You are confused. The taxable income for the 401(k) distribution is the amount of the distribution period. It makes no difference whatsoever if part of that is withheld for tax or not - the amount withheld for tax is also taxable income. Either way, if you have a $25,000 distribution then $25,000 will be added to your AGI as taxable income.
The difference is if you have $5,000 withheld for tax then only $20,000 can go to the IRA to grow, but if you can pay the tax form other funds then the entire $25,000 can grow int he IRA.
That is an *investment* decision that you must make and has nothing to do whatsoever with the taxable amount of the distribution.
If you thought that the tax withholding was not taxable (meaning that if you took a $25,000 distribution and had $5,000 withheld for tax so only $20,000 would be taxable) then you are wrong. The entire amount of the $25,000 distribution is taxable reguardless of what you do with the money - spend it, invest it, or use it to pay your tax. It cam from the 401(k) so it is taxable.
The only way to avoid the tax is to roll the 401(k) into a Traditional IRA and not convert it to a Roth IRA.
**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**
