IRA Contribution with No Earned Income, then Converted. Help!

Submitted by John Michael Hall on Wed, 2022-10-05 18:06

I brought on a client & his spouse in 2021. Prior to onboarding them, the client’s previous advisor contributed $7K to his and her traditional IRA. They did not have any earned income in 2021. At the end of 2021, we fully converted her Trad IRA with a balance of $7500, which was obviously her $7K basis + gains. We did a $50K partial Roth conversion of his Trad IRA.

Since they did not actually have earned income in 2021, their CPA is now telling me that we need to reverse the $7K + gains from the Roth back into their Traditional IRA. Then, we need to withdraw from the Traditional IRA.

Does this sound like the proper remedy?

Also, the funds have experienced losses, but it’s impossible to document since they were intermingled with other Roth funds. Would you recommend just reversing the $7500 for her since that’s the amount we converted?



Submitted by Alan - IRA critic on Wed, 2022-10-05 19:29

  • If clients filed their 2021 return on time or filed an extension, they still have about a week to process returns of those excess contributions. The actual deadline is 10/17.
  • Client did not convert his entire IRA, so his situation is simpler because his conversion can be ignored, and the corrective distribution taken from his remaining TIRA account. The IRA custodian will calculate the gain or loss on his 7000 contribution based on the investment results of his entire TIRA account. If there is a gain due to more than 7000 being returned, the gain will be taxable in 2021. 
  • Spouse apparently had no other TIRA balance. CPA is incorrect about reversion of her conversion since conversions can no longer be recharacterized. She will have to convince the Roth custodian to treat her conversion as an excess regular Roth contribution,  and process the corrective distribution from the Roth IRA. Roth custodian will probably ignore any gain or loss that occurred in the TIRA before the conversion was completed, but it’s possible that they will ask for that figure which will be difficult to calculate.
  • If these transactions are completed by 10/17 there will be no 6% excise tax due for 2021. They may need to amend their 2021 return if either spouse has gains on these excess contributions, but more likely they have losses.

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