Is election to spread conversion inc revocable on 10-15-11?
I have a client who converted in 2010 and we are still unsure if we are going to keep the conversion or recharacterize by Oct 15, 2011. If we do keep the conversion in 2010, we will probably elect to pay 100% of the tax in 2010 becuase of the increasing rates coming in 2011+ (client is in the higest bracket now & will be for all forseeable future).
While we are “waiting it out,” my initial assessment is that if even uf we are going to claim the income 2010, we can avoid remitting the taxes due on the conversion with the extension as long we meet one of the safe harbor provisions (acutal tax owed or 110% of prior year). But, I am unsure about whether this would avoid interest on the underpayment of actual tax liability. Becuase the conversion liabilty is close to $200,000, the interest assement on an underpayment could be a deciding factor in taking a wait & see approach or just paying in April & amending later for a refund if we decide to recharacterize. My client and I would also like to wait & see what happens with the sunset provisions (or extension of the lower tax rates) toward the end of 2010 & beginning of 2011 with the election of new members of Congress.
If we [b]WOULD[/b] be subject to interest on the underpayment by “keeping” the conversion income on 2010, does anyone know if we could possibly avoid the interest by initially electing to spread the taxes over 2011 & 2012 in April but then when we file our actual return in October, change our mind & elect to claim all conversion income in 2010?
Basically, I’m wondering if the “wait & see” approach can be applied to the one time 2 year income spreading election as well as the recharcterization election or if you must declare your position on when you are taking the income with your extension. In other words, do we also have an “extension” on the elction of when to claim conversion income or will we owe interest if we decide to claim it all for 2010 in October?
As you can imagine, my client (nor I) want to part with $200,000 of cash to the IRS if we are not sure if we will even keep the $600,000 conversion. I know we will get it back if we choose to recharacterize, but giving it up in the first place is painful, not to mention that we may get hit with a hefty interest charge by waiting out the recharacterization option until October unless we pay in April.
Thanks,
Terri
Permalink Submitted by Alan Spross on Tue, 2010-10-05 17:27
Terri,
There is no exception with respect to estimated taxes in conjunction with the 2010 conversion options. That basically means that whatever year the income is reported in will be subject to the usual rules with respect to underpayment. But the safe harbor rules take care of the problem since there is no underpayment penalty if the client pays in 2010 the 100/110% of 2009 taxes. He may still owe a ton in April, but there will be no underpayment penalty. That should eliminate the problem of paying in the 200k, but would not be as effective if his non conversion income took a big dip and he then deferred for two years.
The scenario is very different depending on the conversion tax election. If reported in 2010, the 2009 taxes would be paid for 2010, but then in 2011 when there is no conversion income, client would change over to the 90% of current year safe harbor.
If the two year deferral was elected, the 2010 estimates would be based on 09 tax liability, 2011 based on 2010 tax liability, 2012 estimates based on 2011 tax liability and then in 2013 would revert to the 90% of current year safe harbor.
A related potential problem is waiting to pay estimates until client is sure he is converting, perhaps in December. By that time paying in the full estimate by 1/15 will not prevent a penalty UNLESS the client completes the difficult annualized income installment method worksheets. The IRS assumes his conversion was spread equally throughout the year otherwise, and absent the AI method any quarterly estimates needed to begin in April.
But the safe harbors generally allow a client to take full advantage of the extended due date decision deadline for both recharacterizations AND selection of the 2010 year or two year deferral without paying in much more upfront than he would have paid without the conversion.
Permalink Submitted by Terri Ward on Tue, 2010-10-05 20:38
Alan-
A follow up question changing the circumstances slightly, what if the client’s normal income outside the conversion did have a substantial decline in 2010? Obviously, this helps from from a marginal rate standpoint, but doesn’t help a client without signficant assets outside the Roth to pay the taxes due unless they use the option to spread the income.
Electing the default, which is to spread income over 11 & 12, we still wouldn’t need to plan on ES payments each quarter as long as we paid 110% of 2010 by Jan 15, 2012, right? Then, for 2012, we would have to pay in either the 90% of 12 liability or 110% of 11 tax, right? This could cause quarterly ES pmts to become due in 2012 unless there is w-2 income where we can increase withholding, right?
Not sure I completely follow you on the related problem about waiting to pay estimates until December. Assuming my example above, 2011 wouldn’t have ES due as long as you paid 110% of 2010, right? A client wouldn’t owe and ES if he wasn’t sure he was converting unless he didn’t already meet one of the safe harbors, correct?
Thanks for your assistance.
Permalink Submitted by mk foss on Tue, 2010-10-05 21:29
Avoiding estimated tax penalties is as much an art as a science.
You can avoid penalties in 2011 by paying in 110% of 2010 tax on a quarterly basis. If you pay the bulk of the estimated tax in December rather than 1/4 in April, 1/4 in June etc – you reduce the penalties instead of eliminate them. Alan’s point about a Roth conversion that occurs before the end of 2010 need not be covered by estimated taxes until the 4th quarter installment assumes that the income annualization process will show that you didn’t owe additional tax until the 4th quarter. For annualization purposes the 4th quarter starts September 1.
If you use the default and pay tax on the Roth conversion with the 2011 and 2012 returns, you won’t be able to use annualization to avoid penalties on the conversion income so you’d need to be safe on a quarterly basis. You’d apply the rules just as if the conversion wasn’t part of the income – paying 110% of the prior year or 90% of the current year on a quarterly basis.
I hope I haven’t confused matters rather than clarifying them.