President Obama has proposed raising tax rates on high income taxpayers, as of 2011. Thus, you might want to convert your traditional IRA to a Roth IRA, so that withdrawals eventually can be tax-free. However, when you convert you’ll owe income tax on the as-yet-untaxed dollars moving into your Roth IRA.
Roth IRA conversions in 2010 get a one-year-only tax break. When you fill out your tax return for 2010, you can pay the income tax on the conversion. That may be a good choice if your income tax rate is scheduled to rise in 2011 and later years.
On the other hand, you may discover that your tax rate is not scheduled to increase. If that’s the case, you can omit that tax payment for 2010. You’ll report half the taxable income from the conversion on your 2011 tax return and the other half on your 2012 return.
Caution: If you convert your traditional IRA to a Roth IRA this year and wind up paying the tax on 2010 income, you might owe an underpayment penalty. To avoid a penalty, use a safe harbor: through payroll withholding and estimated tax payments, pay at least 100% of your 2009 tax obligation in 2010, or 110% of your 2009 tax obligation if your adjusted gross income is over $150,000.
