There were two key tax law changes in 2010 that encouraged people to convert their existing retirement accounts to Roth IRAs.
First, the restrictions that previously prevented Roth IRA conversions for those with high incomes or those filing married-separate returns were eliminated. This opened the Roth conversion door for millions of Americans who previously did not qualify to do conversions. Second, 2010 Roth IRA conversions were given special tax treatment. Instead of having conversion income included entirely in 2010 as would typically be the case, 2010 Roth IRA converters were able to split the income from their conversions equally over 2011 and 2012.
That being the case, many of those converters believe they have seen the end of the cost of their 2010 conversions, but that may not be so. There are two key ways in which you may still be affected by your 2010 Roth conversion.
One possibility is that you may be paying 2013 estimated tax payments that are artificially inflated. Here’s why… There are two safe harbor methods for paying estimated taxes that will definitely keep you from owing estimated tax penalties. One way is to pay in 90% of your current year tax liability through quarterly payments. While this is a perfectly acceptable method, it’s not as foolproof as its counterpart, because your current year tax liability isn’t known for sure until after the year is already over. The other safe harbor method requires you to pay in 100% of your previous year’s tax liability (110% for certain high-income filers) through quarterly installments. This is generally the preferred method because by the time your first estimated tax payment for the year is due (April 15th), you typically know, or at least have a pretty good idea, what your total tax bill was for the previous year.
Suppose however, that you made a large Roth conversion in 2010 – say $600,000 – and you split that income equally, $300,000 per year, over 2011 and 2012. If that’s the case, and you’re paying 2013 estimated taxes based on 2012’s tax liability (the generally preferable way), your 2013 estimated taxes will be artificially high, since 2013 won’t have any of that Roth conversion income. Overpaying your estimated taxes doesn’t technically hurt you, since you will get any overpayment back when you file your 2013 tax return, but giving an interest-free loan to the government isn’t exactly on the top of most people’s priority list.
Another way in which you may still be paying for a 2010 Roth conversion is if you are a Medicare participant. Medicare Part B premiums are income-based, so an increase in your income can increase your premiums. Here’s the thing though… the premiums are generally based on your income from your tax return of two years prior. That means that your 2014 Medicare Part B premiums will likely be based on your 2012 tax return. If that return includes Roth conversion income from 2010, your premiums might be higher than they otherwise would be based on your “real” income. Thankfully, however, those Part B premiums should drop back down in 2015, when they will generally be based on your 2013 tax return, which won’t have any 2010 Roth conversion income reported on it.
Then… maybe… finally… you might truly be done paying for your 2010 Roth IRA conversion.
- By Jeffrey Levine and Jared Trexler