Tax planning for tax year 2010 liberalized IRA-to-Roth-IRA conversion rules.
will be a pivotal one for retirement planning, as it will be the first year in which taxpayers will be able to convert funds
in regular IRAs (as well as qualified plan funds) to Roth IRAs regardless of their income level. This new conversion option
poses significant tax planning challenges and opportunities.
Major change. For tax years beginning after 2009,
the $100,000 modified AGI limit on conversions of traditional IRAs to Roth IRAs is eliminated. Additionally, married taxpayers
filing a separate return will be able to convert amounts in a traditional IRA into a Roth IRA.)
Complex choice for 2010 conversions. A unique income inclusion rule will apply for IRA-to-Roth-IRA conversions
occurring in 2010. Unless a taxpayer elects otherwise, none of the gross income from the conversion is included in income
in 2010; half of the income resulting from the conversion will be includible in gross income in 2011 and the other half in
A major wild card in making this choice is the tax-rate picture after 2010.
Absent Congressional action, 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%. The Administration has proposed to increase taxes only for those making $250,000, but it is difficult to predict who
will get hit by higher rates. What's more, there are proposals on the table to help finance healthcare reform with a surtax
on higher-income taxpayers.
What to do this year. Taxpayers who intend to take advantage
of the new Roth IRA conversion option next year should consider the following year-end strategies:
... Non-high-income taxpayers who are able to make deductible IRA contributions this year should do so. They'll reduce
their 2009 tax bill and, if they make the conversion to Roth IRA next year, they won't have to pay back the tax savings
until 2011 and 2012.
... ... High income taxpayers
who haven't made deductible IRA contributions in the past (or made a tax-free rollover from a qualified plan to an IRA)
should consider making nondeductible IRA contributions this year. The conversion generally is taxable only to the extent of
earnings on the nondeductible contributions. However, if the taxpayer previously made deductible IRA contributions, or rolled
over qualified plan funds to an IRA, complex rules determine the taxable amount. That's because, under Code Sec. 408(d)(2)(A) , all IRAs are treated
as one for distribution purposes. Under Code Sec. 408(d)(1) , the Code Sec. 72 annuity rules govern
what part of the converted amount is treated as a tax-free return of nondeductible contributions and what part is treated
... Some high-income taxpayers plan to make large conversions in 2010 but
to opt out of the deferral of tax until 2011 and 2012 because they fear they will be in a higher tax bracket in those years
than in 2010. These taxpayers should avoid the standard year-end-planning wisdom of accelerating deductions and deferring
income but should, rather, do the reverse in an effort to avoid being pushed into the highest brackets by a large IRA-to-Roth-IRA
conversion. These taxpayers should be considering ways to defer deductions to 2010, and accelerate income from next year into
Our Recommendation: Taxpayers who have never opened a traditional IRA because
they weren't able to make deductible contributions should consider opening such an IRA this year and making the biggest
allowable nondeductible contribution they can afford, e.g., even by taking funds out of savings. If they convert the traditional
IRA to a Roth IRA next year they will have to include in gross income only that part of the amount converted that is attributable
to income earned after the IRA was opened, presumably a small amount. In 2010 and later years, they could continue to make
nondeductible contributions to a traditional IRA and then roll the contributed amount over into a Roth IRA.