Failed conversion
Here’s the scenario.
Converted a portion of SEP-IRA to Roth in 12/06, fully intending to pay tax for 2006. Had a real estate capital gain in 2006 that put me over $100k, thus disqualifying me from the conversion. Came to realize this now, after 10/15/07, and I still have not filed ’06 tax returns. Broker will not allow re-characterization back to the SEP now.
So I have a 1099R for 2006, and if I take the distribution from Roth now (which I now have to do), I will get hit with the 6% penalty, plus tax & 10% early withdrawal penalty. Broker will also issue a 1099R for 2007.
How do I file correctly and fix this mess, as broker has put out 1099R for 2006 and will do so for 2007 as well?
-Ken
Permalink Submitted by Alan Spross on Wed, 2007-10-31 00:58
Yes, you could have fixed this more easily prior to 10/15, and now the recharacterization deadline has passed.
This means that for 2006, you have a taxable conversion to report as you would have anyway. But you also have a 6% excise tax for the amount of the conversion in excess what you could have contributed to a Roth as a regular contribution, probably 4,000.
You now have to correct the failed conversion using the procedure to correct excess regular Roth contributions. If there is any good news, it’s that the earnings on the conversion can STAY IN the Roth and do not incur any tax or penalty. This is the trade off you get for being socked with the 6% excise tax on your 2006 return, plus probably an IRS interest assessment on the 6%.
You will incur another 6% penalty as of 12/31/07 if you do not withdraw the excess amount by then (either the entire conversion or the entire conversion less a regular Roth contribution you are eligible for). Since you have another two months of potential tax free earnings, there is no benefit in rushing to distribute the excess right now. But in mid December, order a regular Roth distribution in the amount of the excess contribution. Don’t bother to tell the custodian you are correcting anything because that does not change the custodian’s 1099R coding. Unfortuneately, the amount of this distribution will no longer be in an IRA of any type.
2007 reporting will include an 8606 to report the Roth distribution in Part III, and it will come out under the ordering rules tax free (you already paid the tax for 2006). You also need a 5329 to report the correction of the excess contribution and the 10% early withdrawal penalty, but because you will have corrected it prior to year end, there is NO 6% penalty for 2007. Remember, any earnings from the failed conversion get to stay in the Roth, so do NOT pull them out. I hope the amount of this conversion was not too large.
At the end of the day, the net result of all of this is that you lose the amount from your IRAs, as if you had simply taken an early SEP IRA distribution, and added 6%.