If you're considering converting a traditional individual retirement account to a Roth IRA, there are two reasons to do so in 2012.
First, you'll avoid the possibly higher 2013 tax rates on the taxable portion of the converted amount.
Second, you won't have to worry about any possible Medicare surtax issues.
"While the surtax does not apply to income from a Roth IRA conversion, the income from a 2013 Roth conversion could push a taxpayer's adjusted gross income above the applicable threshold," says Bob D. Scharin, senior tax analyst for Thomson Reuters in New York City. "If that occurs, the Roth conversion could trigger a surtax on the taxpayer's investment income."
As Scharin notes, Roth earnings are not taxable income when you withdraw them in retirement or after holding them for five years because you paid tax on the money before you put it into the account. But when you convert a traditional IRA on which taxes are deferred to a tax-free Roth, you must pay tax on the amount of pretax contributions and earnings you transfer.
If your traditional IRA earnings are large -- $100,000 is not unusual for an account that's been growing tax-deferred for many years -- the conversion amount combined with your earnings on other taxable assets could push your earnings past the $200,000 threshold for single filers ($250,000 for married couples filing jointly). And that would require you to pay the 3.8 percent Medicare surtax in 2013.
But what happens if you convert and the tax rates don't increase (or your stock holdings suffer losses)? You can nullify the conversion tax by recharacterizing your converted Roth back to a traditional IRA. You have until Oct. 15, 2013, to make that reversal.