Effective Roth IRA Conversions for 2010

Until 2010, individuals with a modified adjusted gross income in excess of $100,000 could not convert their traditional IRAs or 401(k) plans to a Roth IRA. For years after 2009, all taxpayers regardless of income can make the conversion. However, for those taxpayers making a conversion in 2010, there is a special rule which will let them defer paying tax on the amount of the conversion.

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Tax rate in 2010, 2011 and 2012: Before making a decision on whether to defer reporting the income to 2011 and 2012 as a result of the conversion, or reporting all of it in 2010, individuals must consider their tax rate for 2010 to their projected tax rates for 2011 and 2012. As it stands now, the top tax rates are scheduled to go up in 2011 and 2012 to a level where they were in 2001. However, at this point (February 2010) there is much speculation as to what will indeed happen to tax rates in 2011 and 2012. There is some sentiment in Washington to not let the rates increase, or increase by a smaller amount than the scheduled increases.

Tax rate in retirement: Generally, individuals who will be in a lower tax bracket in retirement should not make the conversion since they will be paying tax at a higher rate in the year of conversion than they would if they received distributions during retirement

Impact to taxation of social security benefits: The amount of social security benefits that are required to be reported in gross income is dependent on the level of an individual's income. In general, the greater the amount of income that an individual has, the higher the portion of social security benefits that have to be included in gross income.

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Miscellaneous itemized deductions subject to the 2% limitation: Individuals who have a significant amount of miscellaneous itemized deductions subject to the 2% limitation in 2010 should not elect-out of the installment method. Examples of this type of deduction include professional dues, work clothes, investment expenses, job hunting expenses, etc.

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If the IRA owner dies in 2010 or 2011, the entire conversion amount is included in taxable income in the year of death, unless the surviving spouse is the sole beneficiary and elects the two-year inclusion rule

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Tax strategies to accompany a conversion: If an individual makes a Roth conversion in 2010, there are several things that can be done to not only reduce the tax burden, but to pay for the tax whether or not an individual elects-out of the installment reporting...

• Prepay charitable commitments in the year that the conversion will be reported in gross income.
• If an individual makes a conversion in 2010 and does not make the election-out, pay any fourth quarter tax payments to state and local governments for 2010 in the first quarter of 2011.
• If an individual has been thinking about setting up a charitable remainder trust, the year of the conversion would be a good time to do so since the extra large charitable contribution deduction can offset the additional income reported from the conversion...

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LEXIS users can access the complete commentary here. Additional fees may be incurred. (Approx. 6 pages)

RELATED LINKS: For more information, see:

• LexisNexis Tax Advisor -- Federal Topical § 1C:5.04
• 2-17 Federal Income Taxation of Retirement Plans § 17.11