ROTH IRA over contribution after calculating taxes
I read a couple of threads on this but still not sure that I’m 100% clear. So a client contributed $5500 to their 2015 ROTH IRA February 1, 2016 and about a month later $5500 to their 2016. Their taxes were completed yesterday (April 4, 2016) and determined that they’re AGI is over the limit to contribute to a ROTH IRA. The total balance of the IRA account is about $30,000.
The worksheet calculation will come out with a loss for the contributions, so the recharacterization will be about $4900 of the $5500 for 2015 and about $5400 for 2016. So no earnings to deal with. The custodian will recharacterize the amounts from ROTH IRA to Non-Deductible IRA for 2015 and 2016 and then shortly thereafter they will be converted back into the ROTH IRA as a “back door ROTH IRA”.
What is the client suppose to show on his 2015 tax return? Just a form 8606 with the $5500 original contribution amount chosen to be non-deductible (even though the recharacterized amount has dropped to $4900 the original amount was $5500). Then in 2016 they will have an 8606 showing the $5500 for 2016 and also the $4900 going back into the ROTH IRA for 2015, and since it has a $5500 basis there is no tax effect?
If we assume there was a gain rather than a loss in this scenario for 2015. Say the $5500 had grown to $6000. Would the $500 of earnings just stay in the ROTH IRA or would the $500 need to be removed and taxes/penalties paid on it?
Permalink Submitted by Alan - IRA critic on Tue, 2016-04-05 21:06
Seems more likely to be a gain than a loss since the markets are up over 5% since Feb 1st. If both contributions are recharacterized as TIRA contributions and then converted to a Roth IRA, any earnings that were recharacterized will be taxable for the conversion in 2016. The 2015 return will only include an 8606 showing the 5500 contribution and an explanatory statement regarding the Roth contribution and recharacterization. The contributions can be recharacterized with the same request and as soon as both earnings adjusted contributions are in a TIRA account, it can be converted. If client has any other non Roth IRA balances in other accounts, those balances will result in the conversion being mostly taxable under the pro rating performed on Form 8606.
Permalink Submitted by Arek Puzia on Tue, 2016-04-05 23:56
Thank you for the explanation! I probably had a the dates off a bit but when I checked it looked like it will be a loss. I think the markets came back for them but they were down a lot at one point. So assuming that neither the 2015 nor 2016 ROTH contributions had a gain, then for 2015 it will just be a Form 8606 with a TIRA contribution of $5500 and then in 2016 a conversion with basis of $5500. And for the 2016 contribution it would be the same in 2016. A form 8606 and then if any gains between TIRA and back into ROTH Conversion above the $5500 basis.
Permalink Submitted by Alan - IRA critic on Wed, 2016-04-06 00:16
Correct. For example, if there is a $200 gain on these contributions before they are converted to Roth, the 2016 8606 would show 5500 on lines 1 and 2, 11,000 on line 3. The rest of Part I would calculate the taxable portion of the conversion to be $200, and Part II summarizes the conversion as 11,200 gross, non taxable portion 11,000 and taxable portion $200. The $200 then goes on line 15b of Form 1040.