Conversion/Recharacterization problem…..
I am wondering, if anyone has some thoughts:
Taxpayer(42) converts 100K to Roth in 2009 – that is the only Roth he has.
Distributes 50K in in June 2009 (ie. distribution is now outside of the 60-day rollover window).
He finds out in January 2010 that he is ineligible to convert and therefore does not have enough assets to recharacterize. What should he do?
Thanks,
pko
Permalink Submitted by mk foss on Sat, 2010-02-20 05:11
You recharacterize the entire (remaining) Roth. The main reason that people recharacterize is because assets in the account have lost value.
Permalink Submitted by Anonymous (not verified) on Sat, 2010-02-20 19:35
Thanks.
Somehow, I was thinking of a penalty situation, because the distributed converted money in the Roth was not allowed to be there in the first place – Excess? But, I agree that the recharacterization formula uses an “Adjusted closing balance”, which includes distributions, so it appears to be fine.
pko
Permalink Submitted by Alan Spross on Sat, 2010-02-20 20:49
He also owes ordinary tax on the 50k and the 10% early withdrawal penalty. But the real mess will be reporting these activities on the 8606 and 5329 in a way the IRS will understand after they see the 1099R and 5498 forms. This scenario is not covered by any of the IRA related Instructions, although p 63 of Pub 590 covers the typical unrecharaterized failed conversion. This one is NOT typical so a thorough explanatory statement of the entire chain of events will be the key.
Following p 63 guideline, I would report the 100,000 plus recharacterized amount distribution on line 15a and 50,000 on 15b of Form 1040, and attach a 5329 to change the 1099R 2 coding to a 1. That will trigger the necessary 10% early withdrawal penalty. Then for the J coded 1099R for the 50k Roth distribution, just show it as a return of a regular contribution on Form 8606 (not a conversion or it will incur another 10%). In essence, you are not reporting a conversion here, but an early distribution, a regular Roth contribution and a withdrawal of that contribution. One tax on the 50 k and one penalty.
But the explanatory statement is vital so the IRS can understand that a 5498 showing a conversion will not generate an 8606 conversion entry because half was recharacterized and the other half failed and is not treated as a conversion.
This would probably require either a paper return or professional software. I doubt that the off the shelf products could handle it.