Roth IRA Conversion Rules

Owner must pay taxes on pretax amounts converted

When converting IRA assets to a Roth IRA, the IRA owner must pay tax on all pretax (deductible) assets. Although the assets are taxed, they are not subject to the 10 percent early distribution penalty tax if properly converted into a Roth IRA.

IRA owners must include all pretax assets that are converted to Roth IRAs in their taxable income (but no 10 percent early distribution penalty tax) (IRC Sec. 408A(d)(3)(A)(i) and (ii)).

Form 1099R and Form 5498 Reporting Applies

An IRA distribution that is directly converted to a Roth IRA is reported on Form 1099-R, Box 7, using distribution code 2, Early distribution, exception applies (for IRA owners under age 591⁄2), or code 7, Normal distribution (for IRA owners age 591⁄2 and older). A financial organization that receives a direct conversion reports the amount as a conversion contribution in Box 3 of Form 5498. The 60-day and one-per-12-month rollover restrictions do not apply.

The distributing IRA financial organization must send Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., to the IRS and the individual receiving the distribution.

Form 1099-R generally must be submitted to the IRA owner by January 31 and to the IRS by February 28 if filing on paper, or March 31 if filing electronically.

Conversions Included in Income

An individual generally must include in taxable income in the year the converted assets are distributed from the Traditional IRA any amounts consisting of pretax contributions (salary deferrals, employer contributions, or deductible IRA contributions).

EXAMPLE: Barb has a Traditional IRA to which she has made only deductible IRA contributions. In 2015, Barb decides to convert her Traditional IRA to a Roth IRA. The taxable amount of the Traditional IRA assets converted is $30,000. Barb will include $30,000 in income in 2015.

Conversion of Property

When individuals receive property (such as shares of stock) as part of a Traditional IRA distribution to convert to a Roth IRA, that same property must be converted. The financial organization must be able to take legal title to the property.

Reporting the conversion on your personal tax return

Report the taxable part of the distribution on lines 15a and 15b of Form 1040.

File Form 1099R, which is provided by the IRA custodian, with your 1040.

About Mark Nolan

Each day I speak with energetic entrepreneurs looking to take the plunge into a new venture and small business owners eager to take control of their retirement savings. I am passionate about helping others find their financial independence. Having worked for over 20 years with some of the top retirement account custodian and insurance companies I have a deep and extensive knowledge of the complexities of self-directed 401ks and IRAs as well as retirement plan regulations. Learn more about Mark Nolan and My Solo 401k Financial >>

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