Limit on Roth IRA Conversion Removed

Roth IRAs can be funded by persons who have compensation income (salary, business earnings) and whose total income (modified adjusted gross income) is below $110,000 on a single return or $160,000 on a joint return. Roth IRA contributions are never tax deductible, but Roth IRA funds including investment earnings can be withdrawn tax free. Contribution ceilings were originally $2,000 a year, but have since risen to $4,000 for 2006 (Roth 401(k)s allow more, see [link to] January 2006 Alerts Meet the New Roth 401(k)).

Roth IRA wealth accumulation from investing from $2,000 to $4,000 a year promised to be modest, but there’s a special Las Vegas-style play: Convert traditional IRAs to Roth IRAs. Conversion comes at a tax cost: Amounts in a traditional IRA that would be taxable when withdrawn (that is, deductible contributions, and all earnings) are taxable in the year converted. The benefit: Assuming timing requirements are met (generally, the Roth IRA is in existence at least 5 years and distributions don’t occur before the owner’s age 59 ½), all future withdrawals (including investment earnings) are free of federal income tax.

The owner can pass substantial Roth IRA wealth on to beneficiaries, since (unlike with traditional IRAs), Roth IRA owners aren’t obliged to make lifetime withdrawals in any amount, regardless of age. The owner’s beneficiaries can continue the income tax shelter (tax-free investment buildup of funds not withdrawn). Beneficiaries must withdraw, but may spread withdrawals over their lifetimes.

Roth IRA conversions were allowed only for a year the taxpayer’s modified adjusted gross income was not more than $100,000. This effectively precluded conversions by taxpayers in the top brackets, though there have been some efforts for such taxpayers to manipulate income so that one year’s income could fall below $100,000.

The 2006 Act removes the not-more-than-$100,000 income ceiling, a move benefiting only top-bracket taxpayers, effective for 2010 and after.

Congress treats this as a revenue raiser (tax increase) since conversions generate taxable income and taxes, which would not otherwise arise in the conversion year. The Act allows taxpayers making the conversion in 2010 to elect to defer the tax, dividing the resulting income equally between 2011 and 2012 and paying the tax for those years accordingly. This election is available for 2010 only. Absent the election, the entire conversion amount in 2010 is taxable for that year.

In years after a conversion, major tax savings result for individuals, especially high bracket individuals, and major revenue reductions for the government: $6.4 billion of revenues raised on conversion (through 2015), with $53.3 billion in future revenues foregone, according to estimates reported in the May 16, 2006 New York Times.

NOTE: Is this conversion provision for real? It did not come out of either house of Congress, but was added in House-Senate Conference, an action which sometimes means there was a limited consensus for it. President Bush’s statement on signing the 2006 Act didn’t mention this provision. With such a history, we can wonder whether a conversion provision no longer limited to middle income taxpayers can survive after the coming Congressional and Presidential elections. You and your professional advisor will have time to form an opinion, before the $100,000 ceiling is raised in 2010 under the 2006 Act change.

TIP: Meanwhile, conversions to Roth IRAs continue available to taxpayers with modified adjusted gross income of $100,000 or less. The immediate tax burden and the risk of error (where income may later be found to exceed $100,000) make it advisable to consult a professional advisor before acting.

Judee Slack
CURRICULUM VITAE

Judee Slack is a professional advisor in all areas of small business services, personal & financial strategies and resolution of any type of tax related problem. She has been providing these services in the Orange County, CA area since 1979.

Judee has been assisting small business owners with QuickBooks support since the mid-1990’s and has been a QuickBooks Certified Professional Advisor since 1999. In 2000, she developed this training class designed to help the small business owner understand, maintain and control the financial health of his/her business through QuickBooks.

SlackTax, Inc.
714-755-1040
CustomerService@slacktax.com
http://www.slacktax.com/

Software Training Courses
Software training courses; MS Office, QuickBooks and other business software and word processing programs. - [series list]
 
 
 
The opinions expressed by Cynergy, its Executive Advisors, Affiliates and Associates are intended to be general in nature, mere suggestions and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.