Taxes on a Roth IRA Conversion from IRA
Assume a large conversion is made at the beginning of 2010 and that taxes will be paid with Non Qualified money.
I know taxes can be paid in 2010 or spread in equal parts over 2011 and 2012. My fear is that the tax rate will increase for 2011 and 2012 which might make it advantageous to pay the taxes in 2010 instead of waiting.
If I elect to pay conversion taxes in April of 2011 with my 2010 return, would there be a penalty if I do not pay estimated taxes for the conversion during 2010?
Also, am I correct that State Taxes are also due on the conversion?
Steve Glasgow
Permalink Submitted by Alan Spross on Sun, 2009-09-20 23:18
Yes, state taxes generally apply. There might be a couple states with certain dollar limits on taxable distributions from an IRA. A conversion is a taxable distribution as well as a rollover to a Roth IRA.
You are also correct about the estimated tax problem. The best approach to this is to use the safe harbor of paying in an amount equal to your prior year tax liability (110% for higher incomes). If you do that, there will be no underpayment penalty when the following year taxes overshoot this amount. Of course, if you elect to report the entire conversion in 2010, then you would have to pay in a large amount for 2011 estimates. For 2011, you would more likely use 90% of the 2011 tax liability for your target.
If you elect to defer taxes on the conversion to 2011 and 2012, using the prior year taxes for estimates works well until 2013, when your income would drop. For 2013 you would probably change over to 90% of your 2013 estimate of tax liability.
The deadline for deciding when to report the income is 10/17/2011, the extended due date. To use that date you must either file your 2010 tax report on time or file a timely extension prior to 4/15/2011.
Permalink Submitted by Clyde Wolf on Mon, 2009-09-21 00:30
Here is a link to Kiplinger’s that explains how tax rates will increase even if Congress does nothing….http://www.kiplinger.com/features/archives/2008/11/tax-planning-tax-law-…
Permalink Submitted by Alan Spross on Mon, 2009-09-21 01:55
In addition, tax firms just released an estimate showing that 2010 brackets, standard deductions, personal exemptions and related inflation adjusted items will NOT change from 2009 to 2010. There are a couple of very minor exceptions eg. $50 increase in HofH standard deduction.
Permalink Submitted by Steve Glasgow on Mon, 2009-09-21 13:48
Thanks for the great answers Alan. I see: If I elect to convert and pay all tax in 2010, I should pay estimated tax in 2010 based on 110% of 2009 tax to prevent the possibility of a penalty.
You lost me on the following statement. “Of course, if you elect to report the entire conversion in 2010, then you would have to pay in a large amount for 2011 estimates. For 2011, you would more likely use 90% of the 2011 tax liability for your target.”
Assuming no future conversions, if the conversion is done and the taxes are paid in 2010, would I have to base my 2011 estimated tax on 2010 taxes paid? If I know what my income will be in 2011 (much less due to no conversion) can’t I base the estimated tax for 2011 on the lesser?
Permalink Submitted by Alan Spross on Mon, 2009-09-21 19:17
Yes, you can. That’s why I mentioned that you would switch over to a target of 90% of your actual 2011 tax. There are two safe harbors you can use, either 100% (110% for higher incomes) of the prior year tax or 90% of the current year’s tax. In 2011 when you income will drop considerably due to no conversions, you would use the 90% of 2011 to determine your estimates. Of course, this takes more work trying to guess at your current year’s income and then determining the approximate tax bill in advance than simply using the prior year’s actual taxes. Therefore, most people use the prior year even if income will drop somewhat. However, with a big income drop this results in overpaying considerably and providing the IRS will an interest free loan.
Permalink Submitted by Steve Glasgow on Tue, 2009-09-22 11:52
Thanks Alan. Your posts are most helpful. Steve Glasgow