Can Form 8606 Line 8 ever be negative?

Submitted by Amar Patel on Fri, 2017-03-10 02:18

I’m helping my parents recharacterize some monies from Roth IRA back to traditional IRA, to get them back into a lower tax bracket. In doing so, only some of dad’s initial Roth conversion is being recharacterized, while all of mom’s initial Roth conversion is being recharacterized. In both cases, earnings were realized in the Roth IRA, and so the recharacterizations are including some of the gains while going back to traditional IRA.

For my dad, on Form 8606 Line 8, I’m taking the initial Roth conversion sum and subtracting out the value of what was recharacterized, including part of the gain. This is a positive number. For my mom, on Form 8606 Line 8, I’m taking the initial Roth conversion sum and subtracting out the value of what was recharacterized, including all of the gain. But this would be a negative number.

Can Form 8606 Line 8 ever be negative? I’m thinking not. Instead, I’m thinking dad needs to file a Form 8606 while mom does not (all of her Roth conversion was recharacterized). In both cases, we’ll need to attach letters for the IRS explaining what happened. Right?



Submitted by Alan - IRA critic on Fri, 2017-03-10 02:45

Line 8 (or any other line on Form 8606) cannot be negative. If all conversions of a certain year were recharacterized it would leave a net converted amount of 0, and eliminate the need for an 8606 with respect to conversions.  Any earnings calculations are not considered in determining line 8. And for Dad’s 8606, line 8 should show the conversion amount (not adjusted for earnings) that was retained in the event of a partial recharacterization. For each recharacterization there should be a brief explanatory statement indicating the date and amount of all conversions, the date and amount of the recharacterized conversions and what the conversion was worth when transferred back to the TIRA.  This last amount reflects gains or losses and what is shown on the 1099R reporting the recharacterization.

Submitted by Amar Patel on Fri, 2017-03-10 03:46

  • Hmmm… so it is like the following for dad:
  • Initially converted 30000 in 2016
  • Recharacterized 10000 in 2017
  • Broker included 10 of earnings, and sent 10010 back from Roth to traditional in 2017
  • But report 20000 on Line 8, and not 19990?
  • And the gain of 10 is discussed only in the letter and not otherwise reported?
  • If that is the case, we may need to look at dad’s 2015 filings to see if the gain was included in Line 8 or not.  If it was, it was a small amount (on the order of $10).  Would the IRS still require a Form 1040X to show $10 more income, subject to the 15% marginal rate, thus showing $1.50 more should be owed for 2015?

    • Submitted by Alan - IRA critic on Fri, 2017-03-10 04:18

    Yes,  20,000 goes on line 8. That is the amount tax on the conversion will be based on. As for 2015, if the amount of additional income is very small, I would just let the IRS send a bill for additional amount due if they want to. But for accounting purposes to determine his actual basis from Roth conversions, it will be the amount he actually converted. He needs to keep track of that in the event he ever takes a non qualified distribution from the Roth IRA since that info is required on Form 8606 line 24. 

    Submitted by Amar Patel on Fri, 2017-03-10 04:59

    • I’m not sure I understand that part about determining his actual basis from Roth conversions.  But maybe I don’t have to?
    • Meaning, both mom and dad are retired and in their 70s
    • Their Roths have been open since the 2011 tax year I think, so the 5-year rule on qualified distributions has been met for contributions I think
    • I think I understand that each conversion gets its own 5-year rule; but they’re both over 70, so by definition any distributions are qualified, right?

    Submitted by Alan - IRA critic on Fri, 2017-03-10 15:28

    Yes, once the Roth is qualified and fully tax free, no further accounting of the contribution balance is required. Qualified Roth distributions are not reported on Form 8606, just on line 15a of Form 1040 so that obviously eliminates lines 22 and 24 of Form 8606 where the balance of regular and conversion contributions is requested.

    Submitted by Amar Patel on Mon, 2017-03-13 01:23

    • What about Line 6?  In reviewing calculations, I think I’ve spotted where Line 6 on Form 8606 is supposed to include the 31-Dec balance from the prior year PLUS the recharacterized amount plus gains, right?
    • So, in this example, say that dad’s traditional IRA only had $0.10 on 31-Dec-2016 before recharacterizations executed in 2017
    • Then in March 2017, the broker is instructed to recharacterize 10000, and completes a transfer of 10010 a few days later
    • Line 6 should then equal 10010.10?
    • How does one go about correcting a prior year’s Form 8606 only, if needed?

    Submitted by Alan - IRA critic on Mon, 2017-03-13 04:16

    Yes, line 6 must reflect outstanding rollovers and recharacterizations, therefore if a conversion is recharacterized back to a TIRA the amount transferred back to the TIRA after 12/31 must be added to line 6 as if the conversion never happened. If lines 6-12 are being completed and any were incorrect, an amended return would be needed since these lines affect that tax year, not just later tax years.

    Submitted by Amar Patel on Mon, 2017-03-13 04:38

    • So, in this example, line 6 would be $10010.10, to reflect the recharacterization, the gain, and the original 31-Dec balance?
    • And would re-filing Form 8606 require a 1040X for that year too?  A correction on 8606 didn’t seem to impact the taxable income figures, just the accounting on 8606.

    Submitted by Alan - IRA critic on Mon, 2017-03-13 16:07

    Yes to first question. The IRS may or may not accept the 8606 without a 1040X, but filing the 1040X provides a space to explain why you are changing the 8606 and eliminates the chance of the IRS kicking it back and asking for the 1040X.  The IRS may not be as lenient in accepting an 8606 by itself in this situation as they are for documenting old non deductible contributions.

    Submitted by Amar Patel on Tue, 2017-03-14 20:41

    • Aw man!  This is getting confusing…  Every thoughful response from Alan has me reviewing and re-reviewing Form 1040 and Form 8606.
    • Now I think I’m seeing where, for mom and dad’s filings, Form 8606 Part 1 should not have been used in their case.  According to the instructions on the form itself: 1) they did not make nondeductible contributions to a traditional IRA for 2016, 2) they did take distributions from a traditional IRA in 2016 but did not make nondeductible contributions to a traditional IRA in 2016 or an earlier year, and 3) they did converted part, but not all, of a traditional IRA to Roth IRA in 2016 (excluding any portion recharacterized) but did not make nondeductible contributions to a traditional IRA in 2016 or an earlier year.
    • At first glance, this seems to leave no place to report the RMD dad was required to take (mom was not required to take a RMD for 2016, for not being 70.5 years in age until 2017).  But maybe page 26 of the instructions for Form 1040 has the answer, under the “More than one distribution” paragraph?  Each distribution is to be totaled for Line 15a and each taxable portion is to be totaled for Line 15b.
    • I’ll make up some numbers for the sake of an example:
    • Dad’s 2016 RMD = 5000
    • Mom’s 2016 RMD = 0 (not required)
    • Dad’s initial conversion to Roth in 2016 = 30000
    • Dad’s recharacterization back to traditional IRA in 2017, for the 2016 tax year = 10000
    • Included in the direct transfer back to dad’s traditional IRA was 10 in gains
    • Mom’s initial conversion to Roth in 2016 = 20000
    • Mom’s recharacterization back to traditional IRA in 2017, for the 2016 tax year = 20000
    • Included in the direct transfer back to mom’s traditional IRA was 15 in gains
  • So, taking this piece by piece:
    • 5000 would be included on Form 1040 Line 15a and Line 15b because of dad’s RMD
    • The net 20000 that was converted from Dad’s traditional IRA to Roth IRA would be included on Form 1040 Line 15a and Line 15b, via Form 8606
    • Nothing would be reported on Form 1040 Lines 15a or 15b for mom (no RMD required, and the her entire conversion was recharacterized)
    • A letter would be attached for each of mom and dad, explaining the dates and amounts of RMDs, conversions, recharacterizations, and gains associated with recharacterizations
    • Right?
  • And what is the downside of completing Form 8606 Part 1 when nondeductible contributions were never a part of mom’s or dad’s traditional IRAs?  Either way, in the end, it seems as if Form 1040 Line 15b is reflecting the right taxable amount, but Line 15a and/or the explanation letters may be wrong.

    • Submitted by Alan - IRA critic on Wed, 2017-03-15 01:38

    I agree with all your conclusions except that the explanatory statements should not mention the RMD. Nothing has changed with respect to the RMD. Dad’s 8606 includes only Part II, not Part I. Lines 15a and 15b will be the same showing the total of the RMD and the retained conversion amount. It appears that if Part I of Form 8606 is completed when it should not be, it will not result in errors, just alot of 0s on the form resulting in all distributions not having any non taxable component. Lines 15a and 15b would still be correct, as would Part II of Dad’s 8606.

    Submitted by Amar Patel on Wed, 2017-03-15 02:19

    • What is the downside of reporting different values for 15a and 15b in this example?
    • For example, if 15a was reported as 55000, and 15b was reported as 25000
    • The rationale being, though likely wrong in retrospect, was that 55000 is the total of what initially came out of the traditional IRA accounts before the recharacterizations were completed, and that 25000 was the taxable part after the recharcterizations were completed?
    • Does this in anyway harm the tax-advantaged status of any of the traditional or Roth IRAs?  Does this need to be corrected via amendments/updated returns?  The taxable part was right in the end, just that maybe 15a was wrong.

    Submitted by Alan - IRA critic on Wed, 2017-03-15 02:34

    • Good point. I overlooked the full conversion 1099Rs (both of them) when I said a and b would be the same.  You have two 1099Rs for original conversions and that amount goes on 15a. So 15a will be considerably more than 15b. There is no downside for this as that is what the 8606 Inst. indicate for 15a notwithstanding the recharacterizations.
    • 15a is only used by the IRS for 1099R matching purposes. They want to know at a glance that the taxpayer has reported every 1099R received. That said, a mismatch would not necessarily create an inquiry particularly with your explanatory statement for the recharacterization. The b line is what they are really concerned with.

    Submitted by Amar Patel on Wed, 2017-03-15 19:50

    • So it sounds like maybe 15a and 15b included the correct values after all, even if Form 8606 Part 1 was used erroneously
    • Using Form 8606 Part 1, though potentially incorrectly, does not seem to have introduced any harm (no mis-reporting of basis, only ended up concluding the RMD needs to be added to Line 15b in addition to the net conversion amount)
    • We’ve done our best to explain our calculations in explanatory letters; but we assume that if the IRS has questions or concerns about how things are reported, they will not hesistate to ask, and given that the entries on 15a and 15b do seem correct, the risk of any penalties or fees seems low
    • But, given that these are tax-advantaged accounts, where we do not ever want to see the advantage stripped away, does anything more need to be done?  This may be worth its own thread if not covered already, but what types of cases has compelled the IRS to permanently remove tax-advantages of traditional or Roth IRA accounts?

    Submitted by Alan - IRA critic on Wed, 2017-03-15 22:30

    • You are good to go here. Very little chance of receiving any IRS inquiry on this issue. Many IRS inquiries that are made can be put to bed with a simple explanation. In many cases, the IRS loses or fails to read the explanatory statements that taxpayers do provide, and then send an unnecessary inquiry.
    • Loss of IRA status is very rare, but can happen in the event of a prohibited transaction, such as using IRA assets for personal purposes. This is risk for real estate IRAs. There are several prohibited transaction types, it is a very complex subject. The IRS has also been known to use the lack of a statute of limitations on excess contributions to levy excise taxes when it is too late to do anything else with respect to the IRA. This happened in a recent case where the taxpayer was doing multiple disallowed rollovers, and actually led to the recent revision of the one rollover rule to apply collectively to all IRA accounts instead of per account.
    • On the subject of disallowed reconversions from failing to meet the waiting period, the IRS is not actively concerned with this infraction. Technically, this would also create excess Roth contributions subject to the annual 6% excise tax.

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