Conversion and withdolding
Client did a conversion in 2016 and did not inform the custodian to NOT withhold 10% for federal taxes, which he wanted to do. Custodian withheld the 10% and now client has received 1099 on that which he will owe a penalty on since he’s under 59 1/2. I believe a recharacterization of the conversion may eliminate this issue, but how does the client do that AND get the 10k that went to the IRS back into the TIRA? Thanks -m
Permalink Submitted by Alan - IRA critic on Wed, 2017-02-22 18:29
m- the withholding cannot go back into an IRA as of 60 days after the conversion was done which was the rollover deadline. If the conversion is recharacterized, that will eliminate the tax on the 90% that was converted, but not tax or penalty on the withholding. Of course, the withholding payment will apply against the final 2016 tax bill, so what ends up lost is the tax money on the withheld amount, the penalty if there is no penalty waiver available, and future tax deferral since this money will no longer be in a tax deferred account.
Permalink Submitted by [email protected] on Wed, 2017-02-22 18:48
So, it looks like no way to eliminate the penalty on the withheld amount. So, no reason to recharacterize if they were willing to pay the taxes on the conversion. Thanks.
Permalink Submitted by Alan - IRA critic on Wed, 2017-02-22 19:11
Right. Client would have needed to come up with other cash within 60 days to complete the rollover, which would have resulted in two conversions. They might have even happened in different calendar years. The withholding would still have been in the IRS, but the tax and penalty on the withholding would have been eliminated. And for someone who does all this and wants to recharacterize for other reasons, the withholding will still be in the IRS until they file the tax return to apply it. Unless the taxpayer has a particular strategy such as actually wanting withholding to eliminate a possible underpayment penalty and then completing the full conversion, it is almost always a bad idea to have withholding taken from a conversion distribution.
Permalink Submitted by [email protected] on Wed, 2017-02-22 19:46
Great, thanks. Agreed on the preferred method of not withholding. Paperwork error made. -m