Taxation of Roth Conversion
An individual converts their traditional IRA to a Roth IRA and dies the following year. Since the 5-year holding period has not been met, beneficiary distributions are not considered qualified distributions. Now, normally I would say that there is still no 10% penalty due because “death” is an exception to the additional tax. The catch is that in 590 it seems to indicate that for conversion contributions (each with their own 5-yr. holding period), any distribution within the 5-year timeframe is subject to the penalty, not just the earnings attributable to that distribution.
Can you provide any clarification for me on how conversion contributions are taxed if distributed prior to the 5-year holding period being met?
Thank you!
Permalink Submitted by Alan Spross on Wed, 2009-12-16 20:06
With respect to a post death Roth distribution, there is never an early withdrawal penalty on conversions not held 5 years or on taxable earnings. This is confirmed on p 67 of Pub 590, where it indicates that “unless one of the exceptions listed leter applies, you must pay the additional tax…..” Several exceptions are listed and the third one is beneficiary distributions.
For 2010 conversions, for a single person death prior to reporting the deferred income will result in the full conversion being included in the taxpayers final return. A surviving spouse can still defer.
Permalink Submitted by [email protected] on Tue, 2009-12-22 17:13
[quote=”[email protected]“]
For 2010 conversions, for a single person death prior to reporting the deferred income will result in the full conversion being included in the taxpayers final return. A surviving spouse can still defer.[/quote]
Alan,
I have a follow-up question to your comment above regarding the “loss” of the deferral option if a single individual passes away before they elect the deferral. My understanding is that the deferral is the default income reporting option for 2010 conversions and that the taxpayer must [i]elect[/i] to report all of the income in 2010. If this is the case, when is the taxpayer truly “making the election” to defer? Could one not make the argument that by performing the conversion in 2010, you are choosing to defer the income as you have not yet filed your return and elected to pay the tax in 2010, or is there a specific rule prohibiting deferral if the taxpayer passes away in 2010?
Also, what happens if a taxpayer performs a 2010 conversion, chooses to defer the income into 2011 and 2012 and dies in 2011, how does the “2012 income” get reported?
Permalink Submitted by Alan Spross on Tue, 2009-12-22 19:36
It does not matter whether the default deferral occurs or the Roth owner dies prior to filing the final return. Included in the legislation is a provision that any tax that would be deferred is accelerated to the year of death.
Example: 2010 conversion
a) Death in 2010 after conversion – entire amount MUST be reported on 2010 final return, the deferral is lost.
b) Death in 2011 – both the 2011 half and the 2012 half must be reported on 2011 final return.
c) Death in 2012 – no acceleration here since half was reported in 2011 and the other half would be reported in 2012 anyway on final return or otherwise.
In effect, death results in an automatic opting out of all future year deferrals of the conversion income.
NOTE: A SOLE BENEFICIARY surviving spouse has the option to avoid all this and maintain the original two year deferral by making the election prior to the extended due date for the conversion (10/17/2011). The actual form and mechanics for documenting this election has not yet been released. Possibly will be part of the revised 2010 8606 form, which will need a considerable re design.
Permalink Submitted by [email protected] on Tue, 2009-12-22 19:52
I truly appreciate the thoroughness of your answer. Thank you for your time and assistance.
Permalink Submitted by Heidi LeMieur on Tue, 2010-08-31 17:53
Alan,
Can you please provide me your source. I have reviewed Section 512 of the TIPRA Bill and found no such requirement.
Thank you.
Permalink Submitted by Alan Spross on Tue, 2010-08-31 19:44
Check Sec 408A(d)(3)(E)(ii) – Tipra only specified the changing of the original Roth IRA Code that dealt with 1998 conversions from 4 year to 2 year deferral. The basic provisions of acceleration of income in the event of post conversion death were in this original section.
Let me know if this is not the provision you were requesting.
Permalink Submitted by Heidi LeMieur on Tue, 2010-08-31 20:46
Thanks Alan for such a quick reply!!