Roth Conversion Strategy for Business Owners: When and How to Convert

Business owners have an advantage most W-2 employees don't: variable income. A slow year, a planned transition, or the year after selling your business can create a low-tax window to convert pre-tax retirement money into Roth accounts at a fraction of what you'd pay at peak income. Here's how to time it, size it, and avoid the traps.

What is a Roth conversion?

A Roth conversion moves money from a pre-tax retirement account — a traditional IRA, SEP-IRA, Solo 401(k), or old employer 401(k) — into a Roth IRA. You pay ordinary income tax on the amount converted in the year of conversion. In exchange, the money grows tax-free and qualified distributions (age 59½+, account open ≥5 years) are never taxed again — including all future appreciation.

There is no income limit on Roth conversions.¹ Any business owner at any income level can convert. This is distinct from direct Roth IRA contributions, which phase out at $153,000–$168,000 for single filers and $242,000–$252,000 for married couples filing jointly in 2026.²

Why business owners are uniquely positioned

Most W-2 employees earn nearly the same income every year. Converting in a "low-income year" isn't really an option when every year looks the same. Business owners are different. Income fluctuates by design and by circumstance — and that volatility becomes an asset in Roth conversion planning.

Consider these scenarios where a business owner's taxable income drops sharply:

• Year of business sale: You close December 31 of year one; the next year, you have no business income. Your W-2 is $0. Your ordinary income is whatever you draw from investments or roll over.
• Transition or sabbatical year: You're winding down or ramping up a new venture. Revenue is low; owner comp is low.
• Deliberate S-corp salary reduction: If you temporarily reduce your W-2 salary (with supporting business circumstances), your ordinary income falls — opening a conversion window even during active operations.
• Early retirement before Social Security: From age 55 to 72, you may have little taxable income other than investment distributions. This is the "Roth conversion sweet spot" — convert before required minimum distributions (RMDs) kick in and force higher income.
• Business loss year: A net operating loss (NOL) can offset conversion income dollar-for-dollar. A $200,000 NOL plus a $200,000 Roth conversion can result in zero net taxable income from the conversion.

The bracket-filling strategy

The core strategy is converting just enough to fill lower tax brackets without spilling into higher ones. Roth conversion income is ordinary income — it stacks on top of your other ordinary income for the year.

For 2026, the federal ordinary income tax brackets for married filing jointly are:³

Source: Tax Foundation / IRS Rev. Proc. 2025-28. Thresholds made permanent by OBBBA (July 2025). Standard deduction MFJ: $32,200 for 2026.

The key rate cliff to watch is the jump from 24% to 32% — an 8-percentage-point increase. Converting dollars at 24% is meaningfully cheaper than converting at 32%. Most Roth conversion planning aims to fill up the 24% bracket and stop.

Long-term capital gains don't push your ordinary income — but watch the NIIT

If your low-income year involves harvesting long-term capital gains (from selling appreciated securities, for example), those gains sit in a separate "stack." LTCG does not count as ordinary income for bracket purposes. In 2026, the 0% LTCG rate applies to MFJ filers with taxable income up to $96,700; the 15% rate applies through $600,050 MFJ.⁴

However, Roth conversion income does push your modified AGI higher, which can trigger the 3.8% Net Investment Income Tax (NIIT) on investment income above $250,000 for MFJ filers.⁴ If you have significant passive investment income, model the NIIT interaction before deciding how much to convert. A large conversion can flip LTCG and qualified dividends from 15% to 18.8% effective.

Roth conversion vs. Roth contribution: two different tools

Backdoor Roth: when your income is too high for direct contributions

Business owners at high income levels can still make Roth IRA contributions through the "backdoor Roth" strategy:

1. Make a non-deductible traditional IRA contribution — there is no income limit for this. Contribute $7,500 (or $8,600 if 50+) and file Form 8606 showing it as after-tax basis.
2. Convert the traditional IRA to Roth IRA shortly after. Because the contribution was already after-tax (basis), you owe tax only on any small earnings accumulated between contribution and conversion — typically a few dollars.

The backdoor Roth works cleanly only if you have no other pre-tax money in traditional IRAs. If you have a $500,000 SEP-IRA sitting in a traditional IRA, the pro-rata rule applies (see below).

Mega backdoor Roth via Solo 401(k)

The Solo 401(k) offers a route to move significantly more money into Roth accounts annually. Here's the mechanic:

1. Your Solo 401(k) plan document must permit after-tax (non-Roth) contributions and in-plan Roth conversions or in-service distributions.
2. You make after-tax contributions to your Solo 401(k) — the §415(c) total contributions limit is $72,000 for 2026 (plus catch-up), meaning after your pre-tax deferral ($24,500) and employer profit-sharing match (~20-25% of W-2), there can be room for after-tax contributions.
3. Those after-tax contributions are then converted to Roth in-plan (or rolled out to a Roth IRA).

Note: not all Solo 401(k) custodians support after-tax contributions and in-plan Roth conversions. This requires an individually-designed or prototype plan document with these features explicitly included. Some low-cost providers (Vanguard, Fidelity self-directed) support it; others don't. A fee-only advisor can help you select the right custodian and plan structure.

The pro-rata rule: the trap that silently kills backdoor Roth

If you own any pre-tax IRAs — including SEP-IRAs and traditional IRAs — the IRS treats all your IRAs as a single pool when calculating taxes on a Roth conversion. You cannot cherry-pick which dollars to convert.

The solution: Roll your SEP-IRA into your Solo 401(k) before doing the backdoor Roth. Solo 401(k) accounts are not included in the pro-rata calculation (only IRAs count). Once the SEP funds are inside the 401(k), your IRA balance is $0, and the backdoor Roth converts cleanly.

This is one of the most valuable structure moves a business owner can make — and it's exactly the kind of multi-account coordination that a fee-only business owner advisor handles routinely.

SECURE 2.0 changes that affect business owners

• Roth 401(k) no lifetime RMDs (§325, effective 2024): Prior to 2024, Roth 401(k) accounts were subject to the same RMD rules as pre-tax 401(k)s, forcing distributions at age 73 (or 75). SECURE 2.0 eliminated this — Roth 401(k) and Roth Solo 401(k) money can now compound tax-free indefinitely, just like a Roth IRA. This makes the Roth 401(k) deferral election significantly more valuable for business owners who don't need the money and want to pass it to heirs.⁵
• High-earner catch-up must be Roth (§603, effective 2026): If you paid yourself more than $145,000 in FICA wages in 2025, your 2026 catch-up contributions (age 50+) to a Solo 401(k) or employer 401(k) must go into a designated Roth account. This is a forced Roth conversion of sorts — plan for the additional tax cost.⁵
• RMD age increased: The required beginning date for RMDs is now age 73 for those born 1951–1959, and age 75 for those born in 1960 or later. This extends your Roth conversion window by 2 years for younger owners — more time to convert before RMDs compress your bracket headroom.⁵

Should you convert now or wait?

The math favors converting when:

• Your marginal rate in the conversion year is lower than your expected marginal rate when you'll draw the funds
• You can pay the conversion tax from outside the retirement account (paying from a taxable brokerage account maximizes the after-tax value moved into Roth)
• You have a long time horizon (10+ years) for the converted funds to compound tax-free
• You expect estate tax exposure — Roth IRAs pass to heirs income-tax-free, eliminating a second layer of tax on pre-tax retirement accounts

The math favors not converting when your current income is at peak and you expect meaningfully lower income in retirement. A business owner earning $800,000 in active operations may be better served maximizing pre-tax deductions now (Solo 401(k) + Cash Balance Plan + SEP stack) and converting selectively later when income drops.

Practical checklist before your first conversion

1. Project this year's taxable income including all W-2, K-1, and passive sources before the conversion amount.
2. Identify your bracket headroom — the gap between your projected taxable income and the top of the 24% bracket ($403,550 MFJ / $201,775 single).
3. Check for pre-tax IRA balances — if you have a SEP or traditional IRA, determine whether to roll into a Solo 401(k) first to clear the pro-rata rule.
4. Decide whether to pay the tax from outside the IRA — if you withhold from the converted amount to cover taxes, that withheld amount is treated as a distribution and may incur a 10% penalty if you're under 59½.
5. File Form 8606 — required to report non-deductible IRA contributions and conversions. Do not skip this; it establishes your basis and prevents double taxation on withdrawal.
6. Model the NIIT impact if you have significant investment income — the conversion may push AGI above the $250K MFJ/$200K single thresholds.

Sources

1. IRS — FAQs on Designated Roth Accounts. Roth IRA conversions have no income limit; any taxpayer may convert a traditional IRA or qualified plan to a Roth IRA regardless of MAGI.
2. IRS — 2026 Retirement Plan Contribution Limits (IRS Notice 2025-67). Roth IRA contribution limit $7,500 (under 50) / $8,600 (age 50+). Income phase-out: $153,000–$168,000 single; $242,000–$252,000 MFJ.
3. Tax Foundation — 2026 Federal Income Tax Brackets and Rates. MFJ brackets and thresholds for 2026; rates made permanent by OBBBA (July 2025). Standard deduction MFJ $32,200.
4. IRS Topic 409 — Capital Gains and Losses. 2026 LTCG rates: 0% / 15% / 20%; NIIT 3.8% on net investment income above $250,000 MFJ / $200,000 single per IRC §1411.
5. IRC §402A — Designated Roth Accounts, via Cornell LII. SECURE 2.0 §325 elimination of Roth 401(k) lifetime RMDs (effective 2024); §603 high-earner catch-up Roth mandate (effective 2026, ≥$145K prior-year FICA wages); RMD ages per SECURE 2.0 §107.

Tax brackets and rates verified against 2026 IRS figures and Tax Foundation analysis. Roth IRA limits per IRS Notice 2025-67. SECURE 2.0 provisions per P.L. 117-328. Values current as of May 2026.