In Which Tax Year(s) Should You Include Your 2010 Roth IRA Conversion Income? – Part 1

In Which Tax Year(s) Should You Include Your 2010 Roth IRA Conversion Income? – Part 1

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If you’ve read any of the last 15 blog posts, you understand that the decision to convert a traditional IRA to a Roth IRA isn’t typically a slam dunk. There are some instances when you should never do a Roth IRA conversion (see Three Roth IRA Conversion “Show Stoppers”). When a Roth IRA conversion is appropriate, in most cases it makes sense to convert a portion of a traditional IRA to a Roth IRA over several years rather than 100% in one year (see Roth IRA Conversion – A Multi-Year Strategy).

2010 is a unique year for Roth IRA conversions. In addition to the removal of the $100,000 modified adjusted gross income Roth IRA conversion eligibility threshold (see Year of the Conversion), if you do a conversion in 2010, the income from your conversion won’t be reported in 2010. Instead, one-half of the income will be included in 2011 and the other half will be included in 2012. You will need to make an election on your 2010 income tax return if you would like to report the income in 2010.

At first blush, the default of spreading your conversion income over two future years seems like a great opportunity since (a) you’re not recognizing any income from your conversion on your 2010 federal income tax return, (b) you’re deferring income to a future year, with 50% deferred for two years, and (c) depending upon the amount of your conversion, by splitting your income, you may be able to reduce the top marginal tax bracket at which your Roth IRA conversion income will be taxed in 2011 and 2012.

Unfortunately, the decision regarding when to recognize your Roth IRA conversion income is complicated by the fact that, in the absence of Congressional action, our current relatively low tax brackets will be replaced by the pre-2001 tax brackets which are generally higher. Assuming that Congress takes no action, 2010 income tax brackets will increase by at least 3% for most levels of income as follows:

2010 Tax Bracket

2011 Tax Bracket













While there will be no increase in the 15% tax bracket and the increase will be 3% for the 25%, 28%, and 33% tax brackets, the increases are more severe for the 10% and 35% brackets. The 10% bracket will increase by 5% to 15% and the 35% bracket will increase by 4.6% to 39.6%. It’s important to keep in mind that the tax brackets being illustrated are marginal tax brackets. As an example, if you’re currently in the 33% tax bracket, you are affected by the changes in all of the brackets below 33% as well as the 33% tax bracket, since different layers of your income are taxed at 10%, 15%, 25%, 28%, and 33%, respectively, to calculate your 2010 tax liability.

As if it isn’t difficult enough deciding whether or not you should do a Roth IRA conversion this year and how much of your traditional IRA you should convert to a Roth IRA, you must also decide in which tax year(s) you should include the income from your conversion. Part 2 will show the different levels of income associated with the above 2010 and projected 2011 tax brackets. Part 3 will use an example to compare the use of the 2010 Roth IRA conversion income deferral default to the optional 2010 inclusion.

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