In general, any amount that is converted (or rolled over) from an eligible retirement plan to a Roth IRA is includible in gross income as a distribution for the tax year in which the amount is distributed or transferred from the eligible retirement plan. 5
See §24,450 for the rules on taxation of distributions.
In general, the 10-percent penalty tax under Code Sec. 72(t) does not apply to the taxable conversion amount. 10 See §25,525 for a discussion of the 10-percent penalty tax.
Under the Code Sec. 408(d)(2) distribution rules, all of the taxpayer’s traditional IRAs, and all the basis in those IRAs, are combined. This can lead to an unanticipated result when a taxpayer who has both a regular and a non-deductible IRA converts only the non-deductible IRA.
Jane has made fifteen $2,000 contributions ($30,000) to her non-deductible IRA. This year, when the balance in the account is $40,000, she converts it to a Roth IRA. Jane also has an IRA that she established with a rollover from a former employer’s Code Sec. 401(k) plan that has $60,000. If she converts only the non-deductible IRA into a Roth IRA, she can use only $12,000 of her basis (($30,000/$100,000 × $40,000) and is taxed on $28,000 ($40,000 – $12,000).
Under the rules on IRA distributions, the amount that is included in income generally is the value of the non-Roth IRA. However, any portion that would not be taxed (because it represents the return of basis) if it were actually distributed is not taxed. Reg. §1.408A-4, Q&A-7.
In general, any taxable conversion amount includible in gross income for a year is included in income for all purposes. Reg. §1.408A-4, Q&A-9. For example, it is counted for purposes of determining the taxable portion of social security payments under Code Sec. 86 and for purposes of determining the phaseout of the $25,000 exemption under Code Sec. 469(i) (relating to the disallowance of passive activity losses from rental real estate activities). However, the taxable conversion amount (and any resulting change in other elements of adjusted gross income) is disregarded for purposes of determining modified AGI for Code Sec. 408A and Reg. §1.408A-4, Q&A-9. Reg. §1.408A-3, Q&A-5.
Finally, an individual can convert a regular IRA to a Roth IRA if she is receiving substantially equal periodic payments within the meaning of Code Sec. 72(t)(2)(A)(iv) from the regular IRA. Reg. §1.408A-4, Q&A-12. Not only is the conversion amount itself not subject to the early distribution tax under Code Sec. 72(t), but the conversion amount is also not treated as a distribution for purposes of determining whether a modification has occurred within the meaning of Code Sec. 72(t)(4)(A). Distributions from the Roth IRA that are part of the original series of substantially equal periodic payments will be non-qualified distributions from the Roth IRA until they meet the requirements for being a qualified distribution. Reg. §1.408A-4, Q&A-12. For a discussion of the qualified distribution rules, see §25,525.10.
The additional 10-percent tax under Code Sec. 72(t) does not apply to the extent the non-qualified distributions described above are part of a series of substantially equal periodic payments. Reg. §1.408A-4, Q&A-12. However, if the original series of substantially equal periodic payments does not continue to be distributed in substantially equal periodic payments from the Roth IRA after the conversion, the series of payments will have been modified and, if this modification occurs within five years of the first payment or before the individual is disabled or attains age 59 ½, the taxpayer will be subject to the recapture tax of Code Sec. 72(t)(4)(A) and Reg. §1.408A-4, Q&A-12.
Code Sec. 408A(d)(3)(A); Reg. §1.408A-4, Q&A-7(a); Notice 2009-75, 2009-39 IRB 436.
Code Sec. 408A(d)(3)(A)(ii); Reg. §1.408A-4, Q&A-7(b).