Determining whether a taxpayer might benefit from a Roth IRA conversion.

Facts: Harry Headache, a long-time client, seeks his tax adviser's counsel as to whether to convert the $125,000 balance in his regular IRA to a Roth IRA. Harry is married to Greta; both are age 63. Their joint 2000 modified adjusted gross income (MAGI) will be approximately $78,000. The following is a checklist of factors the tax adviser should consider when talking to Harry about conversion.

Taxpayer: -- Tax Year: --

Prepared by: -- Reviewed by: --

Purpose of this checklist: This checklist can be used as a review of the factors of a given client situation to help determine whether the taxpayer might benefit from a Roth IRA conversion. Questions with a "yes" response generally indicate a factor in favor of a Roth conversion. A "no" response normally indicates a potential problem with a conversion.

                                                   Yes   No   N/A

1. Will the taxpayer's joint MAGI be $100,000 or
less in the year of the conversion? (If no, a
conversion is not allowed.)                        --    --   --

2. If married, are the taxpayers filing a joint
return for the year of the conversion? (If no, a
conversion is not allowed.)                        --    --   --

3. Does the taxpayer understand the Roth IRA
withdrawal provisions (e.g., five-year holding
period, exceptions to early withholding
penalties, etc.) as they relate to rollover
(conversion) accounts?                             --    --   --

4. Will the taxpayer's income or estate tax
planning, or both, benefit from not having to
take minimum distributions from the IRA
beginning at age 70 1/2? A taxpayer is not
required to take distributions from a Roth IRA
at a certain age; the pre-death minimum
distribution rules for traditional IRAs do not
apply.                                             --    --   --

5. Would the taxpayer benefit from the ability
to name new beneficiaries of the IRAs after age
70 1/2? April 1 of the year after a taxpayer
turns age 70 1/2 is the deadline for selecting
beneficiaries that will have a positive effect
on the minimum distributions the taxpayer is
required to take from a traditional IRA. Under a
traditional IRA, after this date, a taxpayer can
still change beneficiaries, but the new
beneficiary will be ignored for purposes of the
minimum distribution rules, unless he is older
than the previous beneficiary (in which case,
the life expectancy of the new beneficiary will
cause the taxpayer's required minimum
distribution to increase). Because the minimum
distribution rules do not apply to a Roth IRA
until the IRA owner's death, the account's
beneficiary can be changed at any time (and have
an effect on the minimum distributions required
after the owner's death), even if it is past
April 1 of the year after the owner turns age
70 1/2.                                            --    --   --

6. Does the taxpayer want to maximize the amount
passed on to heirs?                                --    --   --

7. Does the taxpayer have non-IRA funds available
to pay the income taxes on a Roth IRA conversion
(thus maximizing the IRA funds that can build up
tax-free)?                                         --    --   --

8. Will a conversion have minimal (or no) negative
effect oil the taxpayer's ability to claim
AGI-sensitive deductions, credits or exclusions?
For example, because of the additional income
caused by a Roth conversion, a taxpayer might not
be able to claim such benefits as the child
or education tax credits, adoption credit or
deduction for interest expense on a loan for higher
education expenses. Other items that could be
adversely affected by an increase in income
include the $25,000 rental exception to the
passive loss rules, the personal exemption and
general itemized deduction phaseouts, the medical
and miscellaneous deductions and the $2,000
regular IRA deduction for individuals covered
by a pension plan. In addition, if the taxpayer
is receiving Social Security benefits, more of
the benefits could be subject to tax.               --   --   --

9. Have the alternative minimum tax (AMT)
implications of the conversion been considered?
(Because of the increased regular income caused
by the conversion, the AMT effect of a conversion
should be positive or neutral.)                     --   --   --

10. Have the state inheritance tax implications
of a conversion been considered? (Because the
income tax paid at conversion reduces the taxable
estate, the impact should be favorable in a
taxable estate or neutral in a nontaxable one.)     --   --   --

11. If the taxpayer's Federal and state estimated
income tax (or withholding) payments are not
based on a "safe" estimate for the conversion year,
has the income triggered by the conversion
been considered when determining the need to make
or increase estimated tax payments?                 --   --   --

12. Do taxpayers who intend to make charitable
bequests at death have assets other than the
Roth IRA with which to fund the bequests? Unless
a traditional IRA is used to fund a pecuniary
(fixed dollar) charitable bequest, leaving a
traditional IRA to charity allows the lRA
owner's estate and beneficiaries to avoid paying
income tax related to the IRA. In such a situation,
there is no reason to convert to a Roth; the
conversion will trigger a tax liability that
could be avoided if the charity is simply named
the beneficiary of the traditional IRA.             --   --   --

13. Have professionals and others who might be
concerned about asset protection issues had
their attorneys confirm that the applicable state
laws provide protection for the Roth IRA that
is at least as good as the protection they provide
for traditional IRAs? Because some state
statutes refer specifically to Sec. 408 (for
traditional IRAs) or otherwise apply only to
traditional IRAs, assets in a Roth IRA may not
have the same protection against creditors as
those inside a traditional IRA.                     --   --   --

14. Does the taxpayer anticipate leaving the
funds in the Roth IRA for an extended period
of time (probably at least 10 to 20 years)?
(Without this length of time or more, the benefit
of tax-free income generated by the Roth IRA may
not offset the detriment of having to pay
tax at the time the funds are converted.)           --   --   --

15. When the taxpayer (or his beneficiaries)
takes distributions from the Roth IRA, is it
likely the person receiving the distributions
will be in at least as high a tax bracket as
that applied to the taxpayer on conversion?         --   --   --

16. Does the taxpayer have a relatively high basis
in existing IRAs (because of nondeductible
contributions)? (A higher basis minimizes the
amount of income triggered, because of a conversion
of funds to a Roth IRA.)                            --   --   --

17. Is it likely the taxpayer would not have to
pay income tax on Social Security benefits if it
were not for the requirement to take minimum
required distributions from traditional IRAs?       --   --   --

18. Is it likely that the income from a conversion
will not be taxed at a high rate, because
of expiring net operating loss carryovers or
other carryovers, higher than normal deductions,
low cyclical income, etc.?                          --   --   --

Editor's note: This case study has been adapted from "Guide to Tax Planning For Individuals," 4th Edition, by Anthony De Chellis, Douglas L. Weinbrenner, Catherine A. Roeder and James F. Reeves, published by Practitioners Publishing Company, Fort Worth, Tex. 1999.

Albert B. Ellentuck, Esq.
of Counsel
King and Nordlinger, L.L.P.
Arlington, VA