A Roth IRA can be an attractive investment over a traditional IRA in a couple of different ways: it gives taxpayers the opportunity to avoid tax on their IRA distributions and a Roth is not subject to required minimum distribution rules. When converting a traditional IRA to a Roth IRA, a taxable event occurs and taxpayers must pay tax on their conversion amount as if it were ordinary income. This entices some taxpayers to wait due to hopes of lower tax rates with the proposed tax reforms. Taxpayers may be hesitant to convert their traditional IRA to a Roth IRA in the wake of tax reform, but now may actually be the best time.
Taxpayers who convert a traditional IRA to a Roth IRA have the luxury of choosing whether to pay tax on the conversion in 2017 or 2018. This would allow taxpayers to report the transaction on their 2017 return in case Congress does not pass tax reform or that tax reform fails to reduce their marginal tax rate. However, if tax reform does pass and yields a lower marginal tax rate, taxpayers may choose to recognize their distribution revenue in 2018 through a two-step process:
Step 1: Taxpayers can re-characterize (cancel) a taxable distribution from a traditional IRA that is followed by a timely rollover into a Roth IRA. This is accomplished through a trustee-to-trustee transfer between financial institutions.
Step 2: After transferring an amount back to a traditional IRA, taxpayers can reconvert the amount from a traditional IRA to a Roth IRA at a later date. Reconversion must take place after the beginning of the tax year following the tax year of the Roth conversion and more than 30 days after re-characterization.
These carefully calculated tax planning methods can help taxpayers minimize their taxable income and tax liability for future years. For more information regarding IRA tax consequences, contact your professional at UHY LLP in one of our many locations.
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