Taxes on Traditional-to-Roth IRA Conversions
In the United States, the Internal Revenue Code allows you to convert funds held in a traditional individual retirement account (IRA) to a Roth IRA. If you are seeking to convert assets from a traditional IRA to a Roth IRA, you must include the amount converted within taxable income reported to the Internal Revenue Service (IRS) for the year of the conversion.
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Traditional versus Roth IRAs
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Traditional and Roth IRAs are two types of tax-advantaged retirement plans available to individuals under the Internal Revenue Code. Although there are a number of more minor differences in the characteristics of the two types of plans, the most significant difference is the method of tax benefit. Traditional IRAs allow you to exclude the value of your contribution from income tax. The plan's principal and earnings are taxed upon distribution. In a Roth IRA, although there is no tax benefit upon contribution, the principal grows tax-free, as no taxes are paid upon a qualified distribution.
Conversion
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Prior to 2010, the Internal Revenue Code forbid high-income taxpayers (those with a modified adjusted gross income above $100,000) from converting a traditional IRA to a Roth IRA. The Tax Increase Prevention and Reconciliation Act of 2005 allowed all taxpayers, regardless of income, to convert traditional IRAs to Roth IRAs starting in 2010. If you are converting a traditional IRA to a Roth IRA, you must report the conversion to the IRS and pay tax upon the amount converted.
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Taxation
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If you are converting a traditional IRA to a Roth IRA, you must include the amount of the conversion in your calculation of gross income on Form 1040, U.S. Individual Income Tax Return. You are not liable for the 10 percent tax penalty applied to other early, non-qualified distributions from traditional IRAs. Because the amount of the conversion is included in gross income, a traditional to Roth IRA conversion may push you into a higher income tax brackets and may also disqualify you from certain income-based deductions or credits.
2010 Conversions
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The Internal Revenue Code allows taxpayers converting traditional IRAs to Roth IRAs during 2010 to either include the entire amount of the conversion in 2010 income or to include 50 percent of the conversion in income during 2011 and 50 percent of the conversion in income during 2012. You may find including the conversion in 2011 and 2012 income beneficial, not only because it defers the income, but because only half the amount is included in income during a given year, it may avoid pushing you into higher income tax brackets.
Form 8606
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The IRS requires that you report the traditional to Roth IRA conversion on Form 8606, Nondeductible IRAs. This form must be completed and filed with your individual income tax return. The IRS uses the form to ensure that you have properly computed the income recognizable from the conversion and correctly included it on your income tax return.
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