Why is my IRA conversion being taxed at a higher rate than my income tax rate?

[drichardson90]

I did a IRA conversion in 2016 for $3,082. I received a 1099-R and input all of the information into TurboTax. Here are the details contained in my 1099-R: 

1) Gross Distribution: $3,082.  2a) Taxable Amount is $3,082.  2b) "Taxable Amount Not Determined" & "Total Distribution" boxes are checked.  4) Fed. Income tax withheld is $0.  7) Distribution Code: 2, IRA/SEP/SIMPLE box is checked. 

When I input my 1099-R data into the program, my Federal Tax owed increased by $908 and CA State tax owed increased by $124 for a combined total of $1,032 taxes due on the conversion. I completed the entire "Retirement Plans & SSN" section. 

How do I owe 33% of the conversion amount in taxes if my total income for 2016 was $26,745 (including the conversion) and my taxable income was $16,160? There should be no penalties assessed on the conversion (hence the Distribution Code 2). My federal tax rate is 15% and CA state tax rate is 4%. Does anyone understand why this IRA conversion is being taxed at such a high rate? 

[Anita01 · Accepted solution]

The tax rate on that one transaction is not that high.  You can't look at the tax due in that manner.  What you did was increase your Adjusted Gross Income.  That can cause all sorts of other changes in your return including causing some of your Social Security to become taxable.

Because you are using the Desktop version, it's easy  to double check what's happening. Simply print your 1040 after entering the 1099-R info, then delete it and print the 1040 again. Lay then down next to each other to see what amounts really changed in your return.

It would save you a little time if you print this return that's completed, then save it under a different name.  Then you can delete the pension income from the new file and print the 1040 and you'll still have your completed return under the old name.

[drichardson90]

Thank you for your help. After comparing the two 1040s I realized that because my AGI increased by $3k, it increased my tax liability elsewhere. I will be recharacterizing the amount back to my IRA to avoid this increased tax burden.