I’ve been fighting with my Smith Barney investment advisors for almost two weeks now regarding two $6,000 after tax traditional IRA we took out in early 2010 to apply to 2009. We were told we could convert later in 2010 without incurring any added taxes. I was confused to say the least with the results I was getting from running TurboTax. I went in circles with Smith Barney until I’ve finally threw in the towel.

In addition to doing two $6,000 Roth conversion, I rolled over $105,000 from my 401k plan, which by year’s end was valued at $110,000. My wife had rolled over $34,000 into a traditional IRA in 2009, which by the end of 2010 was valued at $40,000. Form 8606 (which is calculated when running TurboTax) showed $5700 of the $6000 was taxable (110,000/116,000 times 6,000). My marginal tax rate is 25%, so I have a choice to pay $1422 this year, or split the $5700 of increased income until l 2011 and 2012. If my marginal rate stays the same, I’ll just defer paying the taxes.

It was a shock to find out we could owe $2726 for 2010, rather than $0 as we were led to believe. Of course we could split the payment over 2 years which is what we were going to do. Either that, or re-characterize to reverse the Roth back into a non-deductible traditional IRA.

I came up with second strategy for myself. Since I’m “retired”, I am able to amend my 2009 return to change my non-deductible traditional IRA into a deductible IRA. I am no longer able to contribute to my company’s 401k, I’m over 59 1/2, so I eligible. This allows me to get an amended return for 2009 (roughly $1500). I can take a deductible IRA for 2010 also. This is even though we are way over the AGI threshold. Since I’ve already converted the 2009 contribution to Roth, I’ll end up paying taxes on the $6,000, but on $3,000 in 2011 and $3,000 in 2012. Since my wife just retired, our AGI for 2011 and 2012 will be a lot lower than previous. I’m guessing we’ll be in the 15% marginal rate bracket. so 15% of $12,000 worth of my two conversions will generated $1800 in owed taxes going forward, whereas, the reduction in taxes 2009 and 2010 is $3,000. So assuming, a 10% difference in marginal rate, I could end up paying $1200 less in taxes, while deferring paying them by 2 years.

In my wife’s case, the numbers crunch out to a taxable income increase of $5217 (40/46 time 6,000). At 25% (take the hit all at once), our taxes would increase $1304 for 2010 (or could be split to 2011 and 2012). Our MAGI is apparently too high, so she can’t amend the return to make her’s deductible.

I’m guessing my explanation is probably confusing.

I’d appreciate it a lot, if you could confirm whether I understand how all this works, or add what I missed or don’t understand. It would be wonderful, if I could somehow convince my Smith Barney folks, they are the ones who are doing their taxes wrong. I’d like to believe them, as doing it their way could save me a lot in taxes.

My wife has had it up to here with listening to me talk about this issue. She is begging me to let someone do my taxes next year and going forward. You seem to have a good handle on this apparently confusing issue.

I’d like to have my tax guru where I live. But even more important, is I like my tax man to be a tax guru to start with. My Smith Barney advisor called her CPA to verify that converting to a Roth IRA is not taxable. NEVER, NEVER. I think there is at least one exception. Please let me know.

Steve