Friday, June 11, 2010

Q of the Week: 2010 Roth Conversion Income Split

This week the Ed Slott IRA Discussion Forum featured a question on how the income from a 2010 Roth IRA conversion can be split. Want to know how? Read on to find out the answer plus a little known trick…

In most years, if you convert your IRA (or other retirement account) to a Roth IRA, you’re required to include the income from the conversion on your tax return for that year. But 2010 isn’t most years. This year (2010), if you convert you have a choice - you can include all the income from your conversion in 2010 or you can split the income from the conversion equally over 2011 and 2012.

That’s a pretty sweet deal, but some want to make it even better by mixing the two options - and that simply can’t be done. For example, let’s suppose you have an IRA worth $100,000 and you decide to convert it to a Roth IRA in 2010. As a default option, the income from the conversion would be split by adding $50,000 to your 2011 return and $50,000 to your 2012 return. Alternatively, you could make an election to add all $100,000 of conversion income from to your 2010 return. You could not, however, include $50,000 of income on your 2010 and then split the remaining $50,000 between 2011 and 2012 ($25,000/year).

Maybe you’re thinking to yourself, “Well I know how to get around that. I’ll just do two separate conversions and include the income from one conversion this year and split the income from the second conversion equally over 2011 and 2012.” Not so fast… …IRS has that one covered. When you file your 2010 tax return, any conversions done in 2010 will get lumped together and you’ll have to make the choice for the cumulative amount. But nice try!!

Think you’ve got a new angle on it because you and your spouse are each doing a Roth conversion (or multiple conversions) in 2010? Well, if you came up with that one on your own, you get the gold star! IRAs are individual retirement accounts and the Tax Code says that a taxpayer may make the election (to split income or not) - so yes, if you and your spouse each do a Roth conversion in 2010, you can select different options for the inclusion of the conversion income - even if you file a joint return. In essence, you could convert now but split the income from the conversions over three years.

For example, let’s say Jane and Bob are married. Jane’s IRA is worth $40,000 and Bob’s IRA is worth $20,000. If both Jane and Bob convert all their IRAs in 2010, Jane can elect to split the income from her conversion equally over 2011 and 2012 ($20,000 each year) and Bob can elect to include all the income from his conversion in 2010. As a result, Jane and Bob will have $60,000 growing tax free in their Roth IRAs from 2010 on, but will not add more than $20,000 of income to their return in any one year (owed over three years). This could potentially keep Jane and Bob in a lower bracket and reduce the overall tax owed on their conversions.

Of course, in this case, Jane and Bob would actually have four options to choose from. They both could elect to include all their conversion income in 2010, they both could elect the split option, Jane could split the income over 2011 and 2012 while Bob includes it all in 2010, or Bob could split the income over 2011 and 2012 while Jane includes it all in 2010. What should they choose? We’ll that would require careful analysis of a number of factors including their projected other income for those years, projected deductions, credits, exemptions and the projected tax rates - and that’s just the start!!!

Curious as to what option you should choose? Best to speak with a qualified advisor who has specialized knowledge in this area so that they can review your unique situation and help you make the right decision.

By IRA Technical Consultant Jeffrey Levine and Jared Trexler
Comment, Question, Discussion Topic on your mind? Click on the Blue Comment Link below and leave your thoughts then check back to see what other consumers and advisors think.

*Copyright 2010 Ed Slott and Company, LLC