ROTH Conversion and Avoiding State Tax payments

[p_r_s]

Hello All, 

My income is bit less than 100k a year and filling returns as MFJ. I am non citizen-resident alien. 

I have contributed 12,000 to T-IRA last year (2022) for me and spouse.  This entire 12k are pre-tax / deductible funds. 

Q1: I know, I can contribute to ROTH directly.  But for this year (2023), I am planning to contribute 13k to T-IRAs and immediately recharacterize it to ROTH.  So that I can claim 13k as deductible funds in Federal taxes and add it back to my income via form 1099-R.   My understanding is - then I will avoid IL state taxes on these 13k, as state does not tax retirement income - Refer this link. 

Is my understanding correct ? 

Q2: Since I have never contributed to T-IRA - non deductible / after tax  funds, there should not be any complications wrt pro-rata/ aggregation rules from T-IRA side.  But wanted to confirm the same. 

Thanks in advance. 

Thanks, 

PRS

[dmertz · Accepted solution]

"I have contributed 12,000 to T-IRA last year (2022) for me and spouse."

I assume that you meant to say that you contributed $6,000 to your traditional IRA and your spouse contributed $6,000 to your spouse's traditional IRA (perhaps you making the deposit on behalf of your spouse, but it's still your spouse's contribution).

"I am planning to contribute 13k to T-IRAs and immediately recharacterize it to ROTH."

This does seem to make sense in Illinois.  Unlike some other states which exempt certain retirement distributions from state tax, I find nothing in the Illinois tax code that requires one be a particular age to take advantage of this.  This is what is described in the thread to which you linked.

Because you'll have no basis in nondeductible traditional IRA contribution, there is no pro-rata calculation of the taxable amount on your federal tax return, no entries in Part I of Form 8606.  The entire amount of the Roth conversion will be federally taxable, shown on Form 8606 Part II.

[p_r_s]

Thanks @dmertz for clarification. 

I found another article explaining same thing.  

https://thefinancebuff.com/deduct-and-convert-save-hundreds-in-state-income-tax-on-roth-ira-contribu...

I am still trying to understand difference between conversion and recharacterization as explained in that link,.  

[dmertz · Accepted solution]

Recharacterization changes the original contribution to be the opposite type as if the contribution had been the opposite type from the beginning.  For example, of the original contribution is a deductible contribution to a traditional IRA and you recharacterize the contribution to be a Roth IRA contribution instead, the contribution is treated as if it was originally contributed to the Roth IRA to begin with and you would get no deduction (since the traditional IRA contribution would be treated as never having been made).

A Roth conversion moves funds from the traditional IRA to the Roth IRA without treating the traditional IRA contribution as never having been made.  The federally taxable amount of the conversion is calculated on Form 8606.