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Roth Conversion and Taxes

Posted: Tue Apr 07, 2015 7:43 am
by LifeIsGood
I've been working on my tax return and wondered why adding new deductions didn't change the amount of federal tax due ($2,713). It finally dawned on me that TurboTax was using the Standard Deduction rather than itemizing. A lack of Schedule A confirmed this. I then decided to see what effect my Roth conversion ($30,000) had on tax due. If re-characterize the entire Roth conversion, I now have a $4,091 refund due and I'm now able to itemize deductions.
Before I "pull the trigger", is there anything else I need to consider?

Re: Roth Conversion and Taxes

Posted: Tue Apr 07, 2015 7:48 am
by TomatoTomahto
I'm not sure what you're asking. I assume your $30k Roth Conversion was done for a reason, and you knew that it would have tax consequences. Are the tax consequences outside your range of expectation?

Re: Roth Conversion and Taxes

Posted: Tue Apr 07, 2015 7:51 am
by livesoft
The Roth conversion should have no effect on whether you could itemize or take the standard deduction I would think. Except …

If you did the conversion in 2014 and you paid state income taxes on the converted amount in 2014, that should increase your itemized deductions.

I would look to see other reasons about the choice of itemized or standard.

Re: Roth Conversion and Taxes

Posted: Tue Apr 07, 2015 8:14 am
by cheese_breath
What's your AGI and filing status? Is it possible your Roth conversion pushed you into the phase-out range for some deductions?

But then if income is that high I'm wondering why you were doing a Roth conversion anyway.

Re: Roth Conversion and Taxes

Posted: Tue Apr 07, 2015 9:53 am
by LifeIsGood
The Roth conversion took place in 2014. There was no state tax paid on the converted amount.
With the Roth conversion, my effective tax rate is 10.6% and without it drops to 4.5%. It would appear that I'm paying nearly 23% tax on the Roth conversion.
My AGI with the Roth conversion is $111,000 and $80,800 without the conversion. Married filing jointly.
I guess what I'm asking is what would make this Roth conversion a good idea given the numbers presented? The only thing I can think of is that RMD's in 3 years would put me in a higher bracket.

Re: Roth Conversion and Taxes

Posted: Tue Apr 07, 2015 10:03 am
by earlyout
If the total of your schedule A with the Roth conversion is close to the to the standard deduction, it's possible that w/o the $30,000 of Roth conversion, enough of your medical expenses exceed the 7.5% limitation to make your itemized deductions larger than the standard deduction.

Re: Roth Conversion and Taxes

Posted: Tue Apr 07, 2015 10:05 am
by cheese_breath
I believe TT allows you to itemize deductions even though the standard deduction is greater. At least I remember it asking me that although I never chose it. Why not make two trial runs without filing, one with the Roth conversion and one without but itemizing deductions. Then compare the schedule A for both runs.

Re: Roth Conversion and Taxes

Posted: Tue Apr 07, 2015 10:16 am
by Bill M
At $80.8K you're nearly at the top of the 15% marginal tax bracket; the Roth conversion put you well into the 25% marginal bracket. Plugging your numbers into my tax program (assuming MFJ, 2 exemptions) I figure the first $1,200 of Roth conversion topped off the 15% bracket. Is a Roth conversion at 25% worthwhile? That depends on the marginal bracket you'll face with the RMDs in a few years. Personally, I'd rather pay 25% now (and have the account grow tax-free) than pay 25% (of a larger balance) later.

Re: Roth Conversion and Taxes

Posted: Tue Apr 07, 2015 10:16 am
by livesoft
You are probably paying at least 30% tax on the Roth conversion as a marginal rate. The reason is that the extra income bumps some of your qualified dividend income from the 0% tax bracket to the 15% tax bracket, so that costs you 15% and then the Roth conversion is taxed at 15% all by itself. So 15% + 15% = 30%. If you go into the 25% marginal bracket as mentioned by Bill M, then it could be even worse.

I just made similar calculations using TurboTax in a "What if?" mode. I found that I would be able to convert about $6000 of my traditional IRA at a marginal 15% tax rate and any larger amounts would be taxed effectively at 30%.

You may wish to recharacterize SOME, but NOT ALL of your Roth IRA conversion.

I guess your question about standard deduction versus itemized deduction is just a red herring then?

Re: Roth Conversion and Taxes

Posted: Tue Apr 07, 2015 10:39 am
by DSInvestor
Are you receiving Social security income? That additional Roth conversion income could be causing more social security income to be taxed.
If you can see your 1040 form, check line 20a social security benefits, 20b taxable amount and see if the Roth conversion amount changes line 20b.

If you cannot see the 1040 form, check to see what your AGI and Taxable Income are without the 30K roth conversion and then check again with 30K conversion. If the AGI increases by more than 30K when you add 30K of Roth conversion, then it could be that more social security income is taxable. edit: I noticed that you posted AGI of 111,000 with conversion and 80,800 without conversion which is an increase of 30,200 so it's not much of a factor assuming $30,000 conversion.

Your deductions (std or itemized) are on line 40. Having a lower AGI may result in your ability to itemize if you have medical deductions which are subject to 7.5% of AGI floor if age 65 or over for tax years. Folks under age 65 need to use the 10% of AGI floor for medical expenses.

See IRS Questions and Answers: Changes to the Itemized Deduction for 2014 Medical Expenses
http://www.irs.gov/Individuals/Question ... l-Expenses

Re: Roth Conversion and Taxes

Posted: Tue Apr 07, 2015 11:16 am
by LifeIsGood
Taxable Social Security is the same under both scenarios.
It appears TT is using the Standard Deduction ($14,800) with the Roth conversion and itemizing ($15,637) if there is no conversion.
DSInvestor wrote:Are you receiving Social security income? That additional Roth conversion income could be causing more social security income to be taxed.
If you can see your 1040 form, check line 20a social security benefits, 20b taxable amount and see if the Roth conversion amount changes line 20b.

If you cannot see the 1040 form, check to see what your AGI and Taxable Income are without the 30K roth conversion and then check again with 30K conversion. If the AGI increases by more than 30K when you add 30K of Roth conversion, then it could be that more social security income is taxable. edit: I noticed that you posted AGI of 111,000 with conversion and 80,800 without conversion which is an increase of 30,200.

Your deductions (std or itemized) are on line 40. Having a lower AGI may result in your ability to itemize if you have medical deductions which are subject to 10% of AGI floor. Medical expenses in excess of 10% of AGI can be itemized.