roth conversion
I have encountered an IRA situation for which I would like to seek advice. Here is the fact pattern.
In 2010 I converted my entire traditional IRA to a Roth and chose the 2 year gain deferral.
In January, 2011 I made a 2011 non-deductible IRA contribution to my traditional IRA and converted that immediately to a Roth IRA. No gain on conversion as I had full basis in the amount converted.
In October, 2011, I recharacterized the entire 2010 Roth IRA back to my traditional IRA as the market value had dropped below value at conversion in 2010.
My question is how do I determine the taxable income on the 2011 conversion because at the time of that conversion I had 100% basis in the amount converted, however, since I recharacterized the 2010 conversion later in the year how does that affect the basis calculation for the 2011 conversion?
Many thanks for any guidance you may offer.
Permalink Submitted by Alan Spross on Mon, 2012-01-23 18:11
Unfortuneately, the recharacterization will result in your 2011 conversion being mostly taxable.
Both your 2011 non deductible TIRA contribution and your 2011 conversion are reported on Form 8606. But line 6 of Form 8606 requires you to include the full value of all your TIRA accounts as of 12/31/2011 and that will include the recharacterized conversion of 2010. You will have some basis from your non deductible contribution, but the conversion will be taxed according to the pro rated amount of your TIRA that represents pre tax amounts. Decent tax software will take care of all these calculations and form generation for you.
Of course, if this is unacceptable, you could also recharacterize your 2011 conversion.
You also need to amend your 2010 return on a 1040X with explanation of the recharacterization. While your 2010 taxes are unaffected, you should include an 8606 showing -0- where you previously showed the conversion on your 2010 return. This is the most effective way to be sure the IRS clears out their suspense for 2011 and 2012 of conversion income from 2010. If you do that you will be able to ignore the 1099R you should get any day now reporting the recharacterization of your 2010 conversion.
Permalink Submitted by Masha Godlenberg on Wed, 2012-02-08 00:39
We have a similar situation with a client who converted a traditional IRA (with basis) to a Roth in 2010, and then recharacterized about a third of the amount converted due to poor market performance in September of 2011. The return was filed by October 15th 2011, after the conversion, but line 6 of form 8606 did not include the recharacterized amount. We now want to amend the 2010 return showing the correct value on line 6, and here is my question, using the following sample amounts: original conversion from IRA to Roth in 2010 $1,000,000; amount recharacterized in September of 2011 $300,000, which had a value at that time of $260,000 (the $300,000 was placed in a separate account by iteself). Should we include on 8606 line 6 the full $300,000, the recharacterized $260,000, or determine the actual value of the Roth as it was on 12/31/10?
Thank you!
Permalink Submitted by Alan Spross on Wed, 2012-02-08 04:15
It’s a good question, not directly addressed in Pub 590 or the Regs.
However, the question of TIRA year end valuation for RMD purposes IS clearly addressed in the Regs and p 32 of Pub 590. The instructions indicate that the year end value of the TIRA that reflects an outstanding recharacterization is the amount of the recharacterized contribution PLUS (or minus) ALLOCABLE NET INCOME. It would make no sense to use a different amount for basis calculations than used to determine RMDs resulting from recharacterizations.
Therefore, you should use 260,000 for line 6, which is the amount adjusted for earnings, notwithstanding the fact that this adjustment reflects earnings results for a period ending after the actual year end. This eliminates having to make an extra calculation in an attempt to determine what the 12/31 value would have been.
Using 260,000 will increase the non taxable portion of the 700,000 conversion that remains, so client should be happy about that. Note that it is also easier for the IRS to check because the amount agrees with the 1099R recharacterization figure.