Roth conversion when own multiple IRA’s
1. Client owns a rollover IRA (from deductible contributions).
2. Client opens NEW NON-deductible IRA and contributes max allowed.
3. Client immediately converts ONLY non-deductible IRA (no income or gains in that account).
From a tax point of view. Is the convesion creating NO tax as there were no gains/income in the non-deductible IRA, or does he have to apply a ratio as though the non-deductible IRA and prior deductible IRA where one, triggering a partial taxation on that conversion.
If you have the code to support the answer I would appreciate that as I’m getting conflicting answers.
Permalink Submitted by Alan Spross on Tue, 2012-02-14 19:53
It is the latter (apply ratio), because all TIRA accounts are combined as one for tax purposes. The taxable amount would be the same regardless of which TIRA account funded the conversion. When a non deductible contribution is made, it is reported on Form 8606.
Form 8606 applies to all TIRA accounts no matter how many there are. Therefore that 5,000 becomes a percentage of the total TIRA value and that percentage is the tax free portion for any distribution or conversion. Exactly the same ratio applies if there is no conversion, but just a distribution taken from either account. For these reasons, there is no tax reason to make a non deductible contribution to a different TIRA account or to maintain an additional TIRA account.
All you have to do is work through a Form 8606 to see how this works. Line 6 of the form asks for the total year end value of all TIRA, SEP and SIMPLE IRA accounts and creates a decimal by dividing the basis by the adjusted total value. That decimal is the tax free portion of the conversion.
Here is a copy of 408(d)(1) and (2):
>>>>>>>>>>>>>>>>>>>
(d) Tax treatment of distributions
(1) In general
Except as otherwise provided in this subsection, any amount
paid or distributed out of an individual retirement plan shall be
included in gross income by the payee or distributee, as the case
may be, in the manner provided under section 72.
(2) Special rules for applying section 72
For purposes of applying section 72 to any amount described in
paragraph (1) –
(A) all individual retirement plans shall be treated as 1
contract,
(B) all distributions during any taxable year shall be
treated as 1 distribution, and
(C) the value of the contract, income on the contract, and
investment in the contract shall be computed as of the close of
the calendar year in which the taxable year begins.
For purposes of subparagraph (C), the value of the contract shall
be increased by the amount of any distributions during the
calendar year.
>>>>>>>>>>>>>>>>>
Permalink Submitted by Alan Galinsky on Tue, 2012-02-14 21:31
so if one did the conversion and did not apply the ratio for a 2011 contribution, can they recharacterize and reverse the converted amount to the non-deductible IRA?
Permalink Submitted by Alan Spross on Tue, 2012-02-14 21:50
Yes, a 2011 conversion can be recharacterized up to 10/15/2012.
If the 2011 return has already been filed, it will have to be amended if the recharacterization is done OR if the 8606 was incorrect. Of course, if the Roth conversion has generated some nice earnings in the meantime, it may be worth paying a little more in taxes than expected to keep those earnings in the Roth. There is also a compromise option, that is recharacterizing some portion but not all of the conversion. Recharacterizing half would reduce the tax bill by half and keep half of any earnings in the Roth IRA.
The best decision depends on what the taxable % will be and how the investments have done while in the Roth IRA. If the client wants to wait until September to decide, he might file an extension by April 17th, pay the estimated amount due and file the return right after the recharacterization or when he knows he will not recharacterize.
If he just wants to get this all behind him, he might recharacterize now and then file the actual return. If so, the 2011 return should include an explanatory statement showing the amount and dates of the conversion and the amount, date and amount transferred back for the recharacterization.