Taxpayers with more than $100,000 in adjusted gross income are now eligible to convert their individual retirement accounts to a Roth IRA. Conversion is a compelling tax-planning opportunity because: 1) you avoid income tax on future Roth IRA earnings; 2) you lock in tax at today’s historically low income tax rates; 3) you avoid required minimum distributions at age 70 ½; 4) your taxable income will be lower during retirement; 5) beneficiaries of your inherited Roth IRA will receive tax-free distributions; and 6) if you convert in 2010, you may defer recognition of income until 2011 and 2012.
Wisconsin has not yet adopted the federal laws regarding 2010 Roth IRA conversions. According to the Wisconsin Department of Revenue, any 2010 Roth IRA conversion will be fully taxable in Wisconsin in 2010 and the conversion may be subject to an annual 2 percent excess contribution penalty plus a one-time 3.33 percent early withdrawal penalty.
Wisconsin lawmakers are in the process of passing legislation to permit penalty-free Roth IRA conversions. On January 6, 2010, Assembly Bill 648 was introduced, which will adopt the federal law provisions regarding Roth IRA conversions. Committee hearings on this bill have been scheduled and there is hope the bill will be enacted before the current Wisconsin legislative session ends in April.
Should you wait to convert to a Roth IRA if you are a Wisconsin resident? Not necessarily. The proposed legislation should retroactively fix the Wisconsin tax problem. If Wisconsin should fail to pass Assembly Bill 648, you could also undo your 2010 Roth IRA conversion by recharacterizing the conversion no later than your 2010 tax filing due date, including extensions (by Oct. 15, 2011). A recharacterization is a transfer of funds in your Roth IRA back to a traditional IRA. Recharacterizations might also be considered if the value of your Roth IRA conversion significantly declines in value during 2010 or if you decide that you can not afford to pay the income taxes that are due on the 2010 conversion.
All taxpayers with more than $100,000 in adjusted growth income and who have retirement plan accounts should at least consider a Roth IRA conversion in 2010. You should be comfortable immediately proceeding with the conversion because of the proposed Wisconsin legislation and because of your ability to recharacterize a Roth IRA conversion.