Would I pay the same amount in taxes to convert to Roth?

[Guest ctfudge07]

Continuing from where that leviathan thread left off... jims made a suggestion that intrigues me:

"I assume your 2006 income is extra high compared to 2005 and 2007 due to the inheritance. I also assume you like Roth IRA better than traditional IRA (I agree.). So here's how to get the best of both and save taxes. Contribute the max to traditional IRA for 2006 - you can still do it in 2007 up until you file your tax return (4/16/2007). At your income level, you can still get an IRA deduction (even though you contributed to a 401(k)) along with the Savers Credit to reduce your taxes for 2006. After you contribute for 2006, immediately convert to Roth IRA for tax year 2007. You'll owe taxes on the conversion and you should make an estimated tax payment to the IRS. Convert now and pay taxes while you have the extra cash, otherwise you'll never get back to it. Plus the sooner you convert, the less taxable earnings you'll have. When you convert, make sure you covert the entire balance to Roth IRA. Use other funds to pay the taxes. You effectively contributed to a Roth IRA, but you didn't waste the regular IRA deduction for the year you had high income."

Yes, income for 2006 is 20,000 higher than for 2007, not because of the inheritance per se (which is tax free and still forthcoming) but because of a taxable amount of money outside of the estate, so essentially, that supposition is correct. Total income for 2006 is about 65,000 and for 2007 will be about 48,000.

I had pretty much decided to just fund Roths for both years even though the lack of tax break will hurt (a lot). My instincts tell me to just cough up the tax while we're young and working if the tradeoff is to never pay tax again on that money. (by the way, calculated tax break for 2006 for us, if we decided to fund trad. IRAs instead, is about $1200 and for 2007 is about $950, give or take. We are in the 15% bracket currently and barely into the next bracket up for 2006.)

The thought of doing something like suggested above did cross my mind, but I assumed that Uncle Sam would have safeguards about people pulling a fast one, and the tax on the conversion would be just about the same.

I am probably missing something and honestly, I don't completey understand the process. If you could break it down in easier-to-understand chunks I'd appreciate it. For example, I understand how to open and fund IRAs, whether new or established, but I have no idea how a conversion is done or what taxes are assessed and when on a conversion. THANKS in advance!

[Guest jims]

Here's a good reference link on IRA conversions. http://fairmark.com/rothira/decide.htm