Recharacteraization – Taxable amount and when?
Taxpayer, age 66, does a Roth conversion of $100,000 on 12/27/05. On 04/17/06 she files an extension for her 2005 tax year. No other IRA distributions. Sometime in May 2006, she receives a final partnership K-1 with a $217,000 net section 1231 gain (a complete surprise). This puts AGI in 2005 before the Roth conversion over $100,000.
Taxpayer informs the trustee (all money and her Traditional and Roth IRA are witht the same custodian), who then completes the re-characterization on 10/13/2006.
Taxpayer filed 2005 with the IRA distribution of $100,000 in box 15a and $0 in box 15b (the taxable amount because of the recharacterization of the $100,000 failed conversion). Given the timeframe, taxpayer had no specific knowledge of the dollar amount of the recharacterization other than $100,000 (e.g., did not know the amount of gain, if any, during the 10 month period).
It is now time to file the 2006 return. Taxpayer has no IRA distributions, except as noted below, and AGI is safely below $100,000.
Taxpayer has a 2005 Form 5498 showing $100,000 Roth IRA Conversion Amount in Box 3. She also has a 2006 Form 5498 showing $107,142 Recharacterized Contribution in Box 4.
Question: Is the $7,142 taxable, and if so, in what year? I assume the entire $7,142 should be treated as gain within the Traditional IRA, so nothing is taxable until it is withdrawn. How does the taxpayer show all of this on her return? The IRS has already sent her a CP2000 notice taxing the full $100,000 distribution in 2005.
Thank you for your suggestions and advice.
Permalink Submitted by Alan Spross on Fri, 2007-10-05 18:11
The $7,142 is not currently taxable, however it does represent earnings in the Roth which transferred back to the TIRA and will therefore become taxable when they are finally distributed, as you indicate.
Since the suggested explanatory statement did not accompany the 2005 filing, it should be made with the response to the inquiry. While the IRS has the info to match 1099R and 5498 forms, they do not execute this well, and therefore request the explanatory statement. It should be worded as follows:
“On 12/27/05 I converted 100,000 to my Roth IRA, however an unexpected K1 pushed my modified AGI over 100,000 for 2005. I therefore recharacterized the full amount which was then worth 107,142 back to my traditional IRA on 10/13/2006, before the extended due date.”
There is an example of this exact situation shown in the Inst for Form 8606, p 3 (first example shown).