Unintentional Roth Conversion of 2010 RMD
Client was taking monthly RMD’s from his IRA through July 2010, then converted the IRA to a Roth, but failed to take the remaining RMD’s out first. Consequently, there are two problems here: the RMD’s were converted, and the full RMD was not taken out before December 31st. I believe the first problem can be fixed by re-characterizing the RMD amount and taking it out, but since we’re past the 12/31 deadline and RMD’s not taken are subject to penalty, how can this be fixed? Appreciate your thoughts on this.
Permalink Submitted by Alan Spross on Thu, 2011-03-10 01:09
The word that this should not be done is widely published, but you almost never see what to do after it happens………and it happens all the time.
FIrst, the RMDs are deemed to be distributed, despite the conversion. The RMD portion is then considered to be a failed conversion since it is NOT eligible for rollover. It is then treated as an excess REGULAR contribution to the Roth IRA, which must be corrected like any other regular contribution. This is all logical and straight forward.
Now the mess……..how to report all of this. The IRS has not published clear guidance, so the only logical conclusion is to report it in the same manner as you would if the events were not connected. But the custodian issued 1099R forms do not report the individual parts of this clearly, and therefore a detailed explanatory note needs to be attached to the tax return to explain to the IRS why the return differs from the 5498 form reporting the conversion:
1) The 1099R looks the same as usual, just a distribution that does not even indicate a conversion. The entire amount is taxable on line 15b in any event.
2) The 8606 reporting the conversion must reduce the conversion by the amount of the RMD, ie the client only converted an amount net of the RMD. The rest of the money in the Roth is an excess regular contribution to the Roth…….unless the client actually qualified for a regular Roth contribution. In that case, the client can leave the full amount in the Roth IRA. But if the client did not have earned income or the modified AGI is too high for a Roth contribution, the amount of the RMD needs to come out along with allocated earnings. The earnings are taxable in the year the contribution was made, but no penalty since someone taking RMDs is over 59.5. The taxable earnings will make the total amount on line 15b higher than the 1099R and this is where the explanatory statement is needed since the 1099R will often not be issued for the corrective distribution until the following January, like many excess contribution corrections.
Recharacterizing part of the conversion is not the correct solution since the earnings on the RMD rollover are not distributed and get to stay in the TIRA for many more years. Client would then have to re distribute the RMD and that is not correct either since the RMD was deemed distributed originally.
Worse, the IRS is likely to get confused with what is going on even with a good explanatory statement. That is why many taxpayers who proceed to eventually take their full RMD in the conversion year do nothing and never hear further. Their tax return will look entirely normal. The IRS will not have a clue what happened because they don’t know the exact date of the conversion.
Your case is tougher because the client never proceeded to take the RMD by the end of the year and his tax return will be a red flag because the difference of his 8606 conversion from the total distribution does not leave enough for the RMD, so the IRS can see that the RMD was partially converted. And there is no statute of limitations on excess contributions to Roth IRAs.
In summary, the correction procedure is stated above if he wants to put this behind him, but I cannot promise that the IRS will understand it or not send out an inquiry. Client’s tax preparer is unlikely to make any sense out of this either. Client would also have to either extend the 2010 return or get the correction done right away so any taxable earnings on the excess contribution can go on line 15b.
As stated above, this is not a costly error to correct at all, just a real mess to report.