Deferral and Spreading of Roth Conversion Income Not Always Best


This year has been touted as the Year of the Roth IRA Conversion (“2010: The Year of the Roth Conversion?JofA, Jan. 2010, page 28). Advice abounds on when to carry out a conversion and how to pay for it. Often, though, a thorough analysis of the alternatives requires planners to consider a number of details.


For example, how do projected increases in marginal tax rates and the client’s exposure to the alternative minimum tax (AMT) affect the election either to pay the resulting tax in tax year 2010 or to defer and spread it to tax years 2011 and 2012? Our analysis suggests that opting out of the two-year spread may sometimes be the better tax option, particularly for taxpayers subject to a 2010 AMT liability or to increased marginal tax rates.



One concern is the possibility that the top two individual tax rates will be allowed to revert as scheduled to their pre-EGTRRA (Economic Growth and Tax Relief Reconciliation Act) levels of 36% and 39.6% in 2011 and 2012, rather than their current 33% and 35%. For a non-AMT taxpayer who expects tax rates to remain the same, the two-year deferral may be the better option, simply due to the time value of money. But what if the taxpayer expects top tax rates to go to 36% and 39.6%?


A taxpayer with other taxable income large enough to be subject to the 39.6% maximum tax rate in 2011 and 2012 before considering the taxable distribution will benefit from opting out of the two-year spread election. But if the same individual’s other taxable income and/or the conversion amount is taxed at less than that rate in 2011 and 2012, the two-year deferral becomes the better option.



Understanding the nature of the minimum tax credit is critical to evaluating the two-year spread election for Roth IRA conversions when a taxpayer already is subject to the AMT. After all, the maximum AMT rate is 28%, versus a maximum ordinary tax rate of 35% (or 39.6%), so wouldn’t it make sense to accelerate recognition of the conversion into the AMT year? But the workings of the minimum tax credit may simply accelerate the client’s tax liability, not really reduce it, before considering the time value of money. Individuals obtain a minimum tax credit only from AMT preferences and adjustments that are timing (“deferral,” not “exclusion”) differences.


In effect, the tax savings generated by avoiding the 36% and 39.6% rates in 2011 and 2012 on the conversion amount may more than compensate for the time value of money issue caused by the earlier payment of the tax. A greater proportion of permanent differences to timing differences may make the two-year spread election still less attractive.



The better planning strategy for some taxpayers may be to opt out of the two-year spread election for the tax liability from a Roth IRA conversion, incurring the entire resulting income tax in 2010. This may be the case for high-income taxpayers who (1) expect tax rates to increase significantly in 2011 and 2012, and/or (2) are in a 2010 AMT position, especially one caused primarily by permanent (“exclusion”) adjustments and preferences.


An illustrative spreadsheet is available at so that you can examine these possibilities in detail. The spreadsheet allows planners to choose between two possible tax rate schedules for individual taxpayers (any determination of whether a Roth conversion is advisable for a particular person must take into account all of that person’s particular facts and circumstances). One is the current schedule with its 35% top rate. The other retains the current rate structure for up to the first $250,000 of taxable income and then taxes incomes above $250,000 at 36%, up to the current threshold for the 35% rate ($373,650), where a 39.6% rate would apply. For simplicity, tax brackets for 2011 and 2012 include no inflation adjustments, and AMT exemption amounts for 2009 are used. The spreadsheet also allows planners to adjust for the taxpayer’s filing status, provides a discount rate for the present value of tax liabilities in 2011 and 2012, and provides a rate of increase in annual income other than that recognized as a result of the Roth conversion.


By William A. Raabe, CPA, Ph.D., ( of The Ohio State University; John O. Everett, CPA, Ph.D., ( of Virginia Commonwealth University; and Cherie J. Hennig, Ph.D., MBA, ( of the University of North Carolina–Wilmington.


To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at or 919-402-4434.


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