Conversion to Roth

[Ranger]

Client converted $15,000 to Roth (new account) in 2010. So $7,500 will be reported in 2011 and 2012. After conversion, a distribution of $5,000 was taken from the new Roth account.

So in 2010 $5,000 will be taxable with 10% penalty.

For 2011 and 2012, $7,500 will be included on Form 8606 with a basis reduction of $2,500 for net taxable of $5,000.

Does that make sense?

Thanks for any comments you might have.

[jainen]

>>$7,500 will be included on Form 8606 with a basis reduction of $2,500 for net taxable of $5,000.<<

This excellent question apparently slipped by us in the February rush. My understanding is that the entire $5000 distribution is applied to 2012 first. See page 63 at this link: Pub 590.

Might have made a nice planning strategy if we had noticed it before the end of the year.

[OldJack]

>>So in 2010 $5,000 will be taxable with 10% penalty.<<

So in 2010 the 10% penalty will be on earnings distributed. Did the $5,000 represent earnings? I think not!

So since the $5,000 is a return of contributions, nothing is taxable in 2010.

[DANRVAN]

Jack, I think you misunderstood the situation which deals with the tax laws specific to the year 2010.

It is true that withdraw of contributions from a Roth are never taxable, but in this case the funds came from a converted IRA that normally would be taxable in the year of conversion. It sounds like there are two transactions here. First, $15,000 was converted from a regular IRA to a Roth. Under the current tax law, the $15,000 is taxed equally in 2011 and 2012.

In the second transaction, the taxpayer withdrew $5,000 from the converted Roth. So now, instead of deferring the tax on that amount to 2011 and 2012, the $5,000 is taxed in 2010. The net result is $15,000 of a converted IRA taxed over a three year period. Jainen nailed the timing on the remaining $10,000. ($7,500 taxed in 2011 and $2,500 in 2012)

[OldJack]

>>Jack, I think you misunderstood the situation which deals with the tax laws specific to the year 2010.<<

Yes, I misunderstood and stand corrected.

[Ranger]

Thanks Jainen for digging up my dead and forgotten post! Your reference was helpful as this return has been on hold for further research and additional information.

[jlewis]

Jack, I think you misunderstood the situation which deals with the tax laws specific to the year 2010.

It is true that withdraw of contributions from a Roth are never taxable, but in this case the funds came from a converted IRA that normally would be taxable in the year of conversion. It sounds like there are two transactions here. First, $15,000 was converted from a regular IRA to a Roth. Under the current tax law, the $15,000 is taxed equally in 2011 and 2012.

In the second transaction, the taxpayer withdrew $5,000 from the converted Roth. So now, instead of deferring the tax on that amount to 2011 and 2012, the $5,000 is taxed in 2010. The net result is $15,000 of a converted IRA taxed over a three year period. Jainen nailed the timing on the remaining $10,000. ($7,500 taxed in 2011 and $2,500 in 2012)

[jlewis]

I tried the info as presented and the 5,000 got reported in 2010 but 10,000 was split 50/50 on 8606, not 7,500 for 2011 and 2,500 for 2012. Don't know what I am doing wrong or if the form isn't working right.

Thanks for any input

[DANRVAN]

I tried the info as presented and the 5,000 got reported in 2010 but 10,000 was split 50/50 on 8606, not 7,500 for 2011 and 2,500 for 2012. Don't know what I am doing wrong or if the form isn't working right.

Thanks for any input

Keep in mind there are two separate transactions. First, the $15,000 conversion is reported on line 21 form 8606. Of that amount, $7,500 will be deferred to 2011 and 2012. Secondly, the $5,000 withdraw goes on line 26, subject to the 10% penalty.

Then in 2012 there will be a line item to reduce the taxable amount by $5,000 (similar to line 22 “basis” on the current year form). The software will have no idea of the amount taxed in 2010 so that will be a manual entry.