The opportunity was to accumulate additional value during 2010 while deferring the tax to 2011 and 2012.

Here is a link to an article I wrote about Roth conversions during 2010. http://www.taxtrimmers.com/rothconversion.shtml

During the last few months, there has been a significant decline in the stock market. Some taxpayers may find that they are paying income taxes for a value that no longer exists.

For example, if the value of the Roth account converted from a regular IRA during 2010 declined from $200,000 to $100,000 and the taxpayer is subject to the maximum 35% federal income tax rate, the federal income tax attributable to the Roth conversion could be reduced from $70,000 to $35,000 by “undoing” the 2010 Roth conversion and then making the conversion in 2011.

The Internal Revenue Code permits this reversal to be done. It is called a “recharacterization”. The Roth account trustee must be notified of the intention to recharacterize the Roth conversion to a transfer to a regular IRA account. The plan assets must also be transferred from the Roth IRA account to a regular IRA account in a trustee-to-trustee transfer. According to questions and answers posted to the IRS web site (www.irs.gov), the final date for the notice and transfer to be done for a 2010 Roth conversion is October 17, 2011.

When a recharacterization for 2010 is done, a Roth conversion can’t be done for 2011 until more than 30 days after the date of the recharacteriation.

There is some inconvenience involved in doing a recharacterization, including filing an amended 2010 income tax return if your has already been filed. The amended return can be done after October 17, 2011. If the decline in value has been small, I would leave the Roth conversion alone.

If you are wondering if you should “undo” a Roth conversion, I recommend that you consult with your investment advisor/financial planner and your tax advisor.

IRS Circular 230 Disclosure:

As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

Remember you can find past episodes at www.financialinsiderweekly.com under “past episodes”.

Remember you can find past episodes at www.financialinsiderweekly.com under “past episodes”.

Remember you can find past episodes at www.financialinsiderweekly.com under “past episodes”.

Here is a link to my article on the subject. http://www.taxtrimmers.com/rothconversion.shtml

Where do you report the conversion on your federal income tax return?

You report it at Part II of Form 8606.

Check the box at line 19 if you elect to have all of the income for the conversion taxed in 2010, and indicate the amount in the box on the same line. Otherwise, indicate the amounts taxable in 2011 and 2012 on lines 20a and 20b.

Remember you can find past episodes at www.financialinsiderweekly.com under “past episodes”.

For 2010 only, the account owner can choose to have the taxable accumulation of the the account taxed one-half in 2011 and one-half in 2012, or to have the entire amount taxed in 2010. Since we now know the federal tax rates won’t increase for 2011 and 2012, the Roth conversion looks much more attractive.

There is still the issue of coming up with the cash to pay the income taxes. In order to get the maximum benefit from the conversion, all of the funds should be kept in the Roth account. Most individuals don’t have liquid funds available to pay the tax for the conversion.