Heads Up - Roth Conversions Looking Better

Attention High Income Taxpayers. Several months ago our newsletter was devoted to the favorable tax law provisions for Roth conversions in 2010. Since then there has been continued publicity in the financial press about this opportunity for high income taxpayers to make a Roth conversion. The year 2010 offers special benefits for Roth conversions, spreading the taxable income into 2011 and 2012, delaying the final payment of the tax until 2013.

While 2010 offers favorable tax results, there are new rules to the game since our August, 2009 newsletter.

New Tax Looms. High income taxpayers need to be especially vigilant about tax increases that:

1) Have already been included in the new health bill; and,
2) Pending increases in tax rates on ordinary income, capital gains and dividends.

Health Bill. The new health bill has two surtaxes which are interactive. First is a 0.9% levy on earned income. The second is a 3.8% Medicare surtax on unearned income. While taxable income recognized on a Roth conversation from an IRA payment may not be subject to surtax, it may have the effect of pushing up Adjusted Gross Income (AGI), subjecting other income to a Medicare surtax.

New Tax Proposals. As everyone knows, the 2001 tax cuts expire at the end of 2010. Tax rates on ordinary income, capital gain and dividends would go up in that event. There are several proposals around Washington, including those proposed by the Obama Administration that would significantly change the tax consequences of Roth conversion income for high income taxpayers. At this point, no one knows what will come out of Congress to address the staggering high deficits the country is incurring.

The bottom line is that high income tax payers need to be in continuous communication with their financial planners and CPA's to analyze what the financial impact would be from both the health care bill, new income tax legislation and the Roth conversion provisions, including the 2010 option to defer income.

From today's perspective, it appears that tax rates on all type of income are likely to increase for high income taxpayers. Therefore, deferral of income recognized on Roth conversions in 2010 may not be such a good idea.

Run The Numbers. No matter how these changes come about, each taxpayer has to run the numbers on his or her situation, types of income and future expectations to determine the best course of action from a tax standpoint. Overall, it would appear that high income taxpayers are going wind up paying more after 2010 so Roth conversions this year look appealing for these individuals.

Recharacterization. In this whole area of planning, an important aspect is the ability, after the fact, to reverse course, put the funds back into a regular IRA, and treat the whole Roth conversion as never having happened. In other words, a taxpayer gets a limited benefit of 20/20 hindsight and can reverse prior action without suffering a tax liability or penalty. This makes action in 2010 pretty appealing, if you can study tax rates, which may not be finalized for future years. For example, the 2010 election might bring about some changes in legislation that would increase taxes on conversions made this year. If those changes come about, recharacterization and reversing course might be a good alternative.

Bottom Line. Our never simple tax system is getting more complicated for high income taxpayers. So what else is new! It will behoove high income taxpayers, especially older individuals with large IRA�s to study the potential of Roth conversions in 2010, run the numbers and see if higher tax rates in the future make a 2010 Roth conversion a sound plan.

Beneficiary Designations. One further note, beneficiary designations on all retirement plans, including IRAs and Roths are generally an important part of estate planning for high net worth individuals. Financial planners often recommend individual beneficiaries without studying the impact that decision has on the overall estate plan. Sometimes, benefits should be divided among family members. Sometimes a trust is the best beneficiary to accomplish family objectives.

With the crazy estate tax situation in 2010 not yet remedied, estate planning for higher net worth individuals is important and constant vigilance needs to be maintained, especially this year.

Conclusion. If you want a current review of your estate planning documents with the estate tax limbo we now live in, please call James R. Modrall III or Thomas A. Pezzetti, Jr. or any of the attorneys listed below.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau, David H. Rowe and Nicole R. Graf at (231) 941-9660

BRANDT, FISHER, ALWARD & PEZZETTI, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional advice.