Taxpayers with six-figure incomes who like to plan ahead should be aware of a potentially lucrative provision contained in the recently enacted Tax Increase Prevention and Reconciliation Act. The new law provides that, beginning in 2010, the rules that used to prevent a taxpayer with more than $100,000 in modified adjusted gross income from converting a regular individual retirement account (IRA) into a Roth IRA will be eliminated.
Under pre-Tax Increase Prevention and Reconciliation Act law, only taxpayers with $100,000 or less in modified adjusted gross income can convert a regular IRA into a Roth IRA. A taxpayer making the conversion generally must pay tax on money he takes out of his regular IRA, but once it's in his Roth IRA, he won't pay tax on that money or the money it earns. Generally speaking, Roth conversions appeal to taxpayers who either think their tax rate will go up in retirement, or believe that the value of their account will rise significantly, and thus are willing to make an upfront tax payment when they convert in order to reap large tax savings in later years.
Under the new law, beginning in 2010, taxpayers with more than $100,000 of modified adjusted gross income also will be able to convert a regular IRA into a Roth IRA. To make such conversions more attractive in 2010, the new law permits taxpayers who convert in 2010 to spread the income and resulting tax payments on the converted funds over two years-2011 and 2012.
The conversion route should be considered by taxpayers who:
... have a number of years to go before retirement (and are therefore able to recoup the dollars that are lost to taxes on account of the conversion);
... anticipate being taxed in a higher bracket in the future than they are now; and
... can pay the tax on the conversion from non-retirement-account assets (otherwise, there will be a smaller buildup of tax-free earnings in the depleted retirement account).
A major wild card in making this choice is the tax-rate picture after 2010. In the "worst-case scenario"-Congress doesn't act-after 2010 the tax brackets above the 15% bracket will revert to their pre-2001 levels. That means the top four brackets will be 39.6%, 36%, 31%, and 28%, instead of the current top four brackets of 35%, 33%, 28%, and 25%. Other possible scenarios include Congress's allowing the current tax rate structure to stay in effect for everyone, possibly for a year or two, or increasing tax rates for high income individuals only.
Taxpayers can elect to not have the two-year spread apply by simply including in gross income on their 2010 tax return the entire amount of the taxable income from a 2010 distribution rolled over to a Roth IRA. Thus, taxpayers who believe converting to a Roth IRA is a good long-term move will have the luxury of doing so before year-end and then waiting until Apr. 18, 2011, the due date of their 2010 return, to see how they should handle the conversion (i.e., to elect or not elect out of deferral).
