New Issues and Challenges
I have recommended Roth conversions for selected clients. Under the new tax bill, however, there are additional challenges and opportunities that warrant closer analysis.
THE NEW SENIOR DEDUCTION
The bill provides a new $6,000 deduction for taxpayers over age 65, or $12,000 for a married couple. However, this deduction phases out for taxpayers with modified adjusted gross income (MAGI) between $150,000 and $250,000, eventually being reduced to zero.
This phaseout creates a new threshold issue for Roth conversions. At $150,000 of MAGI, a married couple may qualify for the full $12,000 deduction, producing approximately $2,640 of federal tax savings (assuming a 22% bracket).
At first glance, it may appear that a $100,000 Roth conversion would generate an additional $22,000 of federal income tax at a 22% rate. In reality, the tax increase could be $24,640 because the conversion also causes the loss of the $12,000 Senior deduction.
Accordingly, tax projections should isolate this effect, and planners should evaluate whether the Roth conversion remains advantageous at the higher effective rate.
Interestingly, the converse may also be true. Roth conversions completed before age 65 may reduce post-65 MAGI, thereby helping preserve the future Senior deduction.
THE SALT DEDUCTION
Roth conversions are often subject to both federal and state income tax. Since the TCJA, state income taxes have largely been nondeductible for many taxpayers. However, the new $40,000 SALT deduction may reduce the effective combined federal and state tax cost of a Roth conversion.
For some taxpayers, this increased deduction may improve the economics of a Roth conversion. A planner may consider limiting annual conversions so that state income and property taxes do not materially exceed the $40,000 SALT cap.
As with the Senior deduction, planners should isolate the value of this benefit and determine whether it materially enhances the effectiveness of the Roth conversion strategy.
THE SALT PHASEOUT PROBLEM
The SALT deduction is not available in full to everyone. Taxpayers with income above $500,000 are subject to a phaseout equal to 30% of MAGI over $500,000.
At $600,000 of MAGI, the SALT deduction is reduced from $40,000 to the statutory floor of $10,000.
Calculation:
- $600,000 − $500,000 = $100,000 excess MAGI
- $100,000 × 30% = $30,000 reduction in SALT deduction
Thus, the tentative $40,000 deduction is reduced by $30,000, leaving only $10,000.
Example
Assume Jack and Jill have MAGI of $500,000 and itemized deductions of $75,000, including a tentative $40,000 SALT deduction. They then complete a $100,000 Roth conversion, increasing MAGI to $600,000.
As a result, their SALT deduction falls from $40,000 to $10,000.
In simple terms:
- Gross income increases by $100,000
- Taxable income increases by $130,000 (because $30,000 of deductions are lost)
If their marginal bracket is 35%, the effective tax on the additional $100,000 conversion is:
35% × $130,000 = $45,500
This produces an effective tax rate of 45.5% on the $100,000 conversion.
This hidden tax cost may eliminate most, if not all, of the expected benefit of the Roth conversion.
SUMMARY
Roth conversions will likely remain an important planning tool. However, under the 2025 tax bill, the impact of both the Senior deduction and the SALT deduction should be carefully analyzed before implementing a conversion strategy.
Clients who would like to revisit their Roth conversion strategy in light of these changes are welcome to schedule a consultation. Clients should also coordinate with their CPA or other tax advisor to ensure that any strategy is reviewed in the context of their overall tax situation.