We have discovered in doing research for the 2012 Required Minimum Distribution tax basis and 2012 8606 filing that our 8606 for 2010 we filed showing our conversion for a portion of our IRA to a Roth IRA was not correct. In the 2010 8606 we showed only the portion we converted, using just the basis and total IRA amount for the two particular IRA accounts that we converted. This resulted in additional taxable income of $32,199. Line 14 of the 2010 form shows the taxable amount of the basis that will carry forward is $0.0. We spread the tax on the converted portion to 2011 and 2012. On the 2010 form I used the line 16 statement “enter the net amount you converted from traditional IRAs to Roth in 2010”. We did not have the figures for line 6 at the time without hours of research.

Through lots of research for 2012 RMD tax filing we found that we were in error in our assumptions for 2010 Roth conversion. We found copies of all 8606’s that we have filed and found that the last filed 8606 was in 2002 and showed a basis of $27,486 for the total of all non-deductible IRAs. This of course does not match the 2010 8606 because the 2010 8606 amount was ONLY the basis for the IRA that was converted.

We ask you which of the following scenarios is the best solution that will: a) be legal, b) not likely to trigger an audit, and c) minimize taxes owed. Can you suggest a better scenario?

Scenario 1: Change 2010 8606 to reflect TOTAL IRA and Basis values:

File an amended 8606 for 2010 with the corrected amounts for the basis and value of ALL our traditional IRAs as of 12/31/2010. This increases the taxable amount that is spread to 2011 and 2012. This will require that we also file an amended return for 2011. We will owe no additional tax for 2010 and owe approx $2500 additional tax for 2011 For 2012 we will also owe an additional $2500 and our income will be pushed above $170,000, which causes increased Medicare premiums. Overall this will cost us approx $7000 in additional taxes and Medicare premiums.

Scenario 2: Don’t change the 2010 8606 / Use a basis of $0. in 2012:

Use the 2010 8606 showing a $0. basis carry forward in the 2012 8606. This will mean that we give up the approx $8900 that is remaining in non-deductable contributions. But we will not have to file any amended tax returns for 2010 and 2011. We will not owe additional tax for 2011. For 2012 this will keep our income under 170,000 and thus no Medicare increased premiums. We would get a small refund for 2012. Giving up the additional basis will save us approximately $7000+ in taxes, premiums and penalties.

The total basis for the IRAs (line14) on the 2012 8606 will be the SAME value as the total basis on the 2010 8606 (i.e., $0.)..this is good. But we see two potential issues with this scenario: 1) The total value of IRAs in the 2010 8606 was zero ($0.), but the total value we will report for IRAs in 2012 will be about $125,000. 2) The basis we reported (correctly) in 2002 was $27,486, but in 2010 we put our basis at $18,448 (which was the correct basis for the IRAs converted to Roth’s). In 2012 we will report zero ($0.)…a large discrepancy.

For this scenario, are these two discrepancies between the filed 2002 and 2010 the proposed 2012 8606s likely to be RED flags to the IRS? Are they AUTOMATIC red flags due to their various computers checking capabilities? If we do get audited, is it likely that the IRS will require us to go back and do Scenario 1?

Scenario 3: : Don’t change the 2010 8606 / Use a basis of $8998 in 2012:

To recapture the remaining non-deductable contributions that were made, we file a 2012 8606 showing a basis of $8998 ($27,486 less $18,488) that we can carry forward. This means that the 2010 8606 line 14 (total basis at end of 2010 ) will not match the 2012 8606 line 2 (basis at beginning of 2012). We will not have to file 2010 and 2011 amended returns and our 2012 income will be under 170,000. The basis of $8998 will result in some tax savings each year as we convert RMDs in the years ahead, but we think not much.

This scenario has the same two potential issues as Scenario 2, with the additional issue that we are going from a zero ($0.) basis reported in 2010 to an $8998 basis in 2012.

For this scenario, are these three discrepancies between the 2002 , 2010 and the proposed 2012 8606s likely to be RED flags to the IRS? Are they AUTOMATIC red flags due to their various computer checking capabilities? If we do get audited, is it likely that the IRS will require us to go back and do Scenario 1?