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When Should You Pay Taxes on Your 2010 Roth Conversion?

If you’re planning to make a 2010 Roth conversion [1], you’re going to be given an interesting choice on your Roth conversion and when to pay tax: pay the taxes now or spread the Roth conversion taxes over two years.

Roth Conversion When to Pay Tax?

For 2010 Roth conversions, your options of when to pay tax are:

  • Include the entire Roth conversion on your 2010 taxes.
  • Include half of the Roth conversion on your 2011 taxes and half on your 2012 taxes.

Spreading the Roth conversion over two years will be the automatic option. However, if you want, you can elect to have the entire conversion included in your 2010 taxes.

Which Year Should You Pay the Taxes?

Here is where a little planning will come into play for the tax treatment of Roth conversions [2]. Depending on your situation, you might be better off to include the Roth conversion and pay the taxes in 2010.

If your taxes will be higher in 2011 and 2012, because the future tax rates [3] might be higher than they are currently, it might be better to elect the income to be included in 2010.

In addition, you’ll have to estimate your income in the next three years. If you expect higher income in 2011-2012 than in 2010, it might be better to go ahead and include the income in 2010.

The good news is that you’ll be able to wait awhile to see what happens to the tax rates and how much income you’ll have before you make your election. You likely won’t have to make your election until the tax deadline [4] next year.

You can also see other Roth IRA conversion considerations [5].

How to Pay Taxes on Roth Conversions

The tax you pay on your Roth conversion will be reported on your income taxes. The amount of tax will be calculated based on including your conversion amount in your taxable income subject to the tax brackets [6] based on the year you elect.

To make sure you have enough withheld to cover the increase in taxes, you may want increase your withholding with your employer or make quarterly tax payments for a Roth conversion.

And if it turns out that you’ll owe more in taxes than you anticipated, you can always do a recharacterization [7].

Avoid Taxes on Roth IRA Conversions

If you don’t want to pay tax at all, you can always implement the 2010 Roth IRA conversion loophole [8] or look into the Roth Conversion Strategy to Minimize Taxes [9].