Roth Conversion
My friend had converted her traditional IRA to Roth IRA since 9/07 with 10% Federal WH tax automatic deducted by the same trustee. She just had her tax prepared and discovered that she still owes tons of tax .
She talked to the IRS to recharacterize it and she planned to do that next Monday 3/4/2008. And also prepare the 2007 tax with the Recharacterization. The IRS advised that a letter accompanying the mistake be attached to the tax return filed by 4/15/2007.
My question is ,
1. She needs to submit both 1099R ( one for the total gross distribution and full taxable amount, second 1099R is for gross distribution of the tax amount and box 4 fed WH tax of same amount). ? When she input this distribution as recharacterization, will the second 1099R be taken care of , in other words will of these 2 1099R be taken care of?).
2. The letter requested by the IRS to explain this honest mistake , does she need to explain what it is? As it simply will make her paying tons of taxes and last year she was off work for 2 months and her compensation was from one month of vacation and the second month is no pay at all?
Does she need to mention any of these off time at all.
3. She cannot converted it to Roth again till, Jan 1, 2008? or Different date.
Lots of confusion and THANK YOU very much.
Permalink Submitted by Alan Spross on Mon, 2008-03-03 04:32
What makes this one a mess is the withholding, which she should have asked to avoid when she make the conversion. She cannot now recharacterize the withheld amount because a recharacterization of a conversion is done by direct trustee transfer by the Roth IRA custodian to the traditional IRA custodian of her TIRA. But the withheld funds are in the IRS, not in the Roth. Therefore, the maximum that can be recharacterized is the amount that went to the Roth IRA. That will leave the 10% withholding as taxable and probably subject to the early withdrawal penalty as well, and she cannot do anything about that.
Reflecting the full recharacterization of the amount in the Roth, she does not need a Form 8606 because she still will have done a full recharacterization of the Roth IRA. The explanatory statement you referred to should read like this –
” On 9/xx/2007 I converted $x to my Roth IRA, and on 3/4/2008 I recharacterized the full amount, which was then worth $y back to my traditional IRA.”
Her 2007 return will show the full amount distributed on line 15a of Form 1040, and the withheld amount on line 15b. 10% of the withheld amount is the early withdrawal penalty, and that can be directly entered on line 60.
She does not have to explain any of the reasons for the recharacterization, as this is NOT a mistake, just an action that she has the option to reverse. She should have realized in the first place that a Roth conversion is taxable, and would increase her taxes accordingly. People that convert should be able to pay the taxes with OTHER funds, not take them from the conversion distribution as she did.
If she is thinking of a reconversion, perhaps she should first consider if she would be better served to pay the taxes on the present one since she may well have less income in 2007 than in 2008. The amount of any earnings or loss on the conversion should also be considered, since the earnings adjustment will determine how much goes back to the traditional IRA. She may even want to request an installment payment plan from the IRS if the Roth conversion had good earnings. If it had a loss, it is more likely that the recharacterization would be better.
With respect to a reconversion, if she converts a different amount, she could do it any time she pleases. If she converts the same amount, she must wait 30 days after the recharacterization. Next time she should tell the IRA custodian that NO withholding is to be taken.