Roth conversion - spread taxes over 2 or 3 years?

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Roth conversion - spread taxes over 2 or 3 years?

Postby ol_pops » Mon Sep 14, 2009 9:04 am

I had always thought that the taxes for a conversion in 2010 could be spread over 2 years. I just saw this in a CNN article:

"If you convert in 2010 you can stretch the tax payments out over three years, easing the pain. "

Is it 2 or 3 years? Would those 3 years be 2010, 2011, and 2012?
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Postby pshonore » Mon Sep 14, 2009 9:36 am

As I understand it, you have the option of splitting and reporting the taxable income from 2010 conversions on your 2011 and 2012 tax returns (which are due and payable in 2012 and 2013 repectively OR declaring it all on your 2010 return which is due and payable in 2011. One minor complication is if you have a large taxable amount due, you probably should make a quarterly estimated payment on a timely basis for the appropropriate year. Its unclear if the IRS will be forgiving and ignore large balances due that are paid with your return as a result of IRA conversions.
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Postby FinanceGeek » Mon Sep 14, 2009 9:56 am

Fairmark is a good resource for all things related to taxation:

http://www.fairmark.com/rothira/expand.htm

The hitch I see with all of this is that if you spread the income over multiple years, you run the risk of tax rates going up during the period. This factor needs to be considered at both Fedl and State levels.
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Postby grabiner » Mon Sep 14, 2009 10:33 pm

pshonore wrote:As I understand it, you have the option of splitting and reporting the taxable income from 2010 conversions on your 2011 and 2012 tax returns (which are due and payable in 2012 and 2013 repectively OR declaring it all on your 2010 return which is due and payable in 2011. One minor complication is if you have a large taxable amount due, you probably should make a quarterly estimated payment on a timely basis for the appropropriate year. Its unclear if the IRS will be forgiving and ignore large balances due that are paid with your return as a result of IRA conversions.


The IRS is unlikely to be forgiving; you will pay a penalty for underpayment of the estimated tax. However, if you earn most of your income in the last quarter of the year, you can either increase your withholding in the last quarter (it is considered to be paid evenly throughout the year), or make an estimated tax payment in the fourth quarter and then avoid the penalty by filing Form 2210 and allocating your income by quarter.
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Postby pshonore » Tue Sep 15, 2009 6:45 am

grabiner wrote:
pshonore wrote:As I understand it, you have the option of splitting and reporting the taxable income from 2010 conversions on your 2011 and 2012 tax returns (which are due and payable in 2012 and 2013 repectively OR declaring it all on your 2010 return which is due and payable in 2011. One minor complication is if you have a large taxable amount due, you probably should make a quarterly estimated payment on a timely basis for the appropropriate year. Its unclear if the IRS will be forgiving and ignore large balances due that are paid with your return as a result of IRA conversions.


The IRS is unlikely to be forgiving; you will pay a penalty for underpayment of the estimated tax. However, if you earn most of your income in the last quarter of the year, you can either increase your withholding in the last quarter (it is considered to be paid evenly throughout the year), or make an estimated tax payment in the fourth quarter and then avoid the penalty by filing Form 2210 and allocating your income by quarter.


Except in the case of "splitting", the income from the conversion will have been "earned in" 2010 and therefore the IRS can make a fairly good argument that the quarterly was due by 4/15 of 2011 or 2012 depending on which year we're talking about. Remember, if we're takling about a $300K conversion, thats probably $75K minimum in additional tax over the two years. Could be tough to increase your withholding by that much
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From my readings, I think you are mistaken.

Postby Hexdump » Tue Sep 15, 2009 6:59 am

pshonore wrote:As I understand it, you have the option of splitting and reporting the taxable income from 2010 conversions on your 2011 and 2012 tax returns (which are due and payable in 2012 and 2013 repectively OR declaring it all on your 2010 return which is due and payable in 2011. One minor complication is if you have a large taxable amount due, you probably should make a quarterly estimated payment on a timely basis for the appropropriate year. Its unclear if the IRS will be forgiving and ignore large balances due that are paid with your return as a result of IRA conversions.


I believe that you are confusing income with the taxes.

My reading says that you will report all the income on 2010 tax return , and be able to split the tax payments so they appear on your 2011, and 2012 tax returns.

I may be wrong, and appreciate any correction.

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Re: From my readings, I think you are mistaken.

Postby pshonore » Tue Sep 15, 2009 7:30 am

Hexdump wrote:
pshonore wrote:As I understand it, you have the option of splitting and reporting the taxable income from 2010 conversions on your 2011 and 2012 tax returns (which are due and payable in 2012 and 2013 repectively OR declaring it all on your 2010 return which is due and payable in 2011. One minor complication is if you have a large taxable amount due, you probably should make a quarterly estimated payment on a timely basis for the appropropriate year. Its unclear if the IRS will be forgiving and ignore large balances due that are paid with your return as a result of IRA conversions.


I believe that you are confusing income with the taxes.

My reading says that you will report all the income on 2010 tax return , and be able to split the tax payments so they appear on your 2011, and 2012 tax returns.

I may be wrong, and appreciate any correction.

hex

I think the income is split and added to your return in 2011 and 2012 (if you pick that option). As another poster pointed out, rates may be going up in 2011 so that strategy may not be the best.

Here's a link to the langauage of the bill.
http://www.edslott.com/forum/viewtopic.php?f=1&t=3492
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My oh my

Postby Hexdump » Tue Sep 15, 2009 7:53 am

but that sure is different than what I had read and am reading on various articles elsewhere.

The articles support both approaches, and I think there is a Boglehead thread or 2, somewhere that discusses this. I don't really have a horse in this race, I am just trying to get this cleared up.

Every time I read tax code, my blood pressure skyrockets. :evil:
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Postby kaneohe » Tue Sep 15, 2009 8:06 am

pshonore wrote: One minor complication is if you have a large taxable amount due, you probably should make a quarterly estimated payment on a timely basis for the appropropriate year. Its unclear if the IRS will be forgiving and ignore large balances due that are paid with your return as a result of IRA conversions.


If you use the "safe harbor" provisions for estimated tax, you need only pay 100 (or 110%) of previous yrs taxes (which presumably will be low/normal) for estimated taxes. You still have to come up w/ the large lump in April of following yr but there should not be any penalty.
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Re: From my readings, I think you are mistaken.

Postby Wagnerjb » Tue Sep 15, 2009 8:09 am

pshonore wrote:I think the income is split and added to your return in 2011 and 2012 (if you pick that option). As another poster pointed out, rates may be going up in 2011 so that strategy may not be the best.



I believe Pshonore is correct.

Keep in mind that you have considerable flexibility in this conversion. If you find - before October 2011 - that tax rates jump in 2011 or 2012, you can still declare the conversion as part of your 2010 taxes (you will owe a penalty for underpayment, but it will be worth it....you can run the numbers to be certain).

You can also simply "cancel" the conversion - up to October 2011 - by recharacterizing the Roth conversion. You could then do a conversion in 2011 and pay 100% of the tax based on 2011 tax rates.

The ability to recharacterize the Roth conversion, coupled with the window for 2010 taxes extending to October 2011 allow you a measure of flexibility to deal with changing tax rates and personal circumstances.

Best wishes.
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Re: Roth conversion - spread taxes over 2 or 3 years?

Postby earlyout » Tue Sep 15, 2009 8:35 am

ol_pops wrote:I had always thought that the taxes for a conversion in 2010 could be spread over 2 years. I just saw this in a CNN article:

"If you convert in 2010 you can stretch the tax payments out over three years, easing the pain. "

Is it 2 or 3 years? Would those 3 years be 2010, 2011, and 2012?


As others have pointed out, conversion income can be declared in 2010 OR split between 2011 and 2012. The three year option is available to a married couple where both have an IRA they would like to convert. They both convert in 2010, one declares the conversion income for 2010 and the other spouse declares the conversion income for 2011 and 2012. This spreads the conversions for the couple over 3 years.

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Postby wx27 » Tue Sep 15, 2009 12:06 pm

Income will be reported for each year, thus the marginal tax rate for the associated year will apply.

If history is any guide, here's how it all worked the first year the Roth IRA existed and the first year in which you could convert traditional IRA to Roth. Only for the first year, you were allowed to elect to take the income all in the year of the conversion, or spread out equally over that year and the following three. Looking through my tax filing archives, I have the total amount converted declared in the year of conversion under "total IRA distributions", and 25% of that amount declared in the "taxable amount" line. In the three following years, "total IRA distributions" is empty and only the 25% amount for the "taxable amount" shows on the form.

Extrapolating from that, you will have the following choices:
1040 2010
"total IRA distributions": amount of conversion
"taxable amount": taxable amount of conversion

or
1040 2010
"total IRA distributions": amount of conversion
"taxable amount": 0

1040 2011
"total IRA distributions": 0
"taxable amount": 50% of taxable amount of conversion

1040 2012
"total IRA distributions": 0
"taxable amount": 50% of taxable amount of conversion
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