Code for Distribution of Roth Converted Proceeds – Five Years

Submitted by Michael Boster on Sun, 2013-01-13 22:39

I have learned from experience that the odds are high for a Custodian or Trustee involved in any IRA transaction to screw up the subsequent 1099-R unless minute details on the actual reporting are agreed upon in advance – and even then, mistakes happen.

Last year, for example my IRA custodian mis-coded the Distribution Code for a Roth Conversion, with a Distribution Code of 1 instead of 2, which would have subjected me to 10% early withdrawal penalty (I am under 59 1/2). I had to insist upon a corrected 1099-R within the window to avoid any problems.
Next year the first of a series of Roth IRA conversions reaches 5 years.

I understand that the specific case of (a) individuals under age 59 1/2 who (b) nonetheless meet the five-year holding period and who (c) have undergone Roth Conversions but who have made no Roth Contributions may make distributions of Conversion Proceeds tax- and penalty- free.

But what is correct Distribution Code for the Custodian to note for such a distribution?

Possibilities, according to the 1099-R Instructions:

J – Early Distribution from a Roth IRA, no known exception (in most cases, under 59 1/2)
Q – Qualified distribution from a Roth IRA
T – Roth IRA distribution, exception applies

I know that Q does not apply since I am under 59 1/2.

I do not believe that J applies since even though I am under 59 1/2, I have met the five-year holding period for the distribution of Conversion Proceeds. The Exception in question, I understand, is to the 10% penalty.

Therefore, I believe that T applies, with the exception to the 10% penalty.

Do you agree??

The potential problem is the Custodian believes that a code J applies. Her logic is the following, also based on the 1099-R instructions:

Q – Use Q for a distribution from a Roth IRA if you know that the participant meets the five-year holding pariod and the participant : has reached age 59 1/2, or died, or is disabled.

T – Use T for a distribution from a Roth IRA if you don’t know if the five-year holding period has been met and the participant: has reached age 59 1/2, or died, or is disabled.

J – Use J for a distribution from a Roth IRA when Q or T doesn’t apply.

But this is clearly too rigid a definition for T. She knows I have met the five-year holding period since I converted the TIRA with her, and she knows my age, and I have told her I am not disabled. However, she also knows that I am only going to distribute the Converted Amount, and no Earnings. But she is intransigent.

Any advice here, aside from getting another Custodian – at least not right now?! If I actually go forward with the Roth Distribution, I see an IRS accident ready to happen, with them claiming in I owe a 10% penatly when one is clearly not due. It seems much better to discuss calmly here and anticipate the problem ….



Submitted by Alan - IRA critic on Sun, 2013-01-13 23:34

  • Your correct code is J and it complies with IRS instructions. Remember that a Roth owner can have an unlimited number of Roth IRA accounts and distributions are taxed as if you had one combined Roth. Further, the custodian has no way of knowing what distributions you took from any account but their own. All they know for sure is that you are under 59.5. While J is correct, both your taxation of the distribution and any 10% penalty is totally in your control because you must properly complete Form 8606 and 5329 if necessary. Completing Form 8606 correctly depends on knowing the exact amounts of your regular and conversion contributions that remain. You also must know the amounts and years of your conversions because that is where the 10% penalty comes in if you remove conversion dollars not held 5 years. If you owe the penalty, that is reported on Form 5329, Part I.
  • So do not be concerned about the J coding, as it is correct. All it means is that you are under 59.5, so your 5 year holding period for conversions is still required PLUS if you have any taxable amount (you don’t), there would also be a penalty on the taxable amount.
  • You may know the rules, but if you take out conversions, the oldest conversions come out first, so you could avoid any penalty if you limit distributions to 5 year conversions and older. But if you remove newer ones, that is when you need the 5329 to report the amount subject to the penalty.
  • You should make a tally sheet of your Roth activity by the year showing the year and amount of each Roth contribution and conversion, and your accumulated amount. With this sheet, you could glance at it to determine the tax consequences before you take out a distribution.

Submitted by Michael Boster on Mon, 2013-01-14 01:31

Alan, many thanks for your prompt and detailed reply. My situation is a little less complicated than it could have been since all my IRAs are Roths and all Roths were funded by taxable conversions. After studying your response, the instructions to and the forms 5329 and 8606 themselves, I would just appreciate your confirming or correcting my  points below. 1.  it looks like I do not need to complete Form 5329 as in Part I, line 1, no early distributions would be considered income in my case. 2.  I would need to fill out Part III of Form 8606, Distribution from Roth IRAs, entering the Roth distributions in that year on line 19, and total accumulated conversions on line 24.  Since line 23 minus line 24 yields a negative amount in line 25, no taxes are due or reportable on Form 1040.  3,  On Part I of Form 8606, the form seems to indicate that I don’t need to fill anything out but the instruictions seem to otherwise encourage entering the total accumulated basis in TIRAs on line 2.    Thanks again for all your value-added support in this matter. Marcos

Submitted by Alan - IRA critic on Mon, 2013-01-14 03:23

  • 1) Although you will not have any taxable income (your conversions already taxed) and you are not withdrawing earnings, there is no taxable amount to be penalized. HOWEVER, if you are withdrawing conversion money in less than 5 years you will still need the 5329 to report the penalty unless you have a penalty exception. You don’t need the 5329 if you do not withdraw conversions still under the 5 year holding period (if this is for 2012, conversions done before 2008 can be withdrawn without penalty. If you still have any 2010 conversions that you split the income between 2011 and 2012, do not forget to report the 2012 half (this is for tax, not penalty).
  • 2) Correct
  • 3) You don’t need to complete Part I unless you meet one of the 3 requirements listed on the 8606. Do you have basis in your TIRA? If so, then part of your former conversions were not taxable, and if you withdrew some of those conversions under 5 years, you would only owe the 10% penalty on the taxable part.
  • Be careful, because the 2012 8606 form has been released by the IRS, much shorter than the 2011 Form, but the Inst. for 2012 have not, making it hazardous to match the line instructions for a different year.

Submitted by Michael Boster on Tue, 2013-01-15 00:36

Alan, I appreciate your response, which I have studied carefully.  One final set of questions/clarifications if you don’t mind:  1) Clarification: Conversions were made in several years but withdrawal is only contemplated on conversion money exceeding the five-year holding period.  Question:  Thanks to your clarifications, I am far less concerned with the actual distribution code; I think the real issue is whether the custodian includes an amount in Box 2a of 1099-R (taxable amount that must be included in income), which, in turn, applies to Line 1 of Form 5329 (Early distributions included in income).   If this happens, then the distribution of 5-year conversion money would be listed in the same amount in Line 2 (Early distributions included on line1 tha are not subject to the additional tax.   As for the appropriate Exception Number, per the instructions:   This would be #12 (Other), right?   But I don’t see under the subsequent breakdown of Other, below #12, an item that corresponds to the exception at hand! How to properly form fill & communicate the 5-year distribution of conversion money?? 3) Clarification:  Apologies, I misstated my situation, I meant the basis from having converted all of my previous TIRAs, none of which had any basis upon conversion. Thanks again, Marcos

Submitted by Alan - IRA critic on Tue, 2013-01-15 18:26

  1. The custodian should not show anything in 2a for a Roth distribution that is not a corrective distribution. In cases like yours the custodian has no way of knowing if any amount is taxable and the IRS 1099R instructions therefore indicate the nothing should be in 2a.
  2. With respect to the 5329, Part I, there are special Roth instructions. Line 1 would show a total of the taxable amount which you would generate on Form 8606 (in your case this would be -0-) plus the amount of conversions you withdrew in less than 5 years (in your case this would also be -0-). If you have nothing to report on Form 5329, you don’t need the form.
  3. Now let’s say that you did take out conversion money held less than 5 years. You would have to show that distribution on line 1 of the 5329. If you qualified for an exception to the penalty (eg higher education expenses paid), you would then show the amount of education costs on line 2 and the exception code 08 also. Code 12 is only for certain misc exceptions or for multiple exceptions. But I don’t see any of these issues applying to you or that you even need a 5329. To clarify, you don’t need to claim any exception for withdrawal of conversions over 5 years because you don’t list them on line 1 in the first place.

Submitted by Michael Boster on Tue, 2013-01-15 23:45

Thank you Alan for the comprehensive  response.  I had scoured the web and I believe this is the one place where the definitive way to deal with reporting distributions of Roth five-year conversion money is now addressed.  Many folks might also not have been previously aware of this exception to the 10% early withdrawal penalty if they are under 59 1/2, so this might show a path for them to meet pressing financial needs, although I hasten to add that clearly given the tax-free growth and withdrawals inherent in a Roth this would be far from ideal and a last resort. 

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