IRA Recharacterization after IRS time limit
In Nov 2004 I converted an IRA to a Roth IRA. The dollar amount is about $4,000. I later discovered that I was ineligible to convert due to our income. I am married and file jointly. In Nov 2004 I was 50 years of age.
I tried to recharacterize back to an IRA, however, I had past the time limit allowed.
I then learned about filing a Private Letter Ruling with the IRS, however in is my understanding that the IRS fee for this is now $9,000.
What are my options now?
Permalink Submitted by Alan Spross on Fri, 2007-08-10 23:11
With the high PLR fees now, there is no sense in pursuing a PLR unless the reward is well worth the time and expense. In your case, there is a routine solution to your problem.
A failed conversion is treated the same as an excess regular Roth contribution. However, the correction depends on what contributions or distributions you have taken from your Roth since the 2004 conversion. Please advise what these have been and then I can clarify what other steps you may need to take to put this behind you.
Permalink Submitted by Nicholas Scheidt on Sun, 2007-08-12 18:13
I have not taken any distributions, ever..
Thanks
Permalink Submitted by Alan Spross on Tue, 2007-08-14 23:43
The solution is rather complex. I also need to know if you qualified for a regular Roth IRA contribution in any year starting with 2004, that you DID NOT MAKE to either a Roth or traditional IRA.
In other words, your income might be over 100,000 and you could not convert, but it has been about 50% higher for regular Roth contributions. This comes into play because if you did not make a Roth contribution that you were eligible to make, the failed conversion can be applied as if it was a regular contribution. So, starting with 2004 which years were you eligible and which you did NOT contribute?
Permalink Submitted by [email protected] on Wed, 2007-08-15 01:48
With the amount being exactly $4000, and as Alan said, if you were eligible, its possible the custodian treated it as a contribution. Its easy for them to get the amounts mixed up (from personal experience).
Permalink Submitted by Alan Spross on Wed, 2007-08-15 02:54
Yes, that would be a possibility, and the 5498 reporting the contribution to the Roth for 2004 should be checked to see if that happened, but you would also have to eligible for a regular contribution.
What I was primarily getting at was the filing of Form 5329, Part IV, where current line 19 actually applies any remaining excess as a regular Roth contribution for that year, and would result in the elimination of the 6% excise tax by reducing the excess balance to -0-.
Permalink Submitted by Nicholas Scheidt on Wed, 2007-08-15 17:14
I have not made any contributions to a IRA or Roth IRA before or after 2004.
The previous traditional IRA was opened many year ago, I think around 1990.
Many thanks
Permalink Submitted by Alan Spross on Thu, 2007-08-16 02:31
With no distributions or contributions since 2004, you still need to determine IF you were eligible for a Roth contribution in 2004 or any year since. You need to know this to complete Form 5329 for each year.
If you were never eligible in those years for a regular contribution, the correction process follows:
1) Complete 5329 on a stand alone basis for 2004 through 2006. You owe a 6% excise tax for each year (6 X $240 = 720).
2) Request the IRA custodian distribute $4,000 to you near the end of this year. Earnings stay in the Roth. Report the 4,000 distribution on Form 8606 (Part III) with your 2007 return. The distribution should not be taxable since you already paid the tax when you converted.
3) Finally, the 5329 for 2007 with your return, but two parts are needed.
Part I line 3 will be $4,000 and you will owe the 10% early withdrawal penalty. For Part IV, you report your distribution showing that you have eliminated the excess contribution, and therefore do not owe the 6% tax any longer.
Total cost is $1120 plus whatever interest the IRS chooses to bill you.
Permalink Submitted by Nicholas Scheidt on Fri, 2007-08-17 10:06
Okay, thanks!!!
I completed form 5329 for the tax years 2005, and 2006.
Why do I need to wait until the end of this year for the distribution?
What is “whatever interest the IRS chooses to bill” mean?
How can I find out this amount?
Many Thanks again !!!
Permalink Submitted by Alan Spross on Fri, 2007-08-17 18:22
You can take the distribution now if you want to get this out of the way. But the reason I recommended that you wait is that any earnings on your 4,000 will accumulate tax free in your Roth. That’s 4 more months of tax free earnings rather than taxable earnings. You do not incur another 6% excise tax until 12/31, so that’s the vital date before which the distribution needs to come out.
Another very arcane fact that could affect you – if this 4,000 was your only Roth contribution ever, although your earnings will still be in the Roth IRA, your 5 year rule has technically not begun to run because your only contribution was not allowed. This just means that the first opportunity you can, you should make a regular Roth contribution, but if your income is too high, you can always wait to 2010 to make another conversion of any amount you wish. There is no income limit after 2009.
With respect to the interest, the IRS has not been consistent on this issue, sometimes they bill the interest and sometimes they don’t. Since the rate is subject to change quarterly over this period, the calculation could be complex and I do not know how to figure it exactly. So forget the interest, and just hope they don’t bill you. The good news is that once you pay the 6% taxes on these older items, the interest clock stops. Of course, the interest will only be on the $720 because the $400 will be a current obligation.
Permalink Submitted by Nicholas Scheidt on Sun, 2007-08-19 19:27
Thank You for your reply…
I want to summarize the taxes that I will owe for tax year 2007, as follows:
1 – 10 % of $4,000.00 tax penalty for early distribution withdrawal.
2 – $4,000.00 tax as ordinary income?
As stated previously I paid the 6 % excise taxes for tax years 2005 and 2006 on form 5329. I also paid the tax when I converted from IRA to Roth IRA in 2004.
Is the conversion from the IRA to Roth IRA in 2004 considered a “contribution” to a Roth IRA?
Many Thanks again!
Permalink Submitted by Alan Spross on Sun, 2007-08-19 23:40
1) That’s correct, because you had a conversion that you did not hold for 5 years.
2) No tax on the 4,000 income because you already paid tax when you did the conversion in 2004. However, you DO report the distribution on Form 8606, Part IV. If you have had regular contributions, it comes from them, if not it comes from your conversions starting with the oldest.
You did not mention the 6% excise tax for 2004, but you owe that since 2004 was the year of the actual failed conversion. In other words, the free standing 5329 forms are due from 2004, 05 and 06 @ $240 each. See my post of 8/15 19:31
Permalink Submitted by Janine Janine on Tue, 2007-08-21 02:31
Oh, dear, what is this Form 5329? My son has been making the maximum Roth contribution every year since its introduction. Since the contribution is after tax dollars, grows without being taxed, and withdrawals are tax free and penalty free after age 59 1/2, our understanding was that no form needed to be filed with income tax return.
Please clarify.
Thank you very much.
Janine
Permalink Submitted by Alan Spross on Tue, 2007-08-21 02:54
Form 5329 is used to deal with penalties, and the previous poster made a Roth conversion when his income was too high.
As long as your son was eligible to make all those contributions, there is no reason he would need to use Form 5329. If he takes distributions, those are reported on Form 8606 until after he reaches 59.5.