Conversion Questions
Scenario:
A married couple where the husband earns 100% of the family income and is a resident of an income tax free state. The wife earns zero income and is a resident of a different state that does have an income tax. The couple files a joint return. The husband converts all of his IRAs to Roth in 2010 and elects to pay the Federal tax in 2010 and the wife converts all of her IRAs in 2010 and elects to split the income over 2011 and 2012.
Questions;
1. Is it correct that the IRS assumes that someone converting in 2010 will split the income over 2011/12 so in this scenario the Federal return for this couple would need to include a form 8606 to indicate the husbands plan to pay taxes on his conversion in 2010?
2. Do all states honor the option for each person in this scenario to decide separately about how they want to claim the conversion income?
3. Do all states assume like the IRS that unless told otherwise a person doing a conversion plans to pay the tax over 2011 and 2012?
4. Without the wife’s conversion the couple would not need to file a state income tax return for 2010 as there is no income in the taxing state. With the wife choosing to split her conversion income over 2011 and 2012 would the state she is in likely receive something from the custodian of the IRAs that would trigger the state to expect either a complete state income tax return, 8606 equivalent or any filing of any kind or would they just assume the 2011/12 scenario and expect the income to be picked up in a filing then?
5. Is the 5 year clock on a conversion that starts January first of the year of conversion effected by electing to split the income over 2011 and 2012? i.e. if the wife converts in 2010 and elects the 2011/12 option would the converted funds be available for penalty free withdrawal 1/1/15 (assuming the Roth itself has seasoned for 12 years)?
Permalink Submitted by mk foss on Thu, 2010-11-04 16:50
I don’t know the answers to all of your questions, but here’s a start.
— IRAs are individual accounts – IRS and the states allow individual decisions concerning them whether someone is filing a joint return or not.
— Many states require that a complete copy of the federal return accompany the state return. Form 8606 indicating a deferral to 2011 and 2012 would be attached to the complete federal return.
–California has conformed to the IRS sections regarding retirement plans/distributions. A California expert has told me that if IRS allows an election, CA also allows an election. That election can differ from the federal election regarding timing of the income.
–The IRS shares 1099 information with the states, it’s not certain wether or not the custodian would send information directly to the states in addition.
Permalink Submitted by joe fotz on Thu, 2010-11-04 17:02
Thanks for the information, however, if anyone else knows any specific answers it would be much appreciated.
Permalink Submitted by Alan Spross on Thu, 2010-11-04 20:30
Can add some info, but not all:
1) Federal will not assume the default 2 year deferral. An 8606 is required from each spouse reporting a 2010 conversion. The form will have a box to check if opting out of the 2 year deferral. If not opting out, the 8606 is still required, but spouse will not check that box. This is per review of the 8606 draft form on which the IRS is receiving comments.
2, 3) Have not heard of any that will not conform, but that does not mean that there are not a few out there. I think WI does not fully conform, but will confirm later.
4) Nothing further to add to prior post. Have not heard of any additional reporting requirements of IRA custodians with respect to 2010 conversions.
5) The 5 year clock is based on the year of a valid (ie not failed) conversion, not when the taxes are reported. Therefore the conversion could be distributed penalty free in 2015. The 12 year holding period you mentioned is not material to the early withdrawal penalty (or to ordinary income taxes), but turning 59.5 would eliminate the 5 year holding period for conversions.