Avoid state income tax on Roth IRA contribution?

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zhayea
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Avoid state income tax on Roth IRA contribution?

Post by zhayea » Mon Jan 01, 2018 11:33 am

Hi everyone, Happy New year.

I'm looking for more information on how to contribute to my Roth IRA while avoiding state income taxes. I remember reading on here a while ago that it's legal to do so by contributing to a traditional IRA and then immediately converting it to Roth. Thing is, I'm a little hazy on the specific details and I don't remember the exact process. I tried searching the forum and google but couldn't locate it.

Does anyone have a link to the exact steps to do this? Thanks!

mhalley
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Re: Avoid state income tax on Roth IRA contribution?

Post by mhalley » Mon Jan 01, 2018 11:46 am

Sorry, not possible. Roth contributions are fully taxable even when you do a backdoor Roth, unless your specific state has some type of specific law. I think I recall reading about not owing taxes in PA if you had a loss, but if you do a backdoor Roth correctly there should be no gain or loss.
viewtopic.php?t=189081
Backdoor tutorial

https://www.whitecoatinvestor.com/backd ... -tutorial/

zhayea
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Re: Avoid state income tax on Roth IRA contribution?

Post by zhayea » Mon Jan 01, 2018 11:59 am

Thanks mhalley, I live in Illinois and I actually was able to find this thread a few minutes ago talking about the strategy:

viewtopic.php?t=136776
https://thefinancebuff.com/deduct-and-c ... tions.html

But I'm not 100% sure if this is still possible, I think it might be. Looks like Illinois is one of the states that allows this, and it may save me $272 in state taxes each year ($5500 @ 4.95%).

Just wondering if anyone else has tried this & if it still works?

tibbitts
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Re: Avoid state income tax on Roth IRA contribution?

Post by tibbitts » Mon Jan 01, 2018 12:33 pm

I don't know but here in Oklahoma I already take $10k from my traditional IRA every year for Roth conversion, which as far as I know is the limit for state-tax-free treatment.

Alan S.
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Re: Avoid state income tax on Roth IRA contribution?

Post by Alan S. » Mon Jan 01, 2018 1:01 pm

It still works.

Of course, if you needed to distribute this conversion from your Roth IRA in the first 5 years, you would owe the 10% federal penalty unless age 59.5. If that happened the benefit of the state tax free conversion vs. a regular Roth contribution would be erased and more.

In addition, since conversions can no longer be recharacterized, if there was a loss on the conversion you would be stuck with the federal tax bill.

zhayea
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Re: Avoid state income tax on Roth IRA contribution?

Post by zhayea » Mon Jan 01, 2018 2:29 pm

Alan S. wrote:
Mon Jan 01, 2018 1:01 pm
It still works.

Of course, if you needed to distribute this conversion from your Roth IRA in the first 5 years, you would owe the 10% federal penalty unless age 59.5. If that happened the benefit of the state tax free conversion vs. a regular Roth contribution would be erased and more.

In addition, since conversions can no longer be recharacterized, if there was a loss on the conversion you would be stuck with the federal tax bill.
Thanks for the info. I'm 27 and won't touch this money for decades, so no worries on the first point. On your second point, that would just put me in the same position as if I just contributed to a Roth IRA normally, right? The way I see it, if I was going to max out my Roth IRA this year, this is $272 for free in exchange for filling out the form 8606 at tax time. Am I missing something? Seems like a total loophole.

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jmndu99
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Re: Avoid state income tax on Roth IRA contribution?

Post by jmndu99 » Mon Jan 01, 2018 5:12 pm

I'm interested in this thread. I'm in Illinois too. I'm also in accumulation phase.

My situation is married filing jointly so in the 15% marginal tax bracket.

I pay same state tax percent as OP.

by no means do I desire to hi jack this thread, more to ask questions for clarity.

Here is my understanding of the mechanics (not tax percentages or dollar amounts):

1. Contribute $11,000 to tIRA

2. then I can deduct this from my income for federal
AND state tax purposes

3. Convert the $11,000 tIRA to rIRA

4. The conversion forces me to add back the $11,000
To my income for federal tax purposes and I pay
tax at my marginal tax bracket.

5. But I do not have to add back the $11,000 to my
Income for state tax purposes and I DO NOT have
to pay tax at my state tax level?


Please confirm if 4 and 5 are correct, as I understand them. If they are incorrect, please clarify for my further understanding

Thanks for starting this thread OP.
Thanks for helping to clarify everyone else

J

Alan S.
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Re: Avoid state income tax on Roth IRA contribution?

Post by Alan S. » Mon Jan 01, 2018 6:54 pm

zhayea wrote:
Mon Jan 01, 2018 2:29 pm
Alan S. wrote:
Mon Jan 01, 2018 1:01 pm
It still works.

Of course, if you needed to distribute this conversion from your Roth IRA in the first 5 years, you would owe the 10% federal penalty unless age 59.5. If that happened the benefit of the state tax free conversion vs. a regular Roth contribution would be erased and more.

In addition, since conversions can no longer be recharacterized, if there was a loss on the conversion you would be stuck with the federal tax bill.
Thanks for the info. I'm 27 and won't touch this money for decades, so no worries on the first point. On your second point, that would just put me in the same position as if I just contributed to a Roth IRA normally, right? The way I see it, if I was going to max out my Roth IRA this year, this is $272 for free in exchange for filling out the form 8606 at tax time. Am I missing something? Seems like a total loophole.
Well worth doing as long as you qualify for the deduction, loophole or not. On the second point, if you did a regular Roth contribution and incurred a large loss right away, you could recharacterize the contribution as a TIRA contribution and if deductible the IRS would share in the loss since they in effect own a portion of the pre tax IRA, whereas with a Roth you essentially own 100% of it. Granted, a marginal difference at best.

Wakefield1
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Re: Avoid state income tax on Roth IRA contribution?

Post by Wakefield1 » Mon Jan 01, 2018 7:22 pm

In the State of Virginia you pay income tax on your Roth Conversion of deductible IRA funds or your current year contribution to Roth IRA
As far as I know withdrawals of Roth IRA funds in good order (account open 5 years or more,you are old enough) are free of State taxation as well as Federal taxation.

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jmndu99
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Re: Avoid state income tax on Roth IRA contribution?

Post by jmndu99 » Tue Jan 02, 2018 3:24 pm

jmndu99 wrote:
Mon Jan 01, 2018 5:12 pm
I'm interested in this thread. I'm in Illinois too. I'm also in accumulation phase.

My situation is married filing jointly so in the 15% marginal tax bracket.

I pay same state tax percent as OP.

by no means do I desire to hi jack this thread, more to ask questions for clarity.

Here is my understanding of the mechanics (not tax percentages or dollar amounts):

1. Contribute $11,000 to tIRA

2. then I can deduct this from my income for federal
AND state tax purposes

3. Convert the $11,000 tIRA to rIRA

4. The conversion forces me to add back the $11,000
To my income for federal tax purposes and I pay
tax at my marginal tax bracket.

5. But I do not have to add back the $11,000 to my
Income for state tax purposes and I DO NOT have
to pay tax at my state tax level?


Please confirm if 4 and 5 are correct, as I understand them. If they are incorrect, please clarify for my further understanding

Thanks for starting this thread OP.
Thanks for helping to clarify everyone else

J
Bumping. As previously stated, I am not looking to Hi jack this thread, just want more clarity. Thank you all

nanoanalyzer
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Re: Avoid state income tax on Roth IRA contribution?

Post by nanoanalyzer » Tue Jan 02, 2018 6:39 pm

Just completed my first deduct-and-convert a.k.a. Backdoor Both this year. Did not do it previously due to the 5 year rule and needing my Roth IRA contributions for downpayment backup, but now regret giving Madigan another 400 of my hard earned dollars. It's one of the few personal finance no-brainers if your federal marginal rate is now 12%.
"If you think stocks are like physics, you believe there must be smart people who can measure exactly where the Dow Jones Industrial Average will be in five months." -Morgan Housel

Triple digit golfer
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Re: Avoid state income tax on Roth IRA contribution?

Post by Triple digit golfer » Tue Jan 02, 2018 7:32 pm

My wife and I are in IL and both contribute to Roth IRAs. In 2018 she will be leaving her job and therefore not have a workplace plan. Our AGI will be somewhere around $115k, 22% federal tax bracket. I believe we will be eligible for her to do this since she won't have a workplace plan but I cannot do it with my Roth due to having a 402k at work.

Is this interpretation correct? Assuming we will not touch the money for 20+ years is there any reason NOT to do this for her Roth IRA?

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samsoes
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Re: Avoid state income tax on Roth IRA contribution?

Post by samsoes » Tue Jan 02, 2018 8:02 pm

jmndu99 wrote:
Tue Jan 02, 2018 3:24 pm
jmndu99 wrote:
Mon Jan 01, 2018 5:12 pm
I'm interested in this thread. I'm in Illinois too. I'm also in accumulation phase.

My situation is married filing jointly so in the 15% marginal tax bracket.

I pay same state tax percent as OP.

by no means do I desire to hi jack this thread, more to ask questions for clarity.

Here is my understanding of the mechanics (not tax percentages or dollar amounts):

1. Contribute $11,000 to tIRA

2. then I can deduct this from my income for federal
AND state tax purposes

3. Convert the $11,000 tIRA to rIRA

4. The conversion forces me to add back the $11,000
To my income for federal tax purposes and I pay
tax at my marginal tax bracket.

5. But I do not have to add back the $11,000 to my
Income for state tax purposes and I DO NOT have
to pay tax at my state tax level?


Please confirm if 4 and 5 are correct, as I understand them. If they are incorrect, please clarify for my further understanding

Thanks for starting this thread OP.
Thanks for helping to clarify everyone else

J
Bumping. As previously stated, I am not looking to Hi jack this thread, just want more clarity. Thank you all
#2 - Not necessarily. Deducting a tIRA contribution has income limits. Most backdoor Roth strategies assume non-deductible tIRA contributions.
#4 - Not necessarily. It depends on the pro-rata rule.
#5 - It depends on the state involved. Familiarize yourself with the rules of Illinois state tax in this regard.

Please study the rules thoroughly before you make an irrevocable conversion. Here's a good starting point: https://www.bogleheads.org/wiki/Roth_IRA_conversion
"Happiness Is Not My Companion" - Gen. Gouverneur K. Warren. | (Avatar is the statue of Gen. Warren at Little Round Top @ Gettysburg National Military Park.)

nanoanalyzer
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Re: Avoid state income tax on Roth IRA contribution?

Post by nanoanalyzer » Tue Jan 02, 2018 9:02 pm

Triple digit golfer wrote:
Tue Jan 02, 2018 7:32 pm
My wife and I are in IL and both contribute to Roth IRAs. In 2018 she will be leaving her job and therefore not have a workplace plan. Our AGI will be somewhere around $115k, 22% federal tax bracket. I believe we will be eligible for her to do this since she won't have a workplace plan but I cannot do it with my Roth due to having a 402k at work.

Is this interpretation correct? Assuming we will not touch the money for 20+ years is there any reason NOT to do this for her Roth IRA?
She is still eligible for spousal IRA:
https://www.investopedia.com/articles/r ... 021903.asp
https://www.thebalance.com/yes-you-can- ... ow-2388702
https://www.moneycrashers.com/spousal-i ... igibility/

In 2018, if both spouses have a workplace plan, Backdoor Both phases out starting at $101k and ending at $121k. It would still be worth going through the motions regardless of the eligibility related to workplace plans since you would be $6k under the top of that phaseout. I can't comment on whether you are subject to the "spouse with" or "spouse without" workplace plan phaseouts. Check Pub 590-A.
"If you think stocks are like physics, you believe there must be smart people who can measure exactly where the Dow Jones Industrial Average will be in five months." -Morgan Housel

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jmndu99
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Re: Avoid state income tax on Roth IRA contribution?

Post by jmndu99 » Tue Jan 02, 2018 9:24 pm

samsoes wrote:
Tue Jan 02, 2018 8:02 pm
jmndu99 wrote:
Tue Jan 02, 2018 3:24 pm
jmndu99 wrote:
Mon Jan 01, 2018 5:12 pm
I'm interested in this thread. I'm in Illinois too. I'm also in accumulation phase.

My situation is married filing jointly so in the 15% marginal tax bracket.

I pay same state tax percent as OP.

by no means do I desire to hi jack this thread, more to ask questions for clarity.

Here is my understanding of the mechanics (not tax percentages or dollar amounts):

1. Contribute $11,000 to tIRA

2. then I can deduct this from my income for federal
AND state tax purposes

3. Convert the $11,000 tIRA to rIRA

4. The conversion forces me to add back the $11,000
To my income for federal tax purposes and I pay
tax at my marginal tax bracket.

5. But I do not have to add back the $11,000 to my
Income for state tax purposes and I DO NOT have
to pay tax at my state tax level?


Please confirm if 4 and 5 are correct, as I understand them. If they are incorrect, please clarify for my further understanding

Thanks for starting this thread OP.
Thanks for helping to clarify everyone else

J
Bumping. As previously stated, I am not looking to Hi jack this thread, just want more clarity. Thank you all
#2 - Not necessarily. Deducting a tIRA contribution has income limits. Most backdoor Roth strategies assume non-deductible tIRA contributions.
#4 - Not necessarily. It depends on the pro-rata rule.
#5 - It depends on the state involved. Familiarize yourself with the rules of Illinois state tax in this regard.

Please study the rules thoroughly before you make an irrevocable conversion. Here's a good starting point: https://www.bogleheads.org/wiki/Roth_IRA_conversion
Thank you samsoes.

#2. I am allowed to make TIRA contributions. This Roth strategy is called Backdoor Both, or deduct - and - convert.

#4. I have looked at wiki and don't understand the pro-rata rule. Do you have another link to somewhere else, please?

#5. I have and will further check Illinois state tax in this regard

J

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Duckie
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Re: Avoid state income tax on Roth IRA contribution?

Post by Duckie » Tue Jan 02, 2018 10:44 pm

jmndu99 wrote:#2. I am allowed to make TIRA contributions. This Roth strategy is called Backdoor Both, or deduct - and - convert.
No. It's not deduct and convert. It's make a non-deductible contribution and then convert. By not taking the deduction in the first place the conversion is potentially not taxable. I say "potentially" because the IRS considers all non-Roth IRAs to be one big fat IRA. So if you have assets in a Traditional IRA, Rollover IRA, SEP IRA, or SIMPLE IRA, you're going to have a problem with the pro-rata rule.
#4. I have looked at wiki and don't understand the pro-rata rule. Do you have another link to somewhere else, please?
Pro-rata rule

I don't know if you can choose to not deduct on the federal form but deduct on the state form.

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jmndu99
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Re: Avoid state income tax on Roth IRA contribution?

Post by jmndu99 » Wed Jan 03, 2018 4:41 pm

Duckie, thank you for the link. Not sure it applies to me. This will not be a non deductible contribution for my situation.

The idea comes from these links.

viewtopic.php?t=136776

https://thefinancebuff.com/deduct-and-c ... tions.html

viewtopic.php?f=10&t=86262


Thank you.
J

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