Bitten by the IRS over Roth Conversion
I just got a letter from the IRS saying I owe substantial back taxes, penalty and interest from 2008. In 2008, I did several Roth conversions, some of which I recharacterized in early 2009 (prior to filing my FIT). Vanguard reported the 2008 conversions in early 2009 to the IRS but apparently the 2009 recharacterizations did not get reported until later. IRS did not pick up the recharacterizations (and match them to the appropriate conversion; hence they say I owe the money.
All this should be easily explained but it seems strange that I have to go through this extra work. Has anyone else experienced this?
Thanks
Permalink Submitted by Alan Spross on Wed, 2010-12-15 19:19
Because the 2009 recharacterization are not reported to you and the IRS until January 2010, and because the IRS does not always match up the most recent data when they issue inquiries, these letters are fairly frequent. However, the filing instructions for your 2008 return indicate that you should have included an explanatory statement explaining your recharacterizations by date and amount. Since the explanation goes with your 2008 return, the IRS would see why your reported conversion amount was much less than the 1099R amounts for 2008. Did you include such an explanatory statement?
If not, then you need to include that info when you respond to the letter. Suggested format: “On xx/xx/2008 I converted $y to my Roth IRA. On zz/zz/2009 I recharacterized $m of those conversions, which were then valued at $n”. That should resolve the problem unless there are other problems as well.
Permalink Submitted by James Mitchell on Wed, 2010-12-15 19:52
Thanks, you are quite right. I have, of course, a complete spreadsheet that tracks all these transactions. I included that with my explanation to IRS (along with a very conciliatory letter.
The message to everyone who wants to avoid these annoying complications is to include backup documentation with all tax returns. But how do you do this if you file electronically? Can you efile and then send in supporting documents?
Permalink Submitted by Alan Spross on Wed, 2010-12-15 22:40
The way the IRS reacts to voluminous extra paper is not good. So unless filing as they recommend becomes highly problematic, it is not worth the effort to try to anticipate the next question from the IRS, because you could never address that many. In your case, it sounds like another case of the IRS not reading your statement OR someone there not understanding Roth recharacterizations.
In other words, as long as you supply them with the info and format they request, it is usually counterproductive to try to anticipate why they might question that, or to send in a paper return due to restrictions on e filing with your current tax software.
Ironically, thousands of IRA excess contributions and related violations take place every year without hearing from the IRS at all, much less within the next 2 or 3 years. In your case, you were just one of the unlucky few who received an unwarranted inquiry.