19 Oct What taxes are paid when you convert to a Roth IRA?

Q. When you convert a traditional IRA to a Roth IRA, do you pay ordinary income tax or capital gains tax? And can the taxes be paid directly from part of the converted funds or must they be paid from other funds that the converter owns?
— Taxpayer

A. Thanks for your question.

Conversions from a traditional IRA to Roth IRA are taxed as ordinary income.

Ordinary income is taxed based on your tax bracket, said Gail Rosen, a Martinsville-based certified public accountant.

For example, if you convert $10,000 pre-tax retirement dollars into a Roth IRA, and you are in the 22% federal and 5.5% NJ tax bracket, then your tax bill on the conversion should be approximately $2,750, she said.

Normally, taxes paid from your retirement account would count as a taxable distribution, which can be subject to a 10% penalty tax on early withdrawals if you’re under 59 ½, Rosen said.

But the CARES Act eliminated that penalty, at least for the time being.

“I recommend paying the taxes owed from the converted fund using after-tax money to avoid the potential penalty and maximize the amount of your Roth IRA,” Rosen said.

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This story was originally published on Oct. 19, 2020.

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