Taxes w/H on Conversion in error/How to Correct?
Client had taxes withheld from IRA on Conversion to Roth in error and will also owe 10% penalty. Tax accountant is telling client to contribute to the IRA the amount of the taxes withheld and that as long as it is completed within 60 days, it will “eliminate” the amount of the taxes withheld as a distribution. Pershing (IRA custodian) says that is not allowed.
Can client contribute the amount withheld as taxes back to the IRA? This has all happened in 2011.
Permalink Submitted by Jose Morales on Wed, 2011-03-02 16:53
I think they may have suggested a rollover of the withheld amount back to a Traditional IRA, not a contribution. Being that it is now March 2, are you sure that the 60 day rollover window has not passed?
Permalink Submitted by Alan Spross on Wed, 2011-03-02 20:49
If within 60 days, the client can simply replace the tax withholding and complete the Roth conversion. The taxable income for the conversion will remain the same, the early withdrawal penalty on the withholding will be eliminated, and the withholding will stay with the IRS. If this will result in over withholding, client can reduce other withholdings or estimates that would be paid in 2011 to recover the taxes earlier than nect year’s filing season.
If client does not want any more converted than the present amount, they could also replace the withholding in a rollover back to the TIRA. That will result in a lower ultimate tax bill than completing the conversion, but the withholding recovery options remain as above. They would then be reporting a conversion and also a rollover on line 15 of Form 1040.
I am not sure what Pershing was stating would not be allowed. The replaced withholding funds would not change Pershing’s reporting on their 1099R. The rest would be reported by the client on their tax return. But Pershing would have to accept the rollover contribution for the IRA type chosen, if they are the custodian. All that does is change the figures on the 5498 they issue for contributions received.
With respect to the 60 day rollover period, use the receipt date in the Roth if the transfer was done directly, and if done indirectly the receipt date of the client for the TIRA distribution. Also, note that the one rollover limitation applies ONLY if client rolls to a TIRA. It does not apply to Roth conversions.
Most custodians include a specific query about withholding on Roth conversions, since it is usually a bad idea and produces problems like this one. Also, the 10% IRA default withholding rate typically inadequate to cover the tax bill for a conversion.