401K, IRA, Tax and Financial Articles

Calculating taxable income on a Roth conversion

When calculating the taxable income on a Roth conversion, the taxpayer must consider all non-Roth IRAs – Traditional IRAs, Simple IRAs, SEP IRAs – and calculate the proportion of all previously taxed (i.e. non-deductible) contributions to the total value of all IRAs at the time of the conversion.   That ratio is then applied to the Roth conversion amount.  

For example, let’s suppose a taxpayer owns the following IRAs at the time of conversion with the following characteristics:

• Traditional IRA with a basis of zero worth $100,000 (all contributions were tax deductible contributions)
• Traditional IRA with a basis of $20,000 worth $30,000 ($20,000 worth of contributions were considered non-deductible)
• SEP IRA with a basis of zero worth $20,000 (all contributions were tax deductible contributions)

The taxpayer’s total IRA balance is $150,000 with a basis of $20,000.  Therefore, the proportion of previously taxed to total IRA assets is 13.33%. 

If the taxpayer converts $20,000 to a Roth IRA, he is not allowed to cherry-pick the $20,000 of after-tax contributions and assume that the Roth conversion is 100% non-taxable.  He must apply the ratio calculated above. In other words, 13.33%, or $2,666.67 would be considered previously taxed and therefore non-taxable, and the remaining balance, $17,333 would be considered taxable income.

After the conversion, the balance in all IRAs will be $130,000, with a basis of $17,333.

Also note that 401K and 403B assets are not included in this calculation. 

 

Schanel & Associates, PA, Certified Public Accountants, located in Jupiter, FL, provides tax, accounting, and consulting services to clients throughout Palm Beach County, including Palm Beach Gardens, West Palm Beach and Jupiter, as well as  South Florida and the United States.

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