ROTH Re-Characterization
Facts:
Prospect created ROTH IRA in 2005 and made contributions from 2005 through 2008. In 2009 they transferred this ROTH IRA account to a new ROTH IRA account at a new custodian (so they thought). Prospect did not make contributions in 2009 or 2010. In 2011, 2012, 2013 and 2014 prospect contributed $1,800 per year. In 2015 prospect has contributed $450. Prospect discovered last week their 2014 MAGI exceeded the limit (for the first time) and will likely exceed the limit in 2015. Therefore prospect desires to re-characterize the contributions made in 2014 and 2015 to TRADITIONAL IRA contributions.
In the process of discussing the re-characterization process, last week the prospect discovered that when the ROTH IRA was transferred to the new custodian in 2009, the receiving custodian incorrectly coded the account as a TRADITIONAL IRA.
The prospect has reported to the IRS that all contributions since 2005 have been ROTH IRA contributions.
Custodian has admitted to the mistake and plans to take the following action:
1. Re-code the account from the incorrect TRADITIONAL IRA registration to the proper ROTH IRA registration. The re-characterization of the 2014 and 2015 contributions will happen AFTER the account is re-coded to a ROTH IRA.
2. Custodian says they will communicate to the IRS that the contributions made in 2012, 2013 and 2014 were incorrectly reported to the IRS as TRADTIONAL IRA contributions when the custodian should have reported them as ROTH IRA contributions.
3. Custodian says they can only “fix” the contributions made in 2. above for three taxable years (hence 2012, 2013 and 2014). Therefore custodian says they cannot “fix” the 2011 contributions.
4. For the 2011 contributions, the custodian says they will write a letter to the prospect stating that 1. The custodian incorrectly coded the account as a TRADTIONAL IRA rather then the intended ROTH IRA; 2. The 2011 contributions were intended to be ROTH IRA contributions but the custodian reported them to the IRS as TRADTIONAL IRA contributions. Therefore this letter appears to be the only evidence the prospect has to show the IRS (i.e. in the event of an audit) that the contributions were intended to be–and were reported by the prospect to the IRS as such, ROTH IRA contributions.
Questions:
1. Does the action proposed by the Custodian that made the error appear proper?
2. Do you suggest the custodian take any other action?
3. Any other feedback?
THANK YOU!
Permalink Submitted by Alan - IRA critic on Mon, 2015-03-23 21:00
There is no template to fix an issue like this. The only proper way would be to file a PLR Request that the entire pre recharacterization balance in the account be characterized as a Roth IRA. But the cost may be prohibitive in relation to the balance. Is the custodian recoding the entire account as a Roth IRA, or are they proposing to partition some of it to a Roth and leave the pre 2012 balance titled as a TIRA? If they are retitling the entire account as a Roth IRA and the only gap is the 2011 5498, I would be satisfied and reasonably sure that there would not be a problem. If a non qualified distribution was taken, I would show on line 22 of the 8606 the regular contribution balance counting 2011 as a Roth along with all the other contributions. The prospect should carefully save all 5498 forms showing Roth contributions just in case, and document for future use the circumstances regarding the 2011 and later contributions. Prospect is also fortunate that the custodian is doing more than just admitting the error and stating it to be too late to change their records.
Permalink Submitted by Jose Morales on Mon, 2015-03-23 22:06
How did the client not notice the 5498 each year (2011, 2012, 2013) that would have showed a traditional IRA contribution instead of a Roth contribution? Can the client, or the custodian, produce the 5498s and check to be sure exactly how the contributions were reported. I’m stating this because if you are dealing with a very inexperienced group of people (and when it comes to retirement accounts almost all are very lacking in adequate retirement plan knowledge) they may have registered the account incorrectly but actually coded the account on their system correctly, in which case a simple reregistering (correcting the vesting) is all that would be needed. Believe me, I’ve seen many mismatches between the registration and the actual coding of the account so many times that it’s not out of the realm of possibility. If the account was not only registered, but also coded incorrectly, then the corrective procedure will involve submitting updated 5498s for each year needing a correction along with a 1096. There is nothing stopping them from submitting a corrected 5498/1096 for years more than three years prior. These corrections are going to be scanned in and the data on file with the IRS will simply be overwritten. There is very little chance that anyone will actually review the forms, other than to make sure that there are no errors that would cause issues during scanning. A written explanation is more valuable in the hands of the client, in the event of an audit. As Alan stated, the best course of action would be a PLR, but with the amounts involved it may make little to no sense.