Get ready for an avalanche of Form 8606 questions. The form, for non-deductible IRAs, is the one on which your clients will report their Roth conversions. Although this form has been around for years, this year it will be more popular than ever because of two tax law changes in 2010.
The first was the repeal of all Roth conversion income limitations and filing status restrictions for 2010 and all subsequent years. Everyone with funds in an individual retirement account or retirement plan is now eligible to do a Roth conversion.
Second, anyone who converted in 2010 (and only in 2010) is able to split the 2010 Roth conversion income evenly over 2011 and 2012. No 2010 conversion income needs to be reported for the 2010 tax year unless the client elects to do so.
Everyone who has done a 2010 Roth conversion is assumed to use the two-year income spread, unless they elect out of it on Form 8606.
If the funds that were converted came from an IRA, SEP IRA or Simple IRA, your client will need to complete Part II of Form 8606, 2010 Conversions From Traditional, SEP or Simple IRAs to Roth IRAs. Line 19 of Form 8606 is the taxable amount of an IRA conversion that will be included in 2010.
If the two-year income split is desired, this line should be blank (or marked $0). Additionally, there is a small check box which must be left unchecked.
Next, half the taxable conversion income is reported on Line 20a, with the remaining portion included on 20b. This is the amount of taxable income that your clients will have to include on their 2011 and 2012 tax returns, respectively.
Clients will need to have this information handy to complete their 2011 and 2012 tax returns. Advisers should keep a copy of this form on file if clients need it to project 2011 and 2012 income that includes the deferred-conversion income.
If the funds being converted came from a company plan and not an IRA, clients should complete Part III of the 8606, which deals with rollovers from qualified retirement plans, instead of Part II. Those two sections of the form mirror each other closely.
Similar to Line 19 for IRA-based conversions, Line 24 of Part III — and the accompanying check box — should be left blank for conversions of plan assets where the two-year deal is desired. Finally, half the taxable income is reported on Line 25a (to be included in 2011) and the remaining taxable income is reported on Line 25b (to be included in 2012).
For clients who converted both IRA and plan assets to Roth IRAs in 2010, Parts II and III of Form 8606 must be filled out as explained above. Additionally, clients must choose the same income inclusion option for both types of conversions using the boxes on Lines 19 and 24.
Anyone who wants to include all the IRA conversion income on his or her 2010 tax return must actively make an election by checking the box to the right of Line 19 on Form 8606. This is how clients “opt out” of the default two-year deal.
On Line 19, clients will need to input the full amount of the taxable income calculated in Part II on Lines 16-18.
Clients who converted plan assets to a Roth IRA and wish to include all the income on their 2010 tax return once again will follow a similar procedure in Part III of the form. Here, clients must include all the taxable income from all plan conversions on Line 24 and check the accompanying box.
Remember, Form 8606 is an individual taxpayer's form, even if a joint return is being filed. That means that if a husband and wife each made a 2010 Roth conversion, each will need to file a Form 8606 individually and attach both forms to their joint tax return.
This can be used to a client's advantage, though, since a husband and wife can make different elections on their individual 8606 forms (individuals can't elect different options on multiple conversions to a Roth IRA).
Find out
when would you or would you not recommend converting to a Roth IRA here.
For example, if both individuals converted to a Roth IRA in 2010, one spouse could include all the income in 2010, while the other spouse could split the income over 2011 and 2012. The result is a simulated three-year spread of conversion income, as opposed to a two-year split.
Ed Slott, a certified public accountant, created The IRA Leadership Program and Ed Slott's Elite IRA Advisor Group. He can be reached at irahelp.com.
