ROTH conversions have been in the news and on the minds of tax preparers and investment advisors for years, thanks impart to periodic legislation providing for deferral on the taxable income created from the conversion. And although the rules covering 2011 conversions do not provide for deferral of income and taxes, as was possible in 2010, we are finding that this is still the time for many of our clients to consider conversion.

Let’s backup a moment and discuss the merits of the ROTH. The traditional retirement plans, think 401(k) or traditional IRA, allow you to defer income on a tax free basis until which time you begin to make withdrawals. As the money comes out of a traditional plan, you pay taxes at the rates enacted at that time. Conversely, ROTH IRAs allow you to defer post tax income, allowing for tax free withdrawals in the future.

ROTHs make sense for many taxpayers, but it is a particularly attractive retirement vehicle for those expecting a higher effective tax rate at retirement. Additionally, the longer period of time the funds in a ROTH IRA have to grow, the more benefit you will see.

Roth conversions do not come without a price. With converted funds being taxed in the year of conversion, there is a significant tax cost associated with conversion. Historically conversion has made sense only for those taxpayers with surplus cash to pay the toll charge on conversion. However, there are scenarios with limited or no out of pocket cash associated with conversion and we are seeing these scenarios with increasing frequency.

With many taxpayers seeing losses appear on their individual returns due to investments in pass-through entities and piling or expiring credits and carryforwards, a ROTH conversion may become a tool to utilize these attributes and likewise, these attributes may become a tool for allowing conversion by softening or eliminating the upfront tax associated with conversion. The tax attributes that may provide for a reduced or eliminated tax liability on conversion are:

• Current year losses
• Loss carryforwards
• Charitable contribution carryforwards
• Current year tax credits
• Tax credit carryforwards

With any of these attributes present, a ROTH conversion is something to consider, but if attributes are nearing expiration, consideration becomes increasingly important. To the extent taxpayers are able to leverage attributes that would otherwise have expired to offset taxes due on conversion to a ROTH IRA, they will avoid paying taxes on their retirement funds when withdrawn at little to no tax cost upfront.

The combination of rate uncertainty and the recent downturn in the economy are making now the right time for many of our clients, particularly those who prior to the 2010 tax year, were unable to convert to a ROTH IRA due to the previous income limitation. The income limitation was repealed for tax years beginning after December 31, 2009.

IRS Circular 230 Notice: IRS regulations require us to inform you that any tax advice in this communication is not intended or written to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer or (ii) promoting, marketing or recommending to another party any matters addressed herein.