Paying tax on Traditional to Roth IRA conversion

If you are in generally good terms with the IRS, and owe under $25,000 you can apply for an installment plan. That lets you pay what you owe plus the penalties and interest, over a period of time measured often in years. The application fee for this installment agreement is lower if you authorize them to withdraw a fixed amount each month from your savings or checking account.

If you cannot come up with the money in any reasonable time -- and you have no business doing what you are planning if so -- there is a possibility to enter into an Offer in Compromise where the IRS investigates and concludes they can't get all the balance from you in a reasonable time. Since you will have a good chunk in your IRA this is not really applicable to you.

See

Yes, see above.

The taxable amount converted is added to your ordinary income, and the income tax is based on your marginal tax rate. If you had made nondeductible contributions to your IRA, and you would have had to fill out a form 8606 if you did, then you use that form to determine how much of the amount distributed and converted is taxable income.

You didn't ask, but I have some suspicions that this is not the best of all financial planning methods.

You do not have to convert 100% of your total Trad. IRA balance(s). Usually you will only want to convert an amount that takes you up to the top of your current marginal tax bracket, or in your case, only an amount that you *can* afford to pay tax on for this year.

If you adopt this approach, be sure to make each conversion into a "separate" Roth IRA account for each asset, for example, $15K into shares of XYZ mutual fund. Custodians will often keep Roth IRA investments under separate account numbers for this purpose. Then, in the uncommon case you want to "undo" (recharacterize) your conversion within the time limit allowed, it will go much more easily.

Value on the date of conversion, and only on the amount you convert.

Not so bad if done within the parameters above. But I agree, *planning* to owe the IRS more than you can pay is a bad idea.

-Mark Bole

Hopefully, you have also considered alternate times to do this - like 2010, where one gets a 2-year spread of the converted amount.

Thanks for the responses guys, your comments are very beneficial.

I did not realize that in 2010 I would be able to spread the tax expense over two years, that is something I will need to consider.

I also have a follow up question, in order to understand how this is going to impact my taxes this year (I have a few other new things that are also affecting my taxes this year vs last year) I would like to estimate my tax prior to doing the conversion. Ideally I could do this by using TurboTax but the 2008 version has not been released yet, does anyone have an estimate of when TurboTax 2008 will be released?

Or alternatively does anyone have a sugesstion for how I could estimate my taxes for 2008? Filling out the forms manually is probably not a good option for me.

Thanks,

Sam

I just got my renewal mail from Intuit this weekend, and it says the software will be available in mid-to-late November.

You may want to spread the conversion over several years to keep out of the higher tax brackets and AMT.

A full conversion may also cause you to pay higher estimated taxes in the following year.

-- Ron

No, it won't. You always have the option of basing this year's ES payments on this year's income.

Oh, s**t. At least I will get a large refund for this year.

-- Ron

If you've already paid enough ES payments to cover 90% of your 2008 tax you can skip the January installment. Or you can make the January installment just enough to get you to the 90%. IOW, all installments don't have to be equal.

See IRS Publication 505.