Roth Conversions–taxability
My question pertains to a clear tax code citing on whether a roth conversion amount (principal) is immediately available
for distribution or tax free access for an individual over 59 1/2. My understanding is that it is, but my client’s CPA thinks
the deposit and the earnings are subject to 5 year wait–and ordering rules. My understanding is that only the earnings are
subject to the earnings rules and that client’s deposit is a qualified distribution and not subject to these rules.
One of the problems is IRS Publication 590–Indiv Ret Arrangements-which is not worded very clearly regarding one’s
already taxed contribution–rollover amount–Is there anything out here that more clealy explains this to my client and
his tax advisor–we are in the process of a lrge conversion and no one wants to make a mistake.
Thank you for your help and any assistance you can offer—Larry Costa
Permalink Submitted by Alan Spross on Wed, 2010-12-01 23:04
Larry, you are mostly correct, but the key issue here is that if this is the first Roth contribution of any type, the Roth will NOT be qualified for 5 years. However, under the ordering rules distributions are still tax free until all the contributions have been distributed and the taxpayer taps earnings. Also, since the client has passed 59.5, there is no longer a 5 year conversion holding period. The issue that confuses people is that the Roth need not be qualified for the contributions to be distributed tax free.
If you show them Figure 2-1 on p 65 of Pub 590, it will indicate that the distribution is NOT qualified (if first Roth was not 5 years old). It states that the earnings portion will be taxable, but the ordering rules on p 66 clearly indicate that the earnings come out LAST.
But there is another issue to be aware of in a 2010 Roth conversion, and that is income acceleration if the client distributes any conversion money prior to 2012.
Example: Client converts 100,000 and defers the income reporting to 2011 and 2012, 50% each year. 50,000 taxable in 2011 and 2012.
But client takes out 20,000 of conversion dollars (even earlier conversions) in 2011.
This will result in income acceleration by moving 20,000 from the 2012 column into the 2011 column and client will then have to report 70,000 in 2011 and 30,000 in 2012.
This income acceleration issue only applies to 2010 conversions, and only to deferred conversion income where a distribution is taken prior to 2012.