Does Illinois Tax Roth Conversions on Retirement Accounts?
Understand how Illinois taxes Roth conversions on retirement accounts, how it differs from federal rules, and key factors to consider for accurate state filings.
Roth conversions allow individuals to move funds from traditional retirement accounts into a Roth IRA, paying taxes upfront in exchange for tax-free withdrawals later. While the federal government taxes these conversions as income, state taxation varies, making it important to understand local rules before making a decision.
Illinois does not tax retirement income, including Roth conversions, making it an attractive state for retirees considering this strategy. Understanding how Illinois treats these transactions helps investors plan effectively and avoid unexpected tax liabilities.
State Tax Classification
Illinois exempts retirement income from state taxation, including Roth conversions. Under 35 ILCS 5/203(a)(2)(F), taxpayers can subtract distributions from federally taxable retirement plans when calculating state income. Because a Roth conversion is considered a distribution, it qualifies for this subtraction.
To be eligible, funds must come from a 401(k), 403(b), traditional IRA, or government pension plan. Certain annuities and deferred compensation plans may not receive the same treatment. Taxpayers should verify their account type before assuming the conversion is exempt.
Differences From Federal Treatment
At the federal level, the IRS treats Roth conversions as ordinary income, potentially pushing taxpayers into a higher tax bracket. This can also affect eligibility for tax credits, deductions, and Medicare premiums.
Since Illinois does not tax Roth conversions, residents avoid additional state tax burdens. In states that follow federal treatment, a $50,000 conversion could result in significant state taxes, but Illinois residents face no such cost. This allows for more flexibility in conversion planning, helping to reduce future required minimum distributions (RMDs) since Roth IRAs are not subject to RMDs during the account holder’s lifetime.
Calculating Conversions on State Returns
Illinois starts state income tax calculations with federal adjusted gross income (AGI), which includes Roth conversions. To exclude the conversion, taxpayers must make a subtraction on Schedule M under the section for federally taxed retirement income.
Most tax software automates this adjustment for Illinois residents, but those filing manually should consult Form IL-1040 instructions to ensure correct reporting. Failing to subtract the conversion could result in overpayment or require an amended return. Keeping documentation, such as Form 1099-R, helps verify the exclusion if questioned by state tax authorities.
Potential Exemptions
Some distributions may not qualify for Illinois’ exclusion. While most conversions from traditional IRAs and employer-sponsored plans are exempt, non-qualified annuities and some deferred compensation plans may still be taxed.
Employer-sponsored 457(f) plans are one example. Unlike government 457(b) plans, which are treated as retirement income, 457(f) plans often distribute funds upon vesting rather than retirement, making them taxable. Employees should verify the tax treatment of their specific plan.
Rollover timing also matters. If funds are withdrawn from a traditional retirement account but not converted to a Roth IRA within 60 days, they may be considered a taxable distribution rather than a conversion. Missing this deadline could subject the amount to state income tax.
Penalties for Mistakes
Errors in reporting a Roth conversion can lead to unnecessary tax payments or complications with the Illinois Department of Revenue. While the state does not tax these conversions, failing to subtract the converted amount from taxable income could result in an overpayment, requiring an amended return using Form IL-1040-X.
Incorrectly claiming the subtraction for ineligible distributions, such as non-qualified annuities or deferred compensation plans, may result in additional state taxes and interest. While Illinois does not impose penalties for first-time filing errors if corrected promptly, repeated mistakes can lead to further scrutiny. Keeping detailed records, including Form 1099-R and supporting documentation, ensures compliance and prevents disputes with tax authorities.