Roth Conversion ? for Alan S. et al
I am seeking some confirmation of my understanding of a Roth conversion under certain circumstances. I found this subject on another forum and it has me a bit questionable right now.
Situation – Taxpayer (TP) under age 59.5 wants to do a $20,000 traditional to Roth conversion and is considering having $5,000 tax withheld from conversion amount. TP is in marginal bracket of 25%. To simplify things, assume no other IRA transactions this year.
Questions
1. What is the distribution amount that will be reflected on the 1099-R at year end?
2. Will the 1099-R show the $5,000 federal withholding?
3. What is the actual converted amount?
4. Will there be a 10% penalty applied to the $5,000 tax withheld amount (i.e., an early withdrawl penalty)?
According to my understand of the tax laws, my replies would be:
1. $20,000
2. Yes
3. $15,000
4. Yes, an additional $500 tax with show up on the appropriate line of page 2 of Form 1040
Hopefully I have provided all the information needed for a response to my query. If not, just share your additional thoughts. If you can cite some specific page/paragraph references in the 2008 version of Publication 590 that would help.
Thanks,
Permalink Submitted by Alan Spross on Thu, 2009-11-05 21:09
Tom,
You are correct on all 4. This is the reason that paying taxes out of one’s conversion is NOT recommended, particularly if under 59.5. If over 59.5, the 10% early withdrawal on the tax withholding is avoided, but there still is the disadvantage of losing 5,000 out of any IRA type that will no longer earn tax deferred or tax free earnings in the future.
Pub 590 mostly covers this on pages 42 and 43 with the penalty on withholdings at end of p 43. The 1099R box items would be covered in the 1099R Inst., but withholding always is shown on the 1099R. The 5498 reporting contributions to the Roth will only show $15,000 since that is obviously all that went into the Roth.
This also causes recharacterization challenges. The 15,000 conversion would be recharacterized as usual, but the taxpayer would have to come up with the other funds within 60 days to roll over to a TIRA to complete undo the original distribution.