Help – 2 Indirect Rollovers w/in 365 days

Submitted by Mitch on Fri, 2017-04-28 17:44

Here’s the situation….

1. 3/10/2017 = client received a distribution check of $46,500 from IRA Custodian #1. He endorsed the back of the check and made payable to a new Custodian #2 and deposited in new IRA within 60 days. All good except for the fact that he had already executed an indirect rollover from same IRA 10 months earlier.

2. The mistake was realized. As of this post, he is still within the 60 day window.

3. Custodian #1 has offered to receive the funds back and “correct the coding.” (This either means they are willing to redact the transaction as if it never happened or show $46,500 going out and coming back in within 60 days.)

4. The problem is Custodian #2. They are only willing to code the deposit of $46,500 as “excess contribution.” He is 62. So his contribution limit is $6,500. This means they are willing to return $40,000 as excess.

5. The client also has a Roth IRA at Custodian #2. I’ve tried to get Custodian #2 to recode the deposit into his ROTH IRA. This would allow the client to convert the $46,500 to a ROTH and recharacterize later if he wants. They will not do this.

So I’m left wondering if this is possible,…

a.) The client takes $40,000 from Custodian #2 as excess contribution and comes out of pocket another $6,500. He then re-deposits $46,500 into Custodian #1 within 60 days. Custodian #1 “corrects the coding”.

b.) Now at Custodian #2 he has a 2017 contribution of $6,500.

c.) The potential issue I see here is that Custodian #2 shows $46,500 coming in and $40,000 going out on Form 5498 (I think). If Custodian #1 “corrects the coding” by redacting the distribution all together as if it never happened, then everything seems fine. But if Custodian #1 also generates a 5498 showing $46,500 going out and coming back in, then I’m not sure of the potential consequences.

Never-the-less, this is the best idea I have at the moment. Any additional thoughts would be GREATLY appreciated.

All the best,
Mitch



Submitted by Mitch on Fri, 2017-04-28 18:14

The real blessing here is that we are still within the 60 day window.  So I’m thinking worst case scenario is the client takes the $40,000 excess contribution from Custodian #2 and redeposits that amount only back into Custodian #1.  This would create a taxable distribution of $6,500 from Custodian #1 and a contribution of $6,500 to Custodian #2.Thoughts?

Submitted by Ben Meyer on Fri, 2017-04-28 18:33

  • The main question here is what Custodian #1 means by “correct the coding”.  If they mean that they can receive back the $46,500 and fix the books to erase the whole thing, this would be fine, but sounds like an irregular transaction, and they may decide later in the year not to do it.  If “correct the coding” means that they will code it as a distribution and rollover within 60 days, this would be no good at all due to the earlier rollover less than 12 months earlier.  Thus, any solution by Custodian #1 would not be reliable.  Further, you won’t actually know how the back office of Custodian #1 actually processes the transaction until next February, when you either receive a form 1099-R/5498, or perhaps not.  At that point there will be no options available.  
  • But what can be done to resolve the open rollover is to make a rollover deposit of $46,500 into a new Roth account, as a Roth conversion contribution, within 60 days of the distribution from Custodian #1.  A new institution can be used for this, or make the Roth conversion contribution at Custodian #1 if they seem agreeable to this.  But you must be certain that the transaction will be coded as a Roth conversion contribution, deposited directly into a Roth IRA.  Many institutions will actually make the deposit into a traditional IRA and then perform an immediate Roth conversion, which would be completely unacceptable in this situation.  It would help if the client opens a new Roth account first, without making any deposits.  Then, a few days later, deposit the Roth conversion contribution into the new Roth account.  This would help to clarify the nature of the transaction. 
  • Performing a Roth conversion will be a taxable event.  It could be recharacterized to avoid the tax, but consider that a recharacterization would increase the level of complexity of the reporting and may be cumbersome to explain, even though it would be totally compliant.
  • As for Custodian #2, this is probably okay for now.  The excess contribution has been withdrawn, and there is a $6,500 contribution for 2017.  This is actually unrelated to the distribution from Custodian #1 and subsequent Roth rollover.

Submitted by Alan - IRA critic on Sat, 2017-04-29 00:25

  • Custodian’s apparent flexibility would not be proper unless it is indicative of an error they made, but there was no mention of that. I don’t know why they would redact the distribution unless said distribution was never requested, or possibly because they were asked about the one rollover rule and gave bad advice.  It is typically also more likely for the firm receiving the assets to be more flexible than the distributing firm, and for this situation the opposite applies. Note that if custodian 1 did have justification to redact the distribution client could then have the entire 46,500 regular contribution returned from custodian 2 with earnings and sent back to custodian 1, who would not issue either a 1099R or a 5498 for the return of the money..
  • Custodian #2 should issue a 5498 next year for 2017 reporting the entire 46,500 as a regular contribution pursuant to client’s explaining that the rollover was ineligible per the 5498 Inst. They would also issue a 1099R reporting a corrective distribution of 40,000 or 46,500 +- earnings. They are correct to refuse to reconstruct the excess contribution rollover as a Roth conversion if no conversion was requested originally, although such a conversion would preserve the distribution in the Roth for the taxable income instead of loss of this amount from client’s IRA.
  • Note that even the prior version of the 12 month rollover limitation would have been violated in this case, and the IRS does not have the authority to make exceptions to this limitation like they do for the 60 day deadline.
  • Client receives the 40,000 plus earnings as a corrective distribution, but this amount cannot be converted thereafter because it is now an excess contribution rather than a simple distribution.
  • Also, the 12 month limitation is measured from the day of receipt of the prior distribution, not the date that rollover was completed. Any chance that 10 months becomes 12 using the correct time interval?
  • In summary, there redaction of the contribution or reconstructed conversion would resolve the problem, but there is no apparent valid reason for either custodian to pursue this approach unless one of them was solely responsible for the error.

Submitted by Jose Morales on Sat, 2017-04-29 01:17

I’m just posting to stress what Alan posted.  Any “correction” by custodian from which the funds were withdrawn would not be proper if there was no true mistake on their part.  They can’t simply make this type of “correction” for purely customer service reasons.  If the customer did in fact request a withdrawal of the funds and he had already executed a rollover within the previous 12 months then the withdrawn amount was not eligible for rollover and became a contribution when deposited, resulting in an excess contribution for whatever portion of the deposit exceeded the individuals contribution limit for the year.  Too many custodian’s play fast and loose with these types of actions and may not realize the very real consequences to them and their client’s if found out.

Submitted by Ben Meyer on Sat, 2017-04-29 02:16

So in the absence of an actual custodian error, the taxpayer is now faced with a distribution of $46,500, less any basis,  that will be taxable if nothing further is done.  The solution for the taxpayer is therefore to make a Roth conversion contribution within 60 days of receipt of the funds from Custodian #1.  The same amount will still be taxable, but it will at least remain within a Roth IRA.  It could also be recharacterized back to a traditional IRA if the taxpayer wants to deal with the resulting complexity, and the current tax liability thereby abated.

Submitted by Alan - IRA critic on Sat, 2017-04-29 04:27

That should work if client has another 46,500 available to deposit in a Roth IRA as a conversion contribution. There may not be time to get custodian 2 to agree to treat the disallowed rollover as an excess regular TIRA contribution and process the corrective distribution before the 60 day period expires. Depends on how much of the 60 days is left. I don’t think that the order of these transactions matters as the rollover to custodian 2 is an excess contribution regardless of whether the conversion was done before or after that rollover. Probably not a good idea to open the Roth IRA at custodian 2, as that might result in confusion with custodian 2.

Submitted by Mitch on Mon, 2017-05-01 12:01

Thank you very much for your time and expertise! This forum is an amazing resource.  From your feedback, I agree that a Roth Conversion within 60 days of the distribution from Custodian #1 is the proper strategy. I sincerely appreciate each of your input and will advise the client as such.All the best to Benn, Alan and Urusei2! Mitch

Submitted by Alan - IRA critic on Mon, 2017-05-01 19:19

In doing this it is important to explain to custodian 2 that this distribution was not eligible for rollover and therefore should be reported on Form 5498 as a 46,500 regular contribution, not a rollover. Client would then request a return of that full contribution (or 40,000 of it if he wants to make the 6500 TIRA contribution which may or may not be deductible).  As a result only the Roth custodian would report a conversion contribution and the IRS would then match up the Roth 5498 with the 1099R from Custodian 1.

Submitted by Mitch on Mon, 2017-05-01 20:06

I’ve spoken in more detail with Custodian #2 and have a few follow up questions.

Earlier Alan commented,… “if custodian 1 did have justification to redact the distribution client could then have the entire 46,500 regular contribution returned from custodian 2 with earnings and sent back to custodian 1, who would not issue either a 1099R or a 5498 for the return of the money..

  • Custodian #2 should issue a 5498 next year for 2017 reporting the entire 46,500 as a regular contribution pursuant to client’s explaining that the rollover was ineligible per the 5498 Inst. They would also issue a 1099R reporting a corrective distribution of 40,000 or 46,500 +- earnings.”
  1. Custodian #2 confirms they will issue 5498 with coding as INDIRECT ROLLOVER of $46,500. They will not change the coding to REGULAR CONTRIBUTION as the client endorsed the third party check from Custodian #1. I wonder if this alone nullifies any and all options discussed above?
  2. If client distributes excess contribution + earnings to himself, Custodian #2 will generate a 1099 with code 8 “excess contribution.”  46,500 + earnings of 1,310 = $47,810
  3. Custodian #2 will not issue a 1099 if funds are direct transfered back to Custodian #1 b/c they do not issue 1099s on direct transfers. (This obviously would only be after vetting Custodian #1 further to ensure they would be willing to redact all coding.
  4. Custodian #2 will also not allow the client to fund a Roth Conversion at their institution with the same $46,500.
  5. So, I’m wondering if you agree it’s best to have the excess contribution + earnings distributed directly to the client so that a 1099 is generated.
  6. From there he can either,…
  • a)  Deposit into a new Roth at a new custodian as a 60 day Roth conversion.  (If you still think this is viable based on the info above.)
  • b)  or send funds back to Custodian #1 after ensuring they will redact coding.  (The client originally told the contra advisor he wanted to deposit the funds into a new IRA and asked the advisor if he could help him.  So that may be why Custodian #1 has offered to “fix the coding.”) This would require full vetting and obviously a risk remains if they don’t fully redact all transactions on 1099/5498 or otherwise.

Mainly I’m curious what you think of Custodian #2’s coding on the 5498 and whether this poses a roadblock to any and all corrective measures.Thanks in advance! Mitch

Submitted by Alan - IRA critic on Mon, 2017-05-01 23:18

  1. Custodian 2 would be in direct violation of the 5498 Inst if they refuse to report the contribution as an excess contribution once given the evidence that it is. If they issue an incorrect 5498, they will have to amend it. But well before they issue the 5498 the client will force their hand by telling them this is an excess contribution and they want it to be returned with allocated earnings. A 1099R coded 8 will provide alternate documentation to the IRS that this was an excess contribution. Remember, the contribution must be returned with allocated earnings.
  2. Custodian 2 should be forced to distribute the corrective distribution. Do not transfer the account out of custodian 2 unless they refuse and client can convince custodian 1 that they would have to process such a distribution if the account was transferred to them.  I assume that resistance from custodian 2 could result in expiration of the 60 days to do the Roth conversion, which is huge problem if client does not have another 46,500 available to fund the conversion before the 60 days expires.
  3. Since the conversion solution will work, there is no need for any redactions and any attempt to do that could mess things up.
  4. At this point client should not want to keep his account at custodian 2 anyway. The conversion can be done with any other custodian once a Roth IRA is opened and client has 46,500 for the conversion money.
  5. I agree with your point 5 and 6a, but would avoid 6b. Client could do the Roth conversion at custodian 1 however. Not sure if client has other funds for the conversion if custodian 2 resists. Again, if custodian will issue a 1099R coded 8, that constitutes agreement that the rollover was actually an excess contribution, so even if they refused to report the rollover in Box 1, the 1099R should be enough for the client to report return of an excess contribution and a Roth conversion.

Submitted by Mitch on Tue, 2017-05-02 12:08

All the best,Mitch

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