Roth Conversion of IRA Can Make Social Security Income
Taxable
As seniors near the age of 70½, they are faced with
the government's requirement that they receive distributions from their
Individual Retirement Accounts (IRAs). One popular tactic for avoiding these
required distributions is rolling the IRA over into a Roth IRA. Doing this
triggers a tax on the money transferred, but once it's in the Roth
IRA, it can stay there tax-free indefinitely. This strategy can have benefits
in the long run, but only if your circumstances are right. Such a transfer
could have dire tax consequences for those with social security benefits.
This is because proceeds from the conversion of a traditional IRA to a Roth
IRA are considered income for the purpose of determining whether or not
Social Security benefits are taxable. In an unfortunate 2002 case, a couple
inadvertently rendered their previously untaxed Social Security income taxable
with just such a transfer.
Robert and Sara Helm converted their IRAs to Roth IRAs, realizing
over $85,000 of conversion income. They had anticipated this and elected
to report the income on a 4-year ratable basis, reporting about $21,400
on their income tax returns. They did not report their Social Security benefits,
which they figured would not be taxable. However, the IRS determined the
benefits were taxable due to the extra income from the IRA conversions.
The Helms argued that because they had not actually received
any money from the conversions, the amount of realized income should not
be considered when determining whether or not their Social Security benefits
were taxable. But the Tax Court disagreed, pointing out that for tax purposes,
an amount converted from a traditional IRA to a Roth IRA is treated as a
taxable distribution and qualified rollover and is included in gross income.
Remember, every circumstance is unique. If you own IRAs and
aren't sure of the best course of action, please consult an estate
planning professional. As this case painfully illustrates, even a small
misunderstanding of the complexities of tax law can result in serious financial
consequences.
Source: Helm v. Commr., Tax Ct. Sum. Op. 2002-138,
10-18-02
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