Two recent Tax Court cases reinforce the old saying "If it sounds too good to be true, it usually is." In the cases, two relatively wealthy taxpayers consulted with a Big 6 CPA firm and entered into transactions to convert a regular IRA with assets in excess of $1 million into a Roth IRA and not pay any taxes on the conversion. As we have previously discussed, many taxpayers in 2010 converted their regular IRA into a Roth IRA and elected to spread the tax over 2011 and 2012.
In these cases, the taxpayers with advice and documentation from so-called experienced advisers went to elaborate lengths to switch their IRA to a Roth. The IRS finally got around to auditing the taxpayers and, in one case, they assessed five years' worth of excise taxes and penalties in excess of $525,000. The total value of the IRA at the peak was slightly in excess of $1 million, so more than 50% of the IRA was now eaten up by excise taxes. These excise taxes are owed by the taxpayers and, at some point, they will need to cash in the IRA (since it was not a legal Roth conversion) and will owe federal and state income taxes on top of the excise taxes.
Based on my reading of the numbers, I estimate that the taxpayers will owe more in taxes than the IRA was ever worth.
This is a good lesson for all of us. If something sounds too good to be true, get a trusted second opinion. These taxpayers took one adviser's word as truth and never got the correct advice that might have save them substantial money, time and headaches.