Form 8606 Line 6 – outstanding rollover
Hi –
IRS Form 8606 Line 6 says “enter the value of your all of your traditional, SEP and SIMPLE IRAs as of December 31 (on the current year), plus any outstanding rollovers.” In the instructions, it says “a rollover is a tax-free distribution from one traditional, SEP or SIMPLE IRA that is contributed to another traditional, SEP or SIMPLE IRA.” And two paragraphs later is says “Note. Do not include a rollover from a traditional or SEP IRA to a qualified employer plan even if it was an outstanding rollover.” What about the reverse scenario – a distribution from a qualified plan that the taxpayer later (but still within 60 days) deposits into a Traditional IRA, but the timing is such that it crosses 12/31?
The situation I have is that a client is being forced out of a 401(k) as of December 1st (about $400k). Earlier in the year, they converted their $50k Traditional IRA to a Roth IRA, virtually tax free because they contributed $37k in nondeductible contributions over the years. So we planned on paying tax on the $13k. But if the client chooses a direct rollover from the 401(k) to a rollover IRA as of 12/1/10, then most of the Roth conversion winds up being taxable. They do not have self-employment income (so can’t set up a self-employed 401(k)), and don’t want to roll the old 401(k) into their new employer 401(k) because of poor investment choices in their new employer 401(k). So I’m wondering if they could elect a distribution from the old employer plan. Say the distribution is as of 12/1/10, and they get a check for $320 ($400k, less 20% federal tax withheld). Then they would in January (still within 60 days), deposit $400k into a Traditional IRA. When they file their 2010 tax return, they’d get the $80k withholdings back in their refund. If I take the Form 8606 instructions literally, then I wouldn’t count the $400k as an outstanding rollover since it’s not [b][u]from[/u][/b] a traditional, SEP or SIMPLE IRA, and of course it’s not in the Traditional IRA as of 12/31. Is there any guidance from the IRS or a primary source that is contrary to this?
Permalink Submitted by Alan Spross on Mon, 2010-11-08 19:38
There is no contrary guidance, and the client can avoid diluting the basis % of the TIRA by doing this rollover indirectly. The bottom line is that the taxable portion of a conversion is only based on what is actually in the TIRA as of 12/31. Outstanding incoming rollovers from QRPs do not count.
Also, note that line 4 of Form 8606 subtracts out regular IRA contributions made FOR 2010, but not contributed until 2011. This is consistent with how the 8606 Instructions deal with those incoming QRP rollovers, ie. if the funds are not actually in the IRA yet, they do not count in the % of basis calculation. This is also true for the new 2010 draft version of the 8606.
Fortuneately, this client has the 80k in cash to replace the 20% withholding and complete the rollover, or this would not work. Another benefit here is that if the client had any underpayment problems for 2010, the withholding would likely eliminate any penalties there. Now, you just need to decide if the 13k of taxable income should be reported in 2010 or deferred to 2011 and 2012.