As you consider your options for a 2010 Roth Conversion strategy, you’ll probably agonize over the decision of when to pay the tax: you can choose to pay all of the tax in 2010, or half in 2011 and half in 2012. All of it upfront is a lot of money! But then again, half in 2011 and half in 2012 – didn’t someone mention that tax rates are going to increase? It sure would be nice to be able to split this up over all three years!
The problem with this strategy is that each taxpayer is required to treat all Roth conversion taxation with the same method, either all tax paid in 2010 or half in 2011 and half in 2012. So even if you make two or more different Roth conversions in 2010 and elect the deferred treatment for the tax (or elect to pay the tax in 2010), then you have to use that election for all of your conversions for 2010. This rule is per taxpayer… which opens up a possible workaround!
There’s a Workaround
There is one way to work around the tax law on this one – but you have to be married. I know some folks (both guys and gals) who would say that no amount of tax savings would be enough to get married, and it’s probably not the best idea to rely on tax code provisions as a reason to enter into wedlock. Rare indeed is the situation where the IRS is responsible for a flourishing union…
But for the purpose of the example, let’s just say you had other reasons, and now you find yourself eligible to file taxes with the status of Married Filing Jointly. Let’s further say that you and your spouse jointly have $300,000 in IRA accounts, split as follows: $200,000 in your name and $100,000 in your spouse’s name. In order to convert the total amount of $300,000 in 2010 and reduce taxes to the lowest possible amount, your spouse could convert $100,000 and elect to have the conversion taxed in 2010… and then you could convert $200,000 and elect to defer the tax to 2011 and 2012.
Now you’ve effectively spread out the tax over 3 years, with even amounts being taxed each year. Given the graduated nature of our tax system, this is likely the most tax efficient method for affecting a conversion. Unfortunately for filers in other statuses (stati?) this option is not available – it’s either all in 2010 or half & half in 2011 and 2012.
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I can learn from you, you can learn from me - please leave your comments and links!Jim Blankenship, CFP®, EA, is an expert in personal retirement, IRAs, and tax issues, with more than 20 years of experience in the industry. . Read more from this author
