Roth conversion "cost" in ARP tax credits

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Topic Author
GeekGal
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Joined: Fri Aug 09, 2019 1:05 pm

Roth conversion "cost" in ARP tax credits

Post by GeekGal »

Dear BH,
I am planning for tax year 2021 and trying to figure out how much in tax credits a conversion to Roth IRA may cost me given the recently passed American Rescue Plan (ARP). Below is my estimate, but would appreciate any insight you have since I am still learning about taxes.
Thank you so much.
-GeekGal

Age: 40
Tax Year 2021: Last year as Qualifying Widow
Two kids: Ages 6 and 2
AGI without tIRA conversion :$150k, may be up to $160k (which is a "cliff")
AGI w tIRA conversion: $240k

Child tax credit:
$200k threshold for QW without ARP (so the typical $4,000 child credit gets reduced after AGI exceeds $200k. For 2020 it was $1950 for me)
I am not sure if cut off with the ARP-related enhancements for Qualifying Widow cut off at the AGI level of $75k or $150k. Does anyone know?
Reading the actual law did not answer this for me, but I could have missed it.

Assuming cut off for QW is $150k AGI and not $75k, AGI of $150k means credit of: $6,600
AGI of $150k but no enhanced credit assuming threshold is $75k: $4,000
AGI of $240k: ~$1950 credit

Oddly, as others noted in another thread, the Kiplinger calculator yielded surprising results indicating I would receive a greater credit than I calculate.

Difference between three "options" is between $2050 and $4050

Childcare:
$5k (employer not increasing despite ARP)
Childcare costs greater than $16k annually

50% of $16k gets reduced after AGI more than $125k (by 1% for each $2k, up to $185k for “floor” of 20%) —-> rough 38% credit of $11k ($16k-$5k) = $4,180 if AGI is $150k
If AGI is $240k then 20% of $11k = $2,200
Difference : $1,980

If discontinue FSA, then $2,500 since six months will count towards $16k but AGI will go up by $2,500 (employer's plan year is by fiscal year July 1 to June 30, not calendar/tax year)
So AGI of $152.5k —> 36% of credit $13.5 = $4,725
If AGI is $242.5k —> then 20% of $13.5k = $2,700
Difference: $2,025

Stimulus:
$2,000 for me but would be reduced if AGI goes up by $2,500 and eliminated with Roth conversion
Kids received EIP 2 and 3 due to receiving survivor benefits from my deceased husband's Social Security account


So, conversion of the Roth may "cost me" about $6,075, maybe more. Does my math and tax analysis make sense?

How do I think about whether this is "too much" to give up, and perhaps I should plan to convert in future years filing as Head of Household? Is there a good rule of thumb?

I plan to run the numbers in tax software later this year when available, but need to submit my final decision for whether or not to participate in the Childcare FSA by Friday. The other thing is that I am withholding the tax for the conversion right now from my paycheck. If I do not end up converting, I would probably reduce my tax withholdings, significantly improving cash flow.
danaht
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Re: Roth conversion "cost" in ARP tax credits

Post by danaht »

Sorry I can't answer your main question - but.... If you are single be careful of the extra medicare 3.8% (net investment tax) surcharge on investment income above $200,000. Be sure you are aware that a Roth conversion could push your overall income above $200,000 - and then your being taxed at 23.8% instead of 20% for your qualified dividends/ long term capital gains (a lot more for short term capital gains) . I am trying to limit my Roth conversions going forward so that my overall income stays below $200,000 because of this.
calwatch
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Re: Roth conversion "cost" in ARP tax credits

Post by calwatch »

To give you assurance, the qualifying widow is defined as "surviving spouse (as defined in [Internal Revenue Code] section 2(a))" in the law. Generally speaking the rights and phaseouts of MFJ apply uniformly to qualifying widows. https://www.congress.gov/bill/117th-con ... B3E4FC5A5F This also applies to the NIIT where the $250k phaseout for married filing jointly applies.

Afterwards you would be Head of Household and subject to the $112,500 phaseout. https://crsreports.congress.gov/product/pdf/IN/IN11613

I think you maximize the unique benefits of the American Rescue Plan while you can and worry about Roth conversion when your children phase out of the tax credit. Given current law you would make too much for the college tax credits.
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retiredjg
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Re: Roth conversion "cost" in ARP tax credits

Post by retiredjg »

GeekGal, as I recall, after being widowed, you decided to do some large Roth conversions during the years you were eligible to file as qualifying widow (same rate as MFJ). This year, 2021, is the last year of that plan.

In 2022, your tax rate will go up some because you will start filing as Head of Household. Then in 2026, tax rates are set to revert to the old higher percentages.

It appears that you have about $90k left to convert.

If I understand correctly, if you convert nothing in 2021, you will be in the 22% tax bracket with some room to spare. With similar income in 2022, I think you will be in the 24% tax bracket when you change to Head of Household. Do you get similar numbers?

If that is correct, it seems to me there is no great urgency in getting the entire Roth conversion completed in 2021, because you won't be paying that much more if you convert some in 2022 or even 2023.

I can't help at all on your main question. Hoping that someone who understands the ARP tax credits will be along to assist.
Topic Author
GeekGal
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Re: Roth conversion "cost" in ARP tax credits

Post by GeekGal »

danaht wrote: Wed May 19, 2021 3:24 pm Sorry I can't answer your main question - but.... If you are single be careful of the extra medicare 3.8% (net investment tax) surcharge on investment income above $200,000. Be sure you are aware that a Roth conversion could push your overall income above $200,000 - and then your being taxed at 23.8% instead of 20% for your qualified dividends/ long term capital gains (a lot more for short term capital gains) . I am trying to limit my Roth conversions going forward so that my overall income stays below $200,000 because of this.
Thank you. I need to learn more about the NIIT. But it is helpful to know that $200k for HoH/Single (and $250 for MFJ/QW) is another "threshold" for purposes of additional tax on dividends, LTCG, and STCG. I do not voluntarily have STCG because I have never sold anything, but when I did my 2020 taxes I noticed I did because one of the funds I hold distributed some.
Topic Author
GeekGal
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Re: Roth conversion "cost" in ARP tax credits

Post by GeekGal »

calwatch wrote: Wed May 19, 2021 3:48 pm To give you assurance, the qualifying widow is defined as "surviving spouse (as defined in [Internal Revenue Code] section 2(a))" in the law. Generally speaking the rights and phaseouts of MFJ apply uniformly to qualifying widows. https://www.congress.gov/bill/117th-con ... B3E4FC5A5F This also applies to the NIIT where the $250k phaseout for married filing jointly applies.

Afterwards you would be Head of Household and subject to the $112,500 phaseout. https://crsreports.congress.gov/product/pdf/IN/IN11613

I think you maximize the unique benefits of the American Rescue Plan while you can and worry about Roth conversion when your children phase out of the tax credit. Given current law you would make too much for the college tax credits.
OK, thank you for the links. I had looked at the language of the ARP, but have not been able to find the definition of "surviving spouse." I too thought MFJ carried over the QW until I realized it does not for the Child Tax Credit. Prior to the ARP (meaning for my 2020 taxes), for any other status except MFJ the child tax credit is reduced. Therefore, instead of the full $4,000 credit, I received $1,950 for tax year 2020.

Yes, perhaps it makes sense to maximize the unique benefits of the ARP. I am trying to figure out how the "lost tax benefits" compare to completing the conversion from tIRA to Roth.
Topic Author
GeekGal
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Re: Roth conversion "cost" in ARP tax credits

Post by GeekGal »

retiredjg wrote: Thu May 20, 2021 7:11 am GeekGal, as I recall, after being widowed, you decided to do some large Roth conversions during the years you were eligible to file as qualifying widow (same rate as MFJ). This year, 2021, is the last year of that plan.

In 2022, your tax rate will go up some because you will start filing as Head of Household. Then in 2026, tax rates are set to revert to the old higher percentages.

It appears that you have about $90k left to convert.

If I understand correctly, if you convert nothing in 2021, you will be in the 22% tax bracket with some room to spare. With similar income in 2022, I think you will be in the 24% tax bracket when you change to Head of Household. Do you get similar numbers?

If that is correct, it seems to me there is no great urgency in getting the entire Roth conversion completed in 2021, because you won't be paying that much more if you convert some in 2022 or even 2023.

I can't help at all on your main question. Hoping that someone who understands the ARP tax credits will be along to assist.
Yes, retiredjg, your recollection is correct.
And yes, I have about $92k left to convert (including ~$3,600 basis). So the taxable portion about be roughly $88k.

I agree with the tax brackets you indicate.

I think I am trying to figure out:

1. a more detailed question of the mechanics/math of the impact ARP for my 2021 taxes, both with and without the tIRA conversion, which will impact the Child Tax Credit, Dependent Care Tax Credit, and the Stimulus for me. This gets tricky because there are several "cliffs" - I think $125k for the Child Tax Credit; $150k for the Childcare tax credit and the stimulus, and others that I do not know about (like the $200/$250k for NIIT another poster mentioned). So, understanding the cliffs would help me figure out the amount to convert in 2021, if any, and how much beyond 2021 to extend the conversions to. Tax software would certainly help with number crunching, but I do not believe tax software for year 2021 is out yet.

2. a broader question regarding the "opportunity cost" of the growth of the Roth if I wait to convert beyond 2021 versus not maximizing the tax benefits of the ARP. The funds in the tIRA are only in a Money Market account. The Roth is primarily is VTSAX. Is it better to complete the conversion "forgo," say, $6,100 in tax credits? Or is it better to complete the conversion, be done with it, and not worry about the forgone tax credit since the Roth over my lifetime will likely earn much more than $6,100. I suppose I could invest the tIRA in VTSAX and I would not forgo growth (but may end up with more to convert; a good "problem" to have. Or, I could have less to convert as well if the market takes a downturn).

3. whether it makes sense to continue the FSA to reduce my AGI by ~$2,500 for the second half of tax year 2021. The deadline to decide was yesterday and I decided to continue to contribute to the FSA (so my AGI will be reduced by a total of ~$5,000 for year 2021. So, I expect AGI to be between $150k and $160k - within several of the "cliffs" within the ARP).

4. whether to eliminate the extra withholding from my paycheck. Since I am withholding the taxes due to the planned tIRA conversion, I would have significantly better cash flow if I decide not the complete the conversion earlier in the 2021 year and eliminated the "extra" tax withholding. I suppose a work around to this would be to get rid of the extra withholding and pay estimated taxes in the last quarter if I decide to proceed with the tIRA (but then have to deal with that horrid Form 2221 (?) again).
calwatch
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Re: Roth conversion "cost" in ARP tax credits

Post by calwatch »

GeekGal wrote: Sat May 22, 2021 1:05 pm
1. a more detailed question of the mechanics/math of the impact ARP for my 2021 taxes, both with and without the tIRA conversion, which will impact the Child Tax Credit, Dependent Care Tax Credit, and the Stimulus for me. This gets tricky because there are several "cliffs" - I think $125k for the Child Tax Credit; $150k for the Childcare tax credit and the stimulus, and others that I do not know about (like the $200/$250k for NIIT another poster mentioned). So, understanding the cliffs would help me figure out the amount to convert in 2021, if any, and how much beyond 2021 to extend the conversions to. Tax software would certainly help with number crunching, but I do not believe tax software for year 2021 is out yet.
Try the 2021 Excel 1040. https://sites.google.com/view/incometax ... authuser=0
Line 19 supposedly incorporate the American Rescue Plan credits, however it uses the old law of restricting credit to MFJ and not also qualifying widow(er).
2. a broader question regarding the "opportunity cost" of the growth of the Roth if I wait to convert beyond 2021 versus not maximizing the tax benefits of the ARP. The funds in the tIRA are only in a Money Market account. The Roth is primarily is VTSAX. Is it better to complete the conversion "forgo," say, $6,100 in tax credits? Or is it better to complete the conversion, be done with it, and not worry about the forgone tax credit since the Roth over my lifetime will likely earn much more than $6,100. I suppose I could invest the tIRA in VTSAX and I would not forgo growth (but may end up with more to convert; a good "problem" to have. Or, I could have less to convert as well if the market takes a downturn).
I would just invest based on your allocation. If the TIRA was part of your bond or emergency allocation then that is perfectly fine to have less volatile/less potential for growth in the TIRA knowing that you were going to convert in the future. But if you are just waiting for a chance to convert, and you aren't going to do it this year, then I would move it to match your overall allocation, or if you want to do more work put riskier/higher potential in Roth and less growth/potential in TIRA.
3. whether it makes sense to continue the FSA to reduce my AGI by ~$2,500 for the second half of tax year 2021. The deadline to decide was yesterday and I decided to continue to contribute to the FSA (so my AGI will be reduced by a total of ~$5,000 for year 2021. So, I expect AGI to be between $150k and $160k - within several of the "cliffs" within the ARP).
I think this is fine. You could do some tax loss harvesting if needed to bring yourself under the limit. I presume you already max the 401k.
4. whether to eliminate the extra withholding from my paycheck. Since I am withholding the taxes due to the planned tIRA conversion, I would have significantly better cash flow if I decide not the complete the conversion earlier in the 2021 year and eliminated the "extra" tax withholding. I suppose a work around to this would be to get rid of the extra withholding and pay estimated taxes in the last quarter if I decide to proceed with the tIRA (but then have to deal with that horrid Form 2221 (?) again).
As long as you paid 110% of the tax from last year (due to your income being over $150k) you would be in the safe harbor. I wouldn't worry too much about it, other than increasing withholding at the end of the year if you decide to convert so that the 110% safe harbor (of last year's taxes) is met.
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GeekGal
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Re: Roth conversion "cost" in ARP tax credits

Post by GeekGal »

calwatch wrote: Sat May 22, 2021 3:11 pm
Try the 2021 Excel 1040. https://sites.google.com/view/incometax ... authuser=0
Line 19 supposedly incorporate the American Rescue Plan credits, however it uses the old law of restricting credit to MFJ and not also qualifying widow(er).

Neat tool! Thank you.

*****

I would just invest based on your allocation. If the TIRA was part of your bond or emergency allocation then that is perfectly fine to have less volatile/less potential for growth in the TIRA knowing that you were going to convert in the future. But if you are just waiting for a chance to convert, and you aren't going to do it this year, then I would move it to match your overall allocation, or if you want to do more work put riskier/higher potential in Roth and less growth/potential in TIRA.

Yes, good point. I am not sure why I didn't invest the tIRA. I think I planned for conversion within 3 years of my husband's death in 2019 and did not want to fiddle with it too much, so the conversion amount is somewhat predicable. My asset allocation is 100% equities. In the back of my mind I have been considering reducing the equity portion since I am now 40 but I am not sure I would feel or do any different about a downturn if I had, say, 20% bonds. I plan to leave the Roth to my kids, so that will have many years to grow and I don't expect to change the Roth itself to anything but 100% stocks. So, if I extend the conversion of the tIRA well beyond 2021, then perhaps I should purchase VTSAX for the tIRA balance.

You bring up an interesting point about waiting until I no longer qualify for child tax credits to do the tIRA conversion. I think you are saying maximum my tax benefits while I can and then convert. This is a perspective I had not yet considered, so thank you. I would have to track the basis in the tIRA each year, although I am not versed well-enough in tax rules to know whether I would have to fill out Form 8606 even in years I do not convert anything. I suppose I could convert the tIRA slowly too (e.g., $6,000 a year or some other number), assuming in future years there are no special tax credits like those in the ARP that would put me over thresholds. I guess I thought completing the conversion before I no longer qualify for the QW/MFJ tax bracket makes sense, but there is the $200k cliff for the Child Tax Credit in normal years and the cliff is lower and more dramatic this year with the ARP.


*****

I think this is fine. You could do some tax loss harvesting if needed to bring yourself under the limit. I presume you already max the 401k.

Yes, tax-deferred account is at $19,500 annually. I am not familiar with tax loss harvesting and need to educate myself regarding it. No one know what the rest of the year or future years hold, but I (thankfully) don't have losses to claim right now.

*****

As long as you paid 110% of the tax from last year (due to your income being over $150k) you would be in the safe harbor. I wouldn't worry too much about it, other than increasing withholding at the end of the year if you decide to convert so that the 110% safe harbor (of last year's taxes) is met.

Safe harbor is something else I don't know a lot about (although I tried reading up on it; perhaps my tired brain has not been able to absorb it). Tax year 2020 I completed year 2 of my planned 3-year tIRA conversion. So, I paid my income tax due plus tax due to the partial tIRA conversion. So, in 2021 I would have to have paid 110% of the taxes due in 2020? If that is the case, then my withholdings being high still makes sense to qualify for safe harbor.
calwatch
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Re: Roth conversion "cost" in ARP tax credits

Post by calwatch »

I would suggest taking a look at the following Congressional Research Service reports which show how the child tax credit works under current law and when the Trump tax cuts (TCJA) expire:
https://crsreports.congress.gov/product/pdf/IN/IN11656
https://crsreports.congress.gov/product/pdf/IN/IN11613

Based on a rereading of the law it's very possible that the enhanced tax credit follows MFJ rules for qualifying widow(er)s but the normal credit follows single/HOH rules. Based on the $20,000 phaseout zone for HOH (page 4 of the second link), every dollar of income there is functionally a 5% tax per child. You should add that in your consideration of traditional to Roth conversions. Don't stress too much about this, as you still have many months to make a decision, but the charts should help.
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retiredjg
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Re: Roth conversion "cost" in ARP tax credits

Post by retiredjg »

GeekGal wrote: Sat May 22, 2021 6:39 pm You bring up an interesting point about waiting until I no longer qualify for child tax credits to do the tIRA conversion. I think you are saying maximum my tax benefits while I can and then convert. This is a perspective I had not yet considered, so thank you.
Some of these tax credit opportunities did not exist when you made your 3 year plan. You might have made a different plan had you known these credits were coming.

It is not unreasonable to change your plan when things change.

I would have to track the basis in the tIRA each year, although I am not versed well-enough in tax rules to know whether I would have to fill out Form 8606 even in years I do not convert anything.
The IRS says to file the form in years when it is needed to document something. In years when nothing changes, you do not need to file the form. However, you would want a copy of your last Form 8606 kept with current year paperwork so that the form does not get lost or forgotten.
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retiredjg
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Re: Roth conversion "cost" in ARP tax credits

Post by retiredjg »

GeekGal wrote: Sat May 22, 2021 1:05 pm 2. a broader question regarding the "opportunity cost" of the growth of the Roth if I wait to convert beyond 2021 versus not maximizing the tax benefits of the ARP. The funds in the tIRA are only in a Money Market account. The Roth is primarily is VTSAX. Is it better to complete the conversion "forgo," say, $6,100 in tax credits? Or is it better to complete the conversion, be done with it, and not worry about the forgone tax credit since the Roth over my lifetime will likely earn much more than $6,100. I suppose I could invest the tIRA in VTSAX and I would not forgo growth (but may end up with more to convert; a good "problem" to have. Or, I could have less to convert as well if the market takes a downturn).
I think part of this is just unknowable. It also probably does not matter much so I would not let this decision worry you very much. Your retirement and your kids' future does not balance on this decision. You should be just fine either way.

Sometimes you just have to make a choice without knowing all you want to know. Just follow your gut or follow your preferences or do half and half. Later on, be satisfied that you made what seemed to be the best decision at the time.
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GeekGal
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Re: Roth conversion "cost" in ARP tax credits

Post by GeekGal »

I have tried plugging in rough numbers into H&R Block's software for taxes year 2021. At this time, it indicates a difference of $2,450 in the child tax credit based on whether or not I convert the remaining tIRA to Roth, but it does not look like all of the updates to the software have yet occurred, including some related to the stimulus. The software says the forms will be updated with the IRS update in January 2022.

Given that the forms may not be up-to-date, I am not sure of other implications (and "cost" in loss of tax credits) that would be attributed to the Roth conversion.

It is probably sage advice to make the best decision I can based on the information I have now, and look back on this accordingly.

Thank you for your input.

-GG
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dodecahedron
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Re: Roth conversion "cost" in ARP tax credits

Post by dodecahedron »

GeekGal wrote: Wed May 19, 2021 2:48 pm $200k threshold for QW without ARP (so the typical $4,000 child credit gets reduced after AGI exceeds $200k. For 2020 it was $1950 for me)
I am not sure if cut off with the ARP-related enhancements for Qualifying Widow cut off at the AGI level of $75k or $150k. Does anyone know?
Good question! The cutoff for the $4,000 ARP-enhanced CTC for Qualifying Widow is MAGI of $150,000. Above that income level, the $4,000 starts phasing down to $2,000. For incomes below that level, a QW gets the full $4,000.

See Question C4 at this irs.gov page for a definitive statement from the IRS.
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GeekGal
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Re: Roth conversion "cost" in ARP tax credits

Post by GeekGal »

Thank you for pointing this out!
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