Academic journal article Journal of Accountancy

Deferral and Spreading of Roth Conversion Income Not Always Best

Academic journal article Journal of Accountancy

Deferral and Spreading of Roth Conversion Income Not Always Best

Article excerpt

[ILLUSTRATION OMITTED]

This year has been touted as the Year of the Roth IRA Conversion ("2010: The Year of the Roth Conversion?" JofA, Jan. 2010, page 28). Advice abounds on when to carry out a conversion and how to pay for it. Often, though, a thorough analysis of the alternatives requires planners to consider a number of details.

For example, how do projected increases in marginal tax rates and the client's exposure to the alternative minimum tax (AMT) affect the election either to pay the resulting tax in tax year 2010 or to defer and spread it to tax years 2011 and 20127 Our analysis suggests that opting out of the two-year spread may sometimes be the better tax option, particularly for taxpayers subject to a 2010 AMT liability or to increased marginal tax rates.

PROSPECTS FOR HIGHER TAX RATES

One concern is the possibility that the top two individual tax rates will be allowed to revert as scheduled to their pre-EGTRRA (Economic Growth and Tax Relief Reconciliation Act) levels of 36% and 39.6% in 2011 and 2012, rather than their current 33% and 35%. For a non-AMT taxpayer who expects tax rates to remain the same, the two-year deferral may be the better option, simply due to the time value of money But what if the taxpayer expects top tax rates to go to 36% and 39.6%?

A taxpayer with other taxable income large enough to be subject to the 39.6% maximum tax rate in 2011 and 2012 before considering the taxable distribution will benefit from opting out of the two-year spread election. But if the same individual's other taxable income and/or the conversion amount is taxed at less than that rate in 2011 and 2012, the two-year deferral becomes the better option.

TAXPAYERS SUBJECT TO THE AMT

Understanding the nature of the minimum tax credit is critical to evaluating the two-year spread election for Roth IRA conversions when a taxpayer already is subject to the AMT. After all, the maximum AMT rate is 28%, versus a maximum ordinary tax rate of 35% (or 39.6%), so wouldn't it make sense to accelerate recognition of the conversion into the AMT year? But the workings of the minimum tax credit may simply accelerate the client's tax liability, not really reduce it, before considering the time value of money. Individuals obtain a minimum tax credit only from AMT preferences and adjustments that are timing ("deferral," not "exclusion") differences. …

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