In the instructions for IRS Form 1040A, reference is made for an Estimated Tax Penalty. Under "Exceptions to the Penalty," it states that if a tax is owed with the tax return, no penalty will be owed if there was no tax liability for the prior year. I want to make sure this applies to us. My wife and I are retired and will have no tax liability for 1997. We plan to either make a sizable withdrawal from our IRAs (approximately $60,000), and/or convert our present conventional IRAs (approximately $300,000) to the new Roth IRA. This will be taxable as income. I would rather not make estimated payments if no penalty will be encountered (I would like to earn the interest income!). Also, where can we obtain information on ALL of the ins and outs of the new Roth IRA?
Your understanding of the penalty rules is correct. Assuming you file a tax return for 1997 showing no tax liability and that tax return is for the full 12 months of 1997, there will be no estimated tax payment requirements for 1998. You'll be able to wait and pay all of your tax when you file your tax return. "No tax liability" means there was no tax at all on your 1997 tax return, not just that there was no tax due with the tax return. You could have paid in all of your 1997 tax through withholding and estimated payments and have no tax owing when you file your 1997 tax return, but there would still be a tax reflected on the return. If that is the case, you would be liable for estimated payments for 1998.
Please plan carefully with regard to your IRA accounts. You mentioned that you are considering converting your IRAs to the Roth IRA in 1998 and that your IRAs total approximately $300,000. The amount you convert to a Roth IRA will have to be included in your income for 1998. In order to convert IRA funds to a Roth IRA, your adjusted gross income for the year cannot exceed $100,000, assuming you and your wife file jointly. (You may not convert IRA funds to a Roth IRA if you file separately.)
When you convert IRA funds to a Roth IRA, any amounts in your IRA not previously taxed will be considered income in the year of conversion. If you have securities in your IRA the tax will be applied as if you sold the securities on the day of the conversion. For example, 100 shares of stock valued at $100 per share on the day of conversion will add $10,000 of ordinary income to your tax return (there is no capital gain tax treatment when considering amounts converted or withdrawn from an IRA).
The tax resulting from any IRA amounts you convert to a Roth IRA during 1998 will be eligible for a special four-year averaging. The form for this averaging won't be available until much later in 1998, and of course you won. t need the form until you prepare your 1998 income tax return.
If you don't want to convert the entire amount of your IRAs to Roth status during 1998, you can make a conversion of additional funds in ensuing years. The four-year averaging of income tax, however, only applies to 1998 taxes, as the law currently stands.
As for the ins and outs of the Roth rules, you will have to wait a bit longer. Congress unleashed this new program on the American public without thoroughly considering its implications. There are many unanswered questions (such as, what happens if you converted funds to a Roth IRA early in the year, then find out later on that your income exceeds the allowable threshold?) and conflicting statements in this legislation. Expect additional legislation on many aspects of the new tax law, particular the Roth IRA, during 1998.
copyright © 1998 - Gail Perry