Roth Conversion
In 2013, client, age 55 made a $6,500 non-deductible contribution to their IRA which had a balance of $260,000 all of which, prior to the $6,500 contribution was pre-tax money. They then immediately converted $6,500 from the IRA to a Roth IRA.
Custodian issued a 1099 R showing the $6,500 with Code 2 Early Distribution 59 1/2 known exception.
Accountant showed the entire $6,500 distribution (conversion) as non-taxable on the 2013 tax return.
I believe this is incorrect since the IRA contained pre-tax money. A portion of the $6,500 should have been allocated as pretax and thus taxable on the tax return.
I was under the impression the strategy of making a non deductible contribution and then immediately converting to a Roth and paying no tax on the conversion only worked if there was no pre tax IRA money.
Am I correct?
Thanks as always for your help
Howard
Permalink Submitted by Ben Meyer on Thu, 2015-02-19 14:31
Yes. Form 8606 should have been completed for 2013 since the IRA now has basis. The form will show the taxable portion of the conversion. From what you say, the non-taxable amount is a low percentage of the conversion, depending on earnings. Most of the $6,500 will be taxable, due to the much higher pre-tax balance. (This may seem like double taxation, but the tax is really due to the large untaxed prior balance.) The penalty for TIRA distributions before age 59 1/2 doesn’t apply for Roth conversions. Filing of an amended return for 2013 should be considered. In retrospect, if the untaxed balance had been rolled over into a qualified employer plan that permits such rollovers, the pre-tax balance in the TIRA could be eliminated. This could still be done in the future, assuming the availability of a suitable employer plan.
Permalink Submitted by Howard Hook on Fri, 2015-02-20 01:42
Thanks Benn.Interesting thing is the accountant did indeed file a form 8606. Looks like the form totally disregarded the pre tax balance. Part I, Line 6 (Dec 31, 2013 IRA balance) was not filled out. Nor was lines 7 -12. Part II Conversion from Traditional IRA was not completed at all.Client also made contributions in 2014 and converted to Roth in 2014. Assume if client does not want to pay the tax on the 2014 converison, I can recharacterize the conversion prior to filing due date?Howard
Permalink Submitted by Alan - IRA critic on Fri, 2015-02-20 03:51
Yes, Howard, the 2014 conversion can be recharacterized. And certainly the client should not be charged for filing the amended 2013 return. The 2014 return will include an 8606 only to report the non deductible contribution if the conversion is recharacterized, and update the basis from the 2013 8606.
Permalink Submitted by Howard Hook on Fri, 2015-02-20 14:44
Thanks Alan.In addition to the reasons you state for filing 8606 for 2014:If client decides to keep the 2014 conversion and pay the tax doesn’t he need to file an 8606 for 2014 to calculate the taxable portion of the 2014 conversion.ThanksHoward
Permalink Submitted by Alan - IRA critic on Fri, 2015-02-20 16:49
Yes, if he retains any portion of the conversion.