Basis rolled into 401k

Submitted by Mhotchkiss on Thu, 2018-03-15 22:51

Client had $92,000 of “basis” in his TIRA from a rollover of a 401k that included after-tax money.
Client had $39,000 of “basis” in his TIRA from contributions of after-tax money.

Client converted $92,000 from his TIRA to his Roth IRA.
Client rolled over the balance of the TIRA to his 401k (including the $39,000 basis)

Now, the client is wondering what happened to his $39,000 basis.

Since 401ks do not accept basis in rollovers, I believe TIRA custodian may have erroneously certified that there was no basis in the money rolled into the 401k. But, there was.

If the client rolls the 401k back to his TIRA, will he be able to re-establish his $39,000 basis? -m

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Permalink Submitted by Alan - IRA critic on Thu, 2018-03-15 23:30

m- He should be able to re establish the basis. Per RR 2014-9 the IRS indicates that if the certification of no basis turns out to be incorrect, the plan should distribute the IRA basis back out of the plan along with allocated earnings. Hpwever, even if they do and even if the 1099R only shows the earnings in Box 2a, technically the distribution was of an excess amount and will probably be coded as such in Box 7, and is not eligible for rollover back to the Roth. Therefore, the plan will likely only offer a distribution check to the client rather than a direct rollover. Client should probably double check the accuracy of these numbers before contacting the plan administrator with this information. The plan will not be happy about this, but hopefully will agree to the distribution. They should be referred to RR 2014-9. Even though the funds will be lost from the IRA, this will avoid double taxation of the 39k.

Permalink Submitted by [email protected] on Fri, 2018-03-16 13:28

thank you, Alan. I suppose my question was really, “If we roll the 401k back to TIRA in its entirety, could we then “re-establish” the basis somehow within the TIRA?” It sounds like you are saying, he can re-establish basis (please explain how he would do this) for the distribution of the basis from the 401k so that it would not be taxable. I assume the plan admin will still issue a 1099R showing this as a taxable distribution and the TP would have to prove otherwise? – m

Permalink Submitted by Alan - IRA critic on Sat, 2018-03-17 03:21

The only legal way would be to attach a self certification as the last step. This is also a stretch because the reason would have to be that the taxpayer mistakenly thought that the amount was rolled into an eligible retirement plan, however he probably just make a mechanical error by doing that. Nonetheless, if the TIRA Custodian accepted the form and the IRS did not question it, he could move the 39,000 back into the TIRA along with the basis after having the 39,000 returned from the plan.
Your question about simply rolling 39,000 back out of the 401k would produce a 1099R that treated the 39,000 as an eligible rollover distribution when it isn’t, as that could only be done by not telling the plan that basis was rolled into the plan in the first place. The IRA 8606 would have to either treat the basis as never having left the IRA (it did) or a new amount of basis would have to be added on line 2 as if the 39,000 came from after tax 401k contributions that were never made. This would be an easy way to return the money, but not proper procedure. The 8606 would have to be completed as if the basis never left the IRA, when it really did.

Permalink Submitted by Mahesh Garg on Sat, 2018-03-17 19:56

MZN

Permalink Submitted by [email protected] on Mon, 2018-03-19 15:40

I suppose this is an error that will be uncorrectable. I have further understood that with the filing of the 8606 for 2017, showing the conversion of the $92k, followed by a zero balance at end of year on the TIRA, the expectation would be for a misc deduction of the “loss” of $39k basis in the TIRA. If that happens, then wouldn’t the corrective distribution from the 401k be considered taxable to the client? if so, can this be avoided by not taking a misc deduction on the 2017 tax return? – m

Permalink Submitted by Alan - IRA critic on Mon, 2018-03-19 17:06

When attempting to report this situation, we could look at the opposite situation (401k to IRA) where there is more clarity with respect to reporting. If a 401k participant made an ineligible contribution (excess contribution or excess annual addition for example) and does a direct rollover to the IRA before this is detected, then because the excess was not rollover eligible, a 1099R will be issued showing the excess as taxable income and participant then has an excess IRA contribution to correct. The corresponding treatment for this IRA basis going into the 401k would be that the 39,000 would be treated as a distribution which should be reported as such and not as a rollover to the 401k. But there will not be a specially coded 1099R from the IRA to state that, so the taxpayer would have to report something inconsistent with the direct rollover G coded 1099R that was issued. That will be tough to explain to the IRS.
Now to your question. Since client did two rollovers (a conversion and rollover to 401k), the remaining basis is 39,000 and the amount received was 39,000 so there is no misc deduction available. For a TIRA full distribution misc deduction, the taxpayer must receive (not counting rollovers) less than their basis. Client did not receive less than his basis here, he received an equal amount. However, if client HAD received less than his basis and claimed a misc deduction then your thinking is correct. Client could not double dip and claim a loss while still treating the plan distribution as basis. The same basis would then be recovered twice. But it’s moot point here because client did not receive less than his basis.
Client will not have a 1099R to support this, but should report a non taxable distribution of the 39,000 and a direct rollover to the 401k of only the amount in excess of 39,000. Explaining what happened to the plan, a corrective distribution from the plan should be made but only the earnings on the 39,000 would be taxable. If the plan wants some proof that the amount was IRA basis, that would be difficult as the 8606 just reflects his accounting, no oversight from any custodian. So client might be stuck with a fully taxable 1099R from the plan, and would then have to provide a complete explanation of the entire chain of events to get the IRS to accept that the 39,000 was IRA basis, rolled into the plan, and then distributed back out of the plan. Yes, this is a real mess.

Permalink Submitted by [email protected] on Mon, 2018-03-19 18:45

Thank you, Alan. So, to take your 3rd bullet to the end, once that corrective distribution is made, the client would be left with $39k distributed, without tax liability and ineligible to roll into Roth/TIRA? The effect of this error is that $39k is forced out of the IRA of the client. – m

Permalink Submitted by Alan - IRA critic on Tue, 2018-03-20 04:10

Yes, that should be the case. Therefore, this is not overly costly but is a real hassle with respect to getting the corrective actions completed, reported on a 1099R, and then reported on client’s tax return.

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