You can calculate your estimated ROTH IRA conversion tax by multiplying the total value of your traditional IRA by your ordinary tax rate. Please note this presumes that your traditional IRA is comprised of pre-tax funds which is not always the case. On that note, I will discuss additional considerations in calculating your ROTH IRA conversion tax.

Determining Your Ordinary Income Tax Rate

1. Determine Your Taxable Income:
   • Start with your total income, which includes wages, interest, dividends, business income, and other income sources.
   • Subtract any adjustments to income, sometimes referred to as “above-the-line deductions.” These can include contributions to certain retirement accounts, student loan interest, and others.
   • Subtract either the standard deduction or your itemized deductions, whichever you choose to use.
   • The result is your taxable income.
2. Consult the IRS Tax Brackets: Each year, the IRS releases tax brackets that indicate the tax rate for different ranges of taxable income. These brackets vary based on your filing status (e.g., Single, Married Filing Jointly, Head of Household). You can find 2023 tax brackets here. 
3. Apply Your Taxable Income to the Brackets: Find where your taxable income falls within the tax brackets for your filing status. The rate at which the last dollar of your income is taxed is your marginal tax rate. However, due to the progressive nature of the U.S. tax system, your income will be taxed at different rates as it moves through the brackets.

Calculate State Taxes

If you live in a state that has an income tax, you’ll also need to factor this in when determining your conversion tax.

After-Tax Contributions (Non-Deductible Contributions)

If you made non-deductible contributions to your Traditional IRA (meaning you contributed with after-tax money and did not take a tax deduction for those contributions), the conversion of these contributions to a Roth IRA is not taxable. This is because you’ve already paid taxes on this money. However, the earnings on these after-tax contributions are still taxable when converted.

Pro-Rata Rule

If your Traditional IRA contains a mix of pre-tax and after-tax contributions, the conversion gets a bit more complicated due to the pro-rata rule. You can’t just choose to convert only the after-tax contributions to avoid taxes. Instead, the taxable amount of the conversion is determined on a pro-rata basis, considering the entire balance of all your Traditional IRAs.

For example, if 20% of your total Traditional IRA funds are after-tax contributions, and you convert a portion of your IRA to a Roth, only 20% of the conversion will be tax-free. The remaining 80% (which represents pre-tax contributions and all earnings) will be taxable.

Capital Loss Deduction

If you have capital losses from your investments in taxable accounts (e.g., stocks, bonds, or real estate sold at a loss), you can use these losses to offset capital gains. If your capital losses exceed your capital gains, you can deduct the difference on your tax return, but there are limits and constraints, see below.

1. $3,000 Limit: The maximum net capital loss you can deduct in any single tax year is $3,000 ($1,500 if married filing separately). If your net capital loss exceeds this amount, you can carry the excess loss forward to future years.
2. Offsetting Roth IRA Conversion Income: The taxable income from a Roth IRA conversion is considered ordinary income, not capital gain. However, since the capital loss deduction reduces your adjusted gross income (AGI), it can effectively offset the additional income from the Roth conversion up to the $3,000 limit (or more in future years if you carry forward excess losses).
3. Example: Let’s say you convert $50,000 from a Traditional IRA to a Roth IRA, adding $50,000 to your taxable income for the year. If you also have a net capital loss of $5,000 from selling stocks at a loss, you can deduct $3,000 of that loss against your ordinary income for the current year. This would effectively reduce the taxable income from the Roth conversion to $47,000 for that year. The remaining $2,000 capital loss can be carried forward to the next tax year.

Business Losses Can Offset Conversion Income

If your business expenses exceed your business income for the year, you may have a Net Operating Loss (NOL). NOLs can be used to offset other types of income, including the income generated from a Roth IRA conversion.

1. Carrybacks and Carryforwards: Prior to the Tax Cuts and Jobs Act (TCJA) of 2017, individuals could carry back NOLs two years and carry forward NOLs 20 years to offset taxable income in those years. The TCJA changed these rules for losses arising in tax years beginning after December 31, 2017. Now, NOLs can’t be carried back (with exceptions for certain farming losses and losses from insurance companies), but they can be carried forward indefinitely. This means that if you have any carryovers from prior years, you can use them to offset any conversion income. Additionally, for losses arising in tax years beginning after 2017, the NOL deduction is limited to 80% of taxable income.
2. Pass-Through Entities: If your business is structured as a pass-through entity (like an S corporation, partnership, or sole proprietorship), the business’s income and losses pass through to the owners’ individual tax returns. This means that a business loss can offset other types of income on the owner’s tax return, including Roth IRA conversion income. Therefore, timing and taking advantage of accelerated depreciation methods will be critical when considering an IRA conversion.
3. Active Participation: To use business losses to offset other types of income, you typically need to be actively participating in the business. Passive activity losses (from activities in which you don’t materially participate) have restrictions on how they can be used to offset other income.
4. Excess Business Loss Limitation: The TCJA introduced a limitation on the amount of business losses that non-corporate taxpayers can use to offset other non-business income. However, this limitation was temporarily suspended for tax years 2018 through 2020 by the CARES Act. It’s essential to be aware of this rule and its implications for your specific situation.

Ability to Pay Taxes

Given that the taxes are due in the year of the conversion and you have to wait five years to access the converted funds without penalties, it’s impractical to use the converted funds to pay the conversion taxes.

Ideally, you should have other, non-retirement funds set aside to cover the tax liability from the conversion. This ensures that the full amount of the conversion can remain in the Roth IRA, growing tax-free.

How to calculate your ROTH IRA Conversion tax summary:

I’ve summed it the main points of my article below for your reference.

• Roth IRA Conversion Tax Calculation:
  • Estimated by multiplying the total value of the traditional IRA by your ordinary tax rate.
  • Assumes traditional IRA is mainly comprised of pre-tax funds.
• Determining Your Ordinary Income Tax Rate:
  • Start with total income.
  • Subtract adjustments to income (“above-the-line deductions”).
  • Subtract either standard or itemized deductions.
  • Result is taxable income.
  • Consult IRS tax brackets for relevant year.
  • Apply taxable income to the tax brackets to determine tax rate.
• State Taxes:
  • Consider state income tax when calculating conversion tax.
• After-Tax Contributions (Non-Deductible Contributions):
  • Conversion of after-tax contributions to Roth IRA is not taxable.
  • Earnings on these contributions are taxable when converted.
• Pro-Rata Rule:
  • Applies when a mix of pre-tax and after-tax contributions exist.
  • Taxable amount is determined on a pro-rata basis considering all Traditional IRA balances.
• Capital Loss Deduction:
  • Can use capital losses to offset capital gains.
  • Maximum net capital loss deductible in a year is $3,000 ($1,500 if married filing separately).
  • Excess losses can be carried forward.
• Business Losses:
  • Net Operating Loss (NOL) can offset Roth IRA conversion income.
  • NOLs can’t be carried back, but can be carried forward indefinitely post-TCJA 2017.
  • NOL deduction limited to 80% of taxable income for losses arising after 2017.
  • Pass-through entities allow business losses to offset income on an owner’s tax return.
  • Active participation required to use business losses for offsetting.
  • Limitation on business losses used to offset non-business income introduced by TCJA.
• Ability to Pay Taxes:
  • Taxes due in the conversion year.
  • Converted funds accessible after five years without penalties.
  • Use non-retirement funds to pay conversion tax for optimal growth of Roth IRA.

Need help?

Understanding and strategizing your Roth IRA conversion can seem daunting with all these intricate details and calculations. However, making the right move can significantly benefit your financial future. Don’t navigate these waters alone:

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About The Author

Joe is s a Certified Public Accountant (C.P.A.) and a Certified Valuation Analyst (C.V.A.). Joe’s professional career in public accounting began in 2012 with one of the “Big 4” international accounting firms. Since 2012, the focus of his professional engagements has been primarily in the area of business tax planning, cash flow planning and management, business valuations, small business financial consulting, and personal tax consulting.