Last year, many financial advisers worked with clients to implement Roth conversions. Now that we are beginning tax season, advisers should be ready for some new tax-related questions about 2010 and 2011 Roth individual retirement accounts. Here are some of the questions that we have received from advisers:
Is the two-year payout deal still available for 2011 Roth conversions?
No. The two-year payout deal is only for 2010 conversions.
For conversions in 2011 or later years, all the conversion income will be included in the year of conversion. A conversion is a 2010 conversion if the funds left the distributing traditional IRA (or other retirement plan) by Dec. 31, 2010.
Can clients include some of the 2010 Roth conversion income in 2010, some in 2011 and the rest in 2012?
No. Either the Roth conversion income is reported under the two-year deal — half in 2011 and half in 2012 — or the entire amount is reported in 2010.
This is true no matter how many conversions were made and/or from how many different types of accounts the funds came.
Although a single person is limited to the two options outlined above, some married couples who file a joint tax return have the flexibility to report Roth conversion income over the three years. In order to do so, each spouse must have converted an IRA or plan funds to a Roth IRA in 2010.
Because IRAs are individual accounts, each spouse can elect a different reporting method. Each would attach a separate Form 8606 to the couple's Form 1040 to report 2010 Roth conversion income.
They each make their own election on their own Form 8606. One spouse can elect to report all his or her 2010 conversion income in 2010 and the other spouse can use the two-year option to split the income from his or her 2010 conversions equally over 2011 and 2012.
If they file married jointly, they can attain a three-year payout this way.
If a client reports all the 2010 Roth conversion income in 2010, can he or she file an amended tax return later to spread the Roth conversion income over 2011 and 2012 — if that proves to be a better deal?
No. The election to report all the 2010 Roth conversion income in 2010 is irrevocable, but if the tax return is on extension until Oct. 17, 2011, the decision can be made then. If your client is going on extension and hasn't decided how to report 2010 Roth conversion income, he or she still should pay their 2010 taxes by April 15. The extension applies only to filing the tax return, not paying the tax.
Are there any restrictions on who can convert to a Roth IRA in 2011?
No. The $100,000 modified-adjusted-gross-income eligibility limit was repealed after 2009 for all future years. The restriction preventing married individuals who file separate returns from converting was also repealed. Unlike the two-year deal on Roth conversions, which was available only for 2010 Roth conversions, the repeal of the Roth conversion income limit is permanent.
Is there still an income limit for those who want to contribute to a Roth IRA for 2011?
Yes. Odd as it seems, there no longer is an income limit on Roth conversions, but there still is an income limit on who can contribute much smaller amounts to a Roth IRA.
In order to contribute the maximum amount to a Roth IRA for 2011 ($5,000 — $6,000 if 50 or older in 2011), income can't exceed $179,000 (married filing jointly) and $122,000 (single or head of household). These limitations however, can be easily bypassed. Anyone under 701/2 at the end of the year, with at least $5,000 to $6,000 of earned income, can make a nondeductible contribution of $5,000 to $6,000 to a traditional IRA and then convert those funds to a Roth IRA, because there is no income limit for Roth conversions.
Warning: The pro-rata rule applies if your client has other IRA funds. Those with other traditional IRA funds can't convert just the nondeductible IRA contributions and pay no tax on the Roth conversion. Each dollar converted will be only partially tax-free, based on the percentage of nondeductible IRA contributions to the balance of all IRAs (including SEP and Simple IRAs, but not Roth IRAs).
Can clients do partial re-characterizations?
Yes. It often makes sense not to re-characterize the entire Roth conversion. Keeping even a small amount in the Roth keeps the five-year clock started for qualifying distributions.
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.
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