custodian reporting of Roth Conversion
Where a taxpayer took taxable distributions from their IRA and also did a Roth Conversion it looks like Schwab and TD Ameritrade for example are reporting one total on Line 1 of Form 1099 – R. Nowhere on the form is it indicated how much of the amount on line 1 is attributable to the Roth Conversion and how much is a taxable distribution that has nothing to do with the Roth.
This seems to have disaster written all over it if the tax preparer does not know to ask if a Roth conversion was done.
I guess Form 5498 might indicate the amount but i thought that those forms are not filed until May.
Many of our clients converted investments in their IRA accounts in kind to a Roth so the actual value of the conversion may differ slightly from the amount they intended to convert.
Is there any additonal reporting that custodians will be doing this year to let their customers know of the amount converted?
Thanks as always.
Howard
Permalink Submitted by Jose Morales on Thu, 2011-02-24 00:19
There isn’t any special reporting of the distribution from the Traditional IRA. The conversion will be documented on the 5498, which does come in May for most financial institutions. Some provide a substitute 5498 with their year end statement. Even if they do not, the conversion should be documented on the year end statement.
Permalink Submitted by Alan Spross on Thu, 2011-02-24 00:44
Howard,
That is how all IRA custodians report distributions and there have been no changes to it. The amount of the conversion officially shows on the 5498 in May as you indicated, but to file their return on time the taxpayer must use the conversion amount shown on the custodian’s statement or on line screen if they don’t get paper statements. Likewise, the custodian is not able to report how much of any IRA distribution shown on a 1099R is taxable because they don’t know. The taxable amount is between the taxpayer and the IRS and documented on Form 8606. But the main point is that the distribution is taxable per the 1099R (disregarding any basis), and for the current year the IRS does not care how much of it was converted or if the values changed (see below).
While the above is not difficult in most cases, the in kind distribution situation you mentioned can turn complex. For example, let’s assume a taxpayer distributes 1,000 shares of Stock X from his TIRA and does not do a direct transfer to a Roth IRA. The value of that stock will be reported on the 1099R whether the transfer is direct or not. But then assume the shares drop 20% in 30 days. Taxpayer panicks and sells all the shares. If taxpayer still wants to convert the entire distribution he must contribute the exact amount of cash received to the Roth IRA. He will then have a conversion amount that is 20% less than the taxable distribution on the 1099R, so the #s will not be equal and he will not be happy.
Instead of panicking, he should have either contributed the shares to the Roth IRA as a conversion or the cash proceeds and then recharacterized the conversion. That will eliminate the current tax and puts the loss back in the TIRA where the IRS shares in the loss.
If the stock gained 20% while he held it outside the Roth instead of taking a loss, in this situation he is very happy to contribute the shares to his Roth. He is still only taxed on their value on the 1099R, but now has a conversion amount that is 20% higher in value than the distribution. The point is that the distribution does not HAVE to equal the conversion value. Current tax is based solely on the distribution value. To add to the complexity here, if he has a 10% basis in his TIRA, the taxable amounts are all reduced by 10%. The conversion amount shown on the 8606 has implications later on. If he withdraws conversions before 5 years he owes a 10% tax on the taxable amount of the conversion, so this is where the actual conversion amount comes into play.
Taxpayers doing an in kind distribution from the TIRA and doing any selling of those assets before converting are going to have a mismatch between the distribution which is taxable and the amount of the conversion.
Anyone doing a distribution of a bunch of different stocks and then selling some of them is going to have a very confused tax preparer unless he provides a clear and detailed spreadsheet or summary.
Permalink Submitted by Howard Hook on Thu, 2011-02-24 02:57
Alan,
Thanks for the explanation.
Since My firm does not prepare the returns for these clients I am thinking that we are going to send out to our clients the amount of the conversion so their accountants can easily put the right numbers in the right places.
Thanks again.
Howard