Transfers to Roth IRAs
Roth Conversions Allowed for High-Income Individuals after 2009. – A taxpayer ordinarily may
not transfer any of the funds in an IRA or employer retirement plan to a Roth IRA if (1) the
taxpayer’s modified “adjusted gross income” for the tax year exceeds $100,000 or (2) the
taxpayer is married filing a separate return. However, after 2009, a taxpayer will be able to make
such transfers to a Roth IRA regardless of the level of his or her income – and regardless of a
separately filed return. Furthermore, one-half the income from such a transfer in 2010 will not be
taxable until 2011 and the other half will not be taxable until 2012 (unless the taxpayer elects to
report it all in 2010). However, if the taxpayer takes a distribution of any of the transferred funds
before 2012, the taxpayer must accelerate payment of the deferred tax on the distributed funds.
(Tax Increase Prevention and Reconciliation Act of 2005, Pub. L. No. 109-455, § 512; I.R.C. §
408A.) See Chapter 7 of the Guide for a more complete discussion of Roth conversions.
IRS Focus on Transactions between Roth IRAs and Related Businesses. – The IRS has
announced it will closely scrutinize transactions involving a Roth IRA and business entities
related to the owner of the Roth IRA. Since a Roth IRA and its distributions are generally not
taxable, the IRS is concerned the owner of a Roth IRA may attempt to shift value tax-free to it by
selling or transferring business assets for less than actual value. The IRS notes it has many
statutory tools available to attack this type of transaction. (Notice. 2004-8, 2004-4 I.R.B. 333.)
See Chapter 7 of the Guide for an explanation of the taxation of Roth IRAs.
The Taxable Value of an IRA Annuity Converted to a Roth IRA. – The IRS has acted to thwart
new IRA annuity products designed to have artificially low cash values subject to taxation when
converted to Roth IRAs. (The artificially low cash values subsequently inflate to their proper
levels.) Under new regulations, a taxpayer must pay tax on an annuity’s “fair market value” upon
conversion to a Roth IRA, without regard to the annuity’s artificial cash value. The regulations
provide several potential methods for determining the fair market value. Some of these methods
may require help from the taxpayer’s insurance company or tax advisor. (Reg. Sec. 1.408A-4T,
Q&A 14.) The IRS has also authorized simpler safe harbor valuations for certain converted
annuities. (Rev. Proc. 2006-13, 2006-3 I.R.B. ___. See Chapter 7 of the Guide for an explanation
of the taxation of Roth IRAs.
Correction of Defective Roth Conversion Denied where Statute of Limitations Had Run. – In
some situations, the IRS may allow a taxpayer to correct retroactively an IRA trustee's failure to
convert an IRA to a Roth IRA. However, the IRS denied this relief where (1) the taxpayer
attempted the failed conversion in a tax year barred by the statute of limitations and (2) the
taxpayer had not paid the tax on the failed conversion. (Ltr. Rul. 200437037.) See Chapter 7 of
the Guide for an explanation of Roth conversions.
Reversal of Defective Roth Transfers Allowed though Reversal Period Had Expired. –
Normally, a taxpayer may reverse a previous transfer of funds from a regular IRA to a Roth IRA
(i.e., a Roth conversion) by taking action within a specified period. In addition, though, the IRS
may allow a taxpayer to reverse a defective Roth conversion even though the normal reversal
period has expired. If allowed, retroactive reversal of a defective conversion avoids penalties
and other adverse tax consequences.
The IRS has generally allowed the reversal of a defective Roth conversion where (1) the
taxpayer requested relief before IRS discovery of the mistake, (2) the taxpayer acted reasonably
and in good faith, and (3) the statute of limitations had not run on the year of the conversion. For
example, the IRS has allowed taxpayers to reverse defective Roth conversions after the normal
period for reversal has expired where:
1. A husband and wife learned their Roth conversions were invalid because their income
exceeded the allowable threshold, even though they had relied in good faith on a professional
tax advisor. (Ltr. Rul. 200431016. Similarly Ltr. Rul. 200431017, 200429014, and 200416014.)
2. A taxpayer did not timely discover his ineligibility for the Roth conversion because of a
catastrophic illness. (Ltr. Rul. 200432030.) A taxpayer missed the 60-day deadline because of
severe illness and heavy medication. (Ltr. Rul. 200729037.)
3. The taxpayer mistakenly believed the allowable income threshold for a Roth conversion was
higher than it actually was. (Ltr. Rul. 200432020.)
4. A taxpayer misunderstood the advice of his tax advisor - after becoming ineligible for his Roth
conversion due to an unanticipated divorce and his former spouse’s refusal to assent to a joint
return. (Ltr. Rul. 200438050.) Similarly, for a taxpayer who received an employer tax information
form that erroneously stated that the conversion was not taxable. (Ltr. Rul. 200716033.)
5. The taxpayer was unaware of the need to reverse a defective Roth conversion, believing
erroneously that the defect in the conversion nullified it. (Ltr. Rul. 200428035.)
6. The taxpayer married after his Roth conversion and discovered that the combined incomes of
he and his spouse exceeded the allowable threshold for a conversion. (Ltr. Rul. 200426023.)
7. A husband and wife did not satisfy the income threshold for their Roth conversions because
the husband subsequently realized a large gain on sale of a partnership interest, and they
received erroneous and confusing advice from their tax advisors. (Ltr. Rul. 200423030.)
8. The taxpayer’s Roth conversion was invalid because the income of he and his wife exceeded
the allowable threshold, and he mistakenly believed he had until the end of the following year to
reverse the conversion. (Ltr. Rul. 200414047.)
See Chapter 7 of the Guide for an explanation of Roth conversions and recharacterizations.
Extension of Roth Conversions to Eligible Retirement Plans. – Taxpayers have long been able
to convert their regular IRAs to Roth IRAs. However, to convert funds in an employer retirement
plan to a Roth IRA, taxpayers have generally had to roll the funds over first to a regular IRA and
then convert the regular IRA to a Roth IRA. By contrast, after 2007, a taxpayer may directly convert
all or part of an “eligible plan” to a Roth IRA without using a regular IRA as an intermediary. For
this purpose, an eligible plan is a qualified retirement plan, a section 403(b) tax-sheltered
annuity (TSA), or an eligible state and local government plan.
Conversions of eligible plans to Roth IRAs will be subject to the same conditions that apply to
regular IRA conversions. That is, before 2010, a taxpayer may generally make the conversion
only if (1) the taxpayer’s modified “adjusted gross income” for the tax year does not exceed
$100,000 and (2) the taxpayer is not a married individual filing a separate return. After 2009, a
taxpayer will be able to make the conversion regardless of the level of his or her income – and
regardless of a separately filed return. Of course, conversions to Roth IRAs are taxable
(exclusive of return of investment) whether the converted funds come from a regular IRA or an
eligible plan.
See Chapter 7 of the Guide for a more complete discussion of Roth conversions. (Tax Increase
Prevention and Reconciliation Act of 2005, Pub. L. No. 109-455, § 512; Pension Protection Act of
2006, Pub. L. No. 109-280, § 824(a), (b), (c); I.R.C. § 408A.)
Beneficiary Transfers to Roth IRAs. – A surviving spouse of a retiree may make taxable
transfers of funds from the retiree’s eligible plans or IRAs to the spouse’s own Roth IRA to the
same extent the retiree could have during his or her lifetime. Furthermore, if the plan or IRA
permits, any beneficiary (whether or not a surviving spouse) may make such a taxable transfer
to a newly formed Roth IRA designated as an “inherited Roth IRA,” provided the transfer is a
trustee-to-trustee transfer. The inherited Roth IRA must be in the form “James Smith, Decedent,
for the benefit of William Smith, beneficiary.” However, in any such case, the spouse or other
beneficiary must personally satisfy the usual requirements for such a transfer (e.g., modified
adjusted gross income of $100,000 or less before the year 2010). (Notice 2008-30, 2008-12 I.R.
B. 638.) See Chapter 6 of the Guide.
To next page
To previous page
To Home page
Roth Conversions Allowed for High-Income Individuals after 2009. – A taxpayer ordinarily may
not transfer any of the funds in an IRA or employer retirement plan to a Roth IRA if (1) the
taxpayer’s modified “adjusted gross income” for the tax year exceeds $100,000 or (2) the
taxpayer is married filing a separate return. However, after 2009, a taxpayer will be able to make
such transfers to a Roth IRA regardless of the level of his or her income – and regardless of a
separately filed return. Furthermore, one-half the income from such a transfer in 2010 will not be
taxable until 2011 and the other half will not be taxable until 2012 (unless the taxpayer elects to
report it all in 2010). However, if the taxpayer takes a distribution of any of the transferred funds
before 2012, the taxpayer must accelerate payment of the deferred tax on the distributed funds.
(Tax Increase Prevention and Reconciliation Act of 2005, Pub. L. No. 109-455, § 512; I.R.C. §
408A.) See Chapter 7 of the Guide for a more complete discussion of Roth conversions.
IRS Focus on Transactions between Roth IRAs and Related Businesses. – The IRS has
announced it will closely scrutinize transactions involving a Roth IRA and business entities
related to the owner of the Roth IRA. Since a Roth IRA and its distributions are generally not
taxable, the IRS is concerned the owner of a Roth IRA may attempt to shift value tax-free to it by
selling or transferring business assets for less than actual value. The IRS notes it has many
statutory tools available to attack this type of transaction. (Notice. 2004-8, 2004-4 I.R.B. 333.)
See Chapter 7 of the Guide for an explanation of the taxation of Roth IRAs.
The Taxable Value of an IRA Annuity Converted to a Roth IRA. – The IRS has acted to thwart
new IRA annuity products designed to have artificially low cash values subject to taxation when
converted to Roth IRAs. (The artificially low cash values subsequently inflate to their proper
levels.) Under new regulations, a taxpayer must pay tax on an annuity’s “fair market value” upon
conversion to a Roth IRA, without regard to the annuity’s artificial cash value. The regulations
provide several potential methods for determining the fair market value. Some of these methods
may require help from the taxpayer’s insurance company or tax advisor. (Reg. Sec. 1.408A-4T,
Q&A 14.) The IRS has also authorized simpler safe harbor valuations for certain converted
annuities. (Rev. Proc. 2006-13, 2006-3 I.R.B. ___. See Chapter 7 of the Guide for an explanation
of the taxation of Roth IRAs.
Correction of Defective Roth Conversion Denied where Statute of Limitations Had Run. – In
some situations, the IRS may allow a taxpayer to correct retroactively an IRA trustee's failure to
convert an IRA to a Roth IRA. However, the IRS denied this relief where (1) the taxpayer
attempted the failed conversion in a tax year barred by the statute of limitations and (2) the
taxpayer had not paid the tax on the failed conversion. (Ltr. Rul. 200437037.) See Chapter 7 of
the Guide for an explanation of Roth conversions.
Reversal of Defective Roth Transfers Allowed though Reversal Period Had Expired. –
Normally, a taxpayer may reverse a previous transfer of funds from a regular IRA to a Roth IRA
(i.e., a Roth conversion) by taking action within a specified period. In addition, though, the IRS
may allow a taxpayer to reverse a defective Roth conversion even though the normal reversal
period has expired. If allowed, retroactive reversal of a defective conversion avoids penalties
and other adverse tax consequences.
The IRS has generally allowed the reversal of a defective Roth conversion where (1) the
taxpayer requested relief before IRS discovery of the mistake, (2) the taxpayer acted reasonably
and in good faith, and (3) the statute of limitations had not run on the year of the conversion. For
example, the IRS has allowed taxpayers to reverse defective Roth conversions after the normal
period for reversal has expired where:
1. A husband and wife learned their Roth conversions were invalid because their income
exceeded the allowable threshold, even though they had relied in good faith on a professional
tax advisor. (Ltr. Rul. 200431016. Similarly Ltr. Rul. 200431017, 200429014, and 200416014.)
2. A taxpayer did not timely discover his ineligibility for the Roth conversion because of a
catastrophic illness. (Ltr. Rul. 200432030.) A taxpayer missed the 60-day deadline because of
severe illness and heavy medication. (Ltr. Rul. 200729037.)
3. The taxpayer mistakenly believed the allowable income threshold for a Roth conversion was
higher than it actually was. (Ltr. Rul. 200432020.)
4. A taxpayer misunderstood the advice of his tax advisor - after becoming ineligible for his Roth
conversion due to an unanticipated divorce and his former spouse’s refusal to assent to a joint
return. (Ltr. Rul. 200438050.) Similarly, for a taxpayer who received an employer tax information
form that erroneously stated that the conversion was not taxable. (Ltr. Rul. 200716033.)
5. The taxpayer was unaware of the need to reverse a defective Roth conversion, believing
erroneously that the defect in the conversion nullified it. (Ltr. Rul. 200428035.)
6. The taxpayer married after his Roth conversion and discovered that the combined incomes of
he and his spouse exceeded the allowable threshold for a conversion. (Ltr. Rul. 200426023.)
7. A husband and wife did not satisfy the income threshold for their Roth conversions because
the husband subsequently realized a large gain on sale of a partnership interest, and they
received erroneous and confusing advice from their tax advisors. (Ltr. Rul. 200423030.)
8. The taxpayer’s Roth conversion was invalid because the income of he and his wife exceeded
the allowable threshold, and he mistakenly believed he had until the end of the following year to
reverse the conversion. (Ltr. Rul. 200414047.)
See Chapter 7 of the Guide for an explanation of Roth conversions and recharacterizations.
Extension of Roth Conversions to Eligible Retirement Plans. – Taxpayers have long been able
to convert their regular IRAs to Roth IRAs. However, to convert funds in an employer retirement
plan to a Roth IRA, taxpayers have generally had to roll the funds over first to a regular IRA and
then convert the regular IRA to a Roth IRA. By contrast, after 2007, a taxpayer may directly convert
all or part of an “eligible plan” to a Roth IRA without using a regular IRA as an intermediary. For
this purpose, an eligible plan is a qualified retirement plan, a section 403(b) tax-sheltered
annuity (TSA), or an eligible state and local government plan.
Conversions of eligible plans to Roth IRAs will be subject to the same conditions that apply to
regular IRA conversions. That is, before 2010, a taxpayer may generally make the conversion
only if (1) the taxpayer’s modified “adjusted gross income” for the tax year does not exceed
$100,000 and (2) the taxpayer is not a married individual filing a separate return. After 2009, a
taxpayer will be able to make the conversion regardless of the level of his or her income – and
regardless of a separately filed return. Of course, conversions to Roth IRAs are taxable
(exclusive of return of investment) whether the converted funds come from a regular IRA or an
eligible plan.
See Chapter 7 of the Guide for a more complete discussion of Roth conversions. (Tax Increase
Prevention and Reconciliation Act of 2005, Pub. L. No. 109-455, § 512; Pension Protection Act of
2006, Pub. L. No. 109-280, § 824(a), (b), (c); I.R.C. § 408A.)
Beneficiary Transfers to Roth IRAs. – A surviving spouse of a retiree may make taxable
transfers of funds from the retiree’s eligible plans or IRAs to the spouse’s own Roth IRA to the
same extent the retiree could have during his or her lifetime. Furthermore, if the plan or IRA
permits, any beneficiary (whether or not a surviving spouse) may make such a taxable transfer
to a newly formed Roth IRA designated as an “inherited Roth IRA,” provided the transfer is a
trustee-to-trustee transfer. The inherited Roth IRA must be in the form “James Smith, Decedent,
for the benefit of William Smith, beneficiary.” However, in any such case, the spouse or other
beneficiary must personally satisfy the usual requirements for such a transfer (e.g., modified
adjusted gross income of $100,000 or less before the year 2010). (Notice 2008-30, 2008-12 I.R.
B. 638.) See Chapter 6 of the Guide.
To next page
To previous page
To Home page
| Copyright © 2005-2008 by Vorris J. Blankenship All Rights Reserved |
The author intends that this website provide accurate and authoritative information on the subject matter
covered. However, the information provided on this website is not a substitute for the advice of an attorney,
accountant, or other professional; and the author is not offering legal, accounting, or other professional
advice. The material presented on this website is not intended for use, and may not be used, to avoid tax
penalties. If you need legal advice or other professional help, you should seek (from an independent
attorney, accountant, or other competent professional) advice based on your own particular circumstances.
covered. However, the information provided on this website is not a substitute for the advice of an attorney,
accountant, or other professional; and the author is not offering legal, accounting, or other professional
advice. The material presented on this website is not intended for use, and may not be used, to avoid tax
penalties. If you need legal advice or other professional help, you should seek (from an independent
attorney, accountant, or other competent professional) advice based on your own particular circumstances.
Key Tax Developments Affecting Retirees
 |
| |
 |
| |
 |
| |
 |
| |
 |
| |
 |
| |
 |
| |
 |
| |
 |
| |
 |
| |
 |
| |
 |