As part of the 2011-2013 Wisconsin Budget Bill, Wisconsin also amended state tax law to adopt the federal tax rules applicable to in-plan Roth conversions. In-plan Roth conversions allow 401(k) and 403(b) plan participants to transfer funds from a non-Roth account within the plan to a Roth account within the plan. Prior to this amendment, Wisconsin residents who took advantage of the in-plan Roth conversion were subject to Wisconsin tax penalties. The amendment is retroactive and therefore applies to participants who elected in-plan Roth conversions in 2010 as well.
The amendment was necessary to conform Wisconsin law to federal law. Federal law was modified to allow plan participants to make in-plan Roth conversions effective after September 27, 2010. If the conversion was made in the 2010 tax year, a special federal tax incentive applied. Although the conversion of pre-tax contributions to Roth after-tax contributions requires the payment of income tax on the converted amount, the special federal tax incentive allowed those participants who made the conversion in 2010 to defer that tax by reporting half of the income in 2011 and half in 2012. However, at the time, there was no corresponding state tax law change in Wisconsin. Therefore, Wisconsin residents who made in-plan Roth conversions in 2010 were required to pay a 2% penalty on excess contributions and (if the participant was under 59 ½) a 3.3% penalty for early distribution in 2010 plus all income generated by the conversion. The 2% excess contribution penalty is cumulative; it applies each year until the excess is withdrawn.
The June 2011 amendment changed Wisconsin law retroactively to match federal law in all respects. Participants who paid the now-repealed Wisconsin tax for 2010 can apply for a refund by filing an amended 2010 Wisconsin tax return.