Excess SEP converted to Roth

Submitted by Ces Bailey on Wed, 2022-07-20 18:01

Just have a quick question –

A taxpayer who has no SE income erroneously contributed 20K to SEP-IRA and converted the same to Roth.

The brokerage firm issued 1099R that shows the 20K plus earnings as fully taxable. The SEP contribution has not been deducted on the return and so should have basis.

How will this conversion be reported on 8606 and show the earnings as the taxable portion only.
Except for Roth, FMVs of all other IRA is zero.

Thanks,
Ces



Submitted by Alan - IRA critic on Wed, 2022-07-20 19:51

  • Tax reporting will not conform to the 1099R forms and will have to include a detailed explanatory statement. There was first an excess SEP contribution apparently to an empty SEP IRA, which was not removed as such. Instead the SEP was converted, creating a double excess contribution via a failed conversion. 
  • The amount distributed from the SEP will be taxable to the extent it exceeded 20k. The failed conversion is reported as an excess regular Roth contribution which must also be removed with an earnings adjustment from the Roth IRA. 
  • There is no 8606 because the contribution to the Roth is not treated as a conversion, and there is no IRA basis to report.
  • This will not be expensive, since the only tax due will be on earnings generated in the SEP and in the Roth IRA plus early withdrawal penalty on the earnings. But it will be a reporting hassle. The Roth custodian will need to be informed why the conversion contribution must instead be treated as an excess regular Roth contribution and removed as such. The 1099R from the Roth custodian should be able to reported as issued, but not the conversion 1099R. 


Submitted by Ces Bailey on Wed, 2022-07-20 21:18

Thank you for that very thorough explanation!



Submitted by Alan - IRA critic on Thu, 2022-07-21 00:23

Sorry, the above post needs to be modified. Form 8606 needs to be completed showing a 20k non deductible contribution because IRS guidance that the excess distribution show 0 as the taxable amount is not feasible. In other words, if the SEP custodian is told why the distribution (the conversion 1099R) should show 0 as the taxable amount (up to 20k), they probably are not going to comply. So if the 1099R shows the entire distribution as taxable, the best way to make the distribution tax free up to 20,000 is to file an 8606 and report a non deductible contribution of 20k. There is no specific IRS guidance on excess SEP contributions that cannot be carried to future years or corrected in the usual fashion, so this explanation is improvising. Again, an explanatory statement should be included with the tax return since the return will deviate from the 1099R issued by the SEP custodian.



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