Traditional IRA Converted to Roth

[Yardley CPA]

MFJ Couple. Husband is 67, wife is 64. Their Financial Advisor suggested they convert both their IRA's (husband's converted amount totaled $105,000 and wife's totaled $110,000) into Roth IRA's to take advantage of the tax deferral into 2011 and 2012. Both of the IRA's were converted to Roth's. The advisor told them to make sure they extended their 2010 return, so that if the value of the converted Roth's decreases you can take advantage of that. I am not all that experienced with IRA conversions to Roth's and would appreciate anyone's input on this one.

I've completed the 2010 1040 and it currently shows a refund in excess of $4,000. I recognize that half the conversion amount will be taxed in 2011 and the remaining half in 2012. I am estimating the 2011 and 2012 tax and will include the additional tax due to the conversions. I assume estimated payments may be warranted since they do not currently have enough withheld.

Any thoughts would be greatly appreciated. Thanks!

[Pacun]

"The advisor told them to make sure they extended their 2010 return, so that if the value of the converted Roth's decreases you can take advantage of that"

I don't understand that and would like someone to explain it if possible.

Check their tax liability for 2010. If it is around $4K, you should apply the refund to 2011 and it should cover the penalty.

Since the rollover already happended, there is nothing you can do now.

[Bees Knees]

"The advisor told them to make sure they extended their 2010 return, so that if the value of the converted Roth's decreases you can take advantage of that"

I don't understand that and would like someone to explain it if possible.

Tax on a conversion is determined by using the fair market value of the IRA at the time it is converted to a Roth. If the value decreases after the date of conversion, the taxpayer is paying tax on an amount greater than the current value of the IRA. Thus, by extending the due date, the taxpayer has the option to recharacterize the Roth IRA back to a traditional IRA and null and void the tax due on the over inflated value of the IRA.

Example: Taxpayer converts a traditional IRA to a Roth on 10/1/2010. As of that date, the value of the IRA was $10,000. Taxpayer files for an extension on his 2010 tax return. $5,000 of the conversion will be taxed on the 2011 return, and $5,000 will be taxed on the 2012 return under the special rule for 2010 conversions. On 5/15/2011, the value of the Roth IRA decreases to $2,000. The taxpayer no longer wants to pay tax on $5,000 on the 2011 return. Since the 2010 return was extended, the taxpayer has the option to recharacterize the Roth IRA as a traditional IRA as of 10/1/2010. In other words, it is treated as if the taxpayer never did a Roth conversion on 10/1/2010 and the taxpayer no longer has to add $5,000 of income to the 2011 return. After the recharacterization on 5/15/2011, the taxpayer now has the option to reconvert the traditional IRA to a Roth IRA using $2,000 as the taxable conversion amount rather than $10,000.

[Yardley CPA]

Tax on a conversion is determined by using the fair market value of the IRA at the time it is converted to a Roth. If the value decreases after the date of conversion, the taxpayer is paying tax on an amount greater than the current value of the IRA. Thus, by extending the due date, the taxpayer has the option to recharacterize the Roth IRA back to a traditional IRA and null and void the tax due on the over inflated value of the IRA.

Example: Taxpayer converts a traditional IRA to a Roth on 10/1/2010. As of that date, the value of the IRA was $10,000. Taxpayer files for an extension on his 2010 tax return. $5,000 of the conversion will be taxed on the 2011 return, and $5,000 will be taxed on the 2012 return under the special rule for 2010 conversions. On 5/15/2011, the value of the Roth IRA decreases to $2,000. The taxpayer no longer wants to pay tax on $5,000 on the 2011 return. Since the 2010 return was extended, the taxpayer has the option to recharacterize the Roth IRA as a traditional IRA as of 10/1/2010. In other words, it is treated as if the taxpayer never did a Roth conversion on 10/1/2010 and the taxpayer no longer has to add $5,000 of income to the 2011 return. After the recharacterization on 5/15/2011, the taxpayer now has the option to reconvert the traditional IRA to a Roth IRA using $2,000 as the taxable conversion amount rather than $10,000.

You learn something everyday. Thanks for both your responses.