislation and the cert states that withholding only applies to taxable distributions, but the certificate payor instructions infer that the taxpayer would know what is taxable. That is not the case for IRAs. There are different provisions for lump sum distributions that are also not real clear, although it is stated again that withholding does not apply to distributions of amounts previously subject to tax. The W-4P does not apply to lump sum distributions. These provisions will result in confusion, and obvious taxpayer inconvenience. 6.99 is also the highest marginal CT rate.