Taxes and Penalties Already Paid… or Still to Pay?

Submitted by Amar Patel on Sun, 2013-03-03 10:45

I’ve recently seen a 1040A filed for 2010 for a single tax-filer under the age of 35, a year that also included a conversion of a traditional IRA to a Roth IRA in that year. No Form 8606 has been found yet for this conversion. However, boxes 11a and 11b for the 1040A do record a number. But this is only 10% of the entire amount that was converted.

Typically I would think that the full amount of the conversion is included in boxes 11a and 11b. However, the amount that was entered is exactly the amount that was taken from the IRA during the conversion process as federal withholding. The filer does not seem to have a copy of 1099-R, so these calculations seem to have been compiled using statements from the IRA provider.

What is the next step here for this filer?



Submitted by Alan - IRA critic on Sun, 2013-03-03 16:39

There should be an 8606 with the 2010 return (unless conversion recharacterized), but since the default rule for 2010 conversions is deferral to 2011 and 2012, line 11 should only include the withholding taken on the 2010 return. so the basic return could well be correct. Check to see if half of the converted amount was included on the 2011 return. Trying to secure a copy of the 1099R for 2010 is necessary to avoid guesswork. It’s also possible that part or all of the 2010 conversion was later recharacterized and there would be later 1099R forms for that, if applicable. Unless the taxpayer has basis in their TIRA, 2010 should not have to be amended just to add the 8606. 



Submitted by Amar Patel on Sun, 2013-03-03 23:40

        • So I’ve been in touch with this other filer (which is my wife currently living in a different state) several times today, and I’m even more thoroughly confused.  But this site has been great to me so far so I’ll keep chipping away and come closer to an answer step by step I’m sure.
        • What I’ve learned so far this morning is that my wife did indeed finally recall once having a 1099-R for the year of the conversion from the IRA provider.  But, like the 1040A required, that copy was sent in to the IRS without retaining a copy for her records.  So she will still contact the provider for another copy for her records soon.
        • But she still has no clear recollection of a Form 8606 being generated then.  And then the rest of the story continues to baffle me.  She seems to be strong in her recollection that she instructed the IRA provider to withhold all the needed taxes for the conversion in 2010.  She is strong in this recollection because she and relatives who were in the same financial position as her all went to the same IRA provider at the same time to convert in the same way.  And the others too, as of this morning, recall instructing the provider to withhold all necessary taxes within the 2010 year to avoid confusion later (which apparently didn’t seem to work to avoid confusion anyway!).
        • From there, the plan was that one of them who always works with a well-known nationally-branded tax preparation company would prepare his 2010 filings first and then report what was done to report to the conversion to the others.  The others would then just follow a similar path when preparing their own 2010 filings.
        • Well this preparer seems to have coached them all into that “default rule” for deferring into 2011 and 2012.  This confuses me because 1) they thought that the instruction was given to withhold all needed taxes for the 2010 tax year and so they thought they “were done paying taxes on that” and 2) their conversion was reported in a wholly different way than my own conversion from TIRA to Roth IRA in 2009.
        • Based on my own conversion, her instruction to the provider to tax it all for 2010, and what I understand of early withdrawal penalties, I would have expected seeing the full conversion amount reported on Page 1 of 1040, the withholding reported on Page 2 (where all the other W-2 and 1099 withholdings would be reported), and the early withdrawal penalty would be reported on Page 2 too somewhere else.
        • Instead, what she has is just the withholding reported on Page 1, the withholding reported again on Page 2 along with the other various withholding amounts on Page 2, and no separate entry for early withdrawal penalties.
        • This is what was apparently recommended by the well-known nationally-branded tax preparation company.  But my first response is a resounding silence accompanied by head scratching and gnashing of teeth.  I mean, I don’t see that a penalty is reported.  Surely the IRS wants that money, and surely the well-known nationally-branded tax preparation company didn’t steer 3 people and who knows how many others down the wrong path (especially considering that Alan on this site also seems to concur the filing for 2010 may well be correct!).
        • I did notice that the withholding was in the exact amount of 10% of the converted amount.  Coincidentally, or perhaps not, this is the expected amount of the penalty.  Is what was reported on the 2010 1040A how that penalty was reported to the IRS?  If not, how is the penalty to be reported?
        • What needs to be found and/or corrected in the 2011 filings for my wife (pre-marriage, so none of those complications there)?  Remember, everyone was thinking that they “were done paying taxes on that” 2010 conversion most likely.
        • Assuming something needs to be corrected, in either the 2010 to reflect the full income and tax and withholdings and penalty there, or something in 2011, this is likely to bump her into the Roth IRA phaseout zone (or deeper into that zone for 2011, since she already was limited to contributing less than $5000 for 2011).  How is that hullabaloo handled under either return that is amended?
        • For 2012, we were already planning to use the Backdoor Roth route, and if a portion of her 2010 conversion needs to be reported as 2012 income, it likely has no further impact (other than having to pay out more in taxes in general).

         



        Submitted by Alan - IRA critic on Mon, 2013-03-04 04:14

        • Generally, withholding from a Roth IRA conversion is not recommended since the entire distribution obviously does not get converted, but 10% is a default % for an IRA distribution if withholding is not declined by the IRA owner. If under age 59.5, the amount withheld would also be subject to the 10% penalty plus ordinary taxes. Due to the unique 2010 conversion rules, the added result of withholding is that unless the 8606  is filed and the box in that form checked to report the entire conversion in 2010, the withholding will not even be for the year(s) the conversion is taxed. Of course, tax credit for it will be realized on the 2010 return, but tax on the conversion will be due in 2011 and 2012. In summary, withholding was very poor advice under the circumstances. I would guess that the IRS expects to see the conversion reported 50% in 2011 and 2012 UNLESS the 2010 return includes an 8606 with the box checked to elect to report the entire conversion in 2010. Seems like they should have asked about 2011 by now.
        • But line 11 of return itself appears correct, except that the 10% penalty should be added to the line on p 2 of the 1040A (10% of the amount withheld). In this situation, there may be two 1099R forms for this distribution as the withholding might appear on a separate 1099R.
        • Her 2011 return would report 50% of the converted amount (only the amount that made it into the Roth) on line 11. If that was not done, the return will have to be amended, and taxes on half the conversion will be due (assumes she had no basis in her TIRA).
        • Fortuneately, the added 2011 and 2012 income from the 2010 Roth conversion is NOT included in modified AGI, so this will not affect regular Roth IRA contributions made in those years.
        • This also should not affect a back door Roth in 2012, ie making a non deductible TIRA contribution and converting it.


        Submitted by Amar Patel on Mon, 2013-03-04 17:22

              • Before I get to what I think I need more help on, let me see if I can repeat what I think I understood.  That yet-to-be found Form 8606 for 2010 might have indicated the option of wanting to convert all of the IRA to Roth in 2010, and thus all of it should have been taxed then.  But it might not have and so the other possibility is splitting the conversion amount and adding a portion to 2011 income and 2012 income.
              • And I think I’m understanding that the withholding amount was indeed a distribution AND a tax credit/payment made, which is why it makes sense that the same number is reported on two separate lines.
              • And I think I’m understanding that it was just probably “standard procedure” that the withholding amount was 10% of the IRA value at the time of the conversion.
              • Finally I think I’m understanding that wherever the conversion amount ends up being reported, the converted amount is not included in the Roth contribution limit/phaseout calculations, nor have any immediate bearing on the backdoor Roth being planned for 2012.
              • So, here are some of the questions I still have.  When it comes time to report a portion of the conversion for 2011 and 2012, does it have to be half and half?  And is it half and half of the full IRA value before the withholding was taken or just the portion that eventually ended up in the Roth?
              • And how/where is the early withdrawal penalty reported if at all?  What line specifically?  On a “new” 1040A for 2010?  On a 1040X for 2010?  In 2011 or 2012?  I saw Form 5329 but was confused on how to complete it.  And even if I did, it said something about reporting it on a 1040, not a 1040A like she actually submitted for 2010.
              • And since her Form 8606 for 2010 still cannot be found, should we just send one in after (most likely) determining that we’ll split the conversion over 2011 and 2012?  Does anything in particular happen if the IRS already had a Form 8606 for 2010 for her and the newer one happened to have conflicting information or was just a duplicate?
              • And if either her 2010 or 2011 return must be amended, is it better to amend the 2011 to possibly reduce any extra fees or penalties on the tax bill if any show up eventually (since the 2010 tax year is more distant in the past and thus the penalties will have had more time to stack up)?

               



              Submitted by Alan - IRA critic on Mon, 2013-03-04 18:48

              • The 2011 and 2012 half of the conversion ignores the withheld amount. Each year is half of the amount that was actually converted to the Roth. There are no options other than 50% and 50%
              • She might request a copy of the 2010 return from the IRS before acting further, but no sense in filing an 8606 now since it’s too late to opt out of the 50-50 conversion reporting. She must have intended that anyway, otherwise the 2010 return would have included the entire conversion.
              • If she did not include the 50% in 2011, she should amend that ASAP.
              • For the 10% penalty in 2010, she would need a 1040X. Check first if she might qualify for a penalty waiver, eg higher education expenses, medical etc paid in 2010.


              Submitted by Amar Patel on Sun, 2013-03-24 20:01

                  • OK, so I think I’m about ready to help my wife file her corrections but I wanted to review once more what I think is going to be done.  And I’ll use some numbers to help make the example more concrete.
                  • In 2010, my wife converted $14000 from a TIRA to a Roth IRA.  Though not ideal, the bank withheld $1400 during the conversion, and it was apparently never added back.  So this counted as an early distribution too.
                  • My wife originally used a 1040A for 2010.  Instead, she should have used a regular 1040.  On that 1040, she should have reported $14000 on line 15a.  Line 15b should have reported $1400, and line 58 should have reported $140.  $1400 should have also been included in the line for the total of all withholdings from all W-2s and 1099s.
                  • Now, to correct this, she’ll file a 1040X.  On this 1040X, Columns A and C will be the exact same and Column B will be zero for lines 1 to 8.  On line 9, Column A will be 0, B will be $140, and C will be $140.  All the rest of the math is followed and line 19 will show $140.
                  • So, for 2010, she’ll send in a Form 1040X and a Form 5329, plus a check for $140.  If she’s assessed any other fees or penalties, the IRS will send a statement.
                  • That’s all for 2010.  Then for 2011, her 1040 for that year should have showed $6300 on line 15b and $0 on line 15a.  So for 2011, she’ll send in a Form 1040X with the corrected lines plus a check for whatever line 19 shows.  If she’s assessed any other fees or penalties, the IRS will send a statement.  For 2012, she’ll just file as normal plus the remaining $6300 on line 15b and $0 on line 15a.
                  • Does all of that sound right?

                   



                  Submitted by Alan - IRA critic on Mon, 2013-03-25 04:52

                  • The 2010 1040A was OK for the conversion, but not when a penalty is due because of the withholding. The safest thing to do now is to include a 1040 and show the penalty on line 58 with the 1040X. That means transferring the 1040A income over to the equivalent lines on the 1040. I didn’t check the specific lines involved.
                  • Your proposed 2011 and 2012 actions look correct.


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