Roth conversion mess. HELP!!!

Submitted by Josh Harmon on Tue, 2018-03-20 14:33

Hello,

I have a business owner client who at the end of 2017 wanted to convert their SIMPLE IRA to their Roth IRA. Worried about the 25% ‘under two year’ penalty, I went back through my notes and noticed that we implemented the SIMPLE IRA in October of 2015. Due to timing, I had them withdraw their SIMPLE IRA funds and write a check to their Roth IRA as a 60 day rollover to get it all done before the end of 2017. Their accountant called last week and told me that the 1099-R was coded ‘S’ meaning that the withdrawal was deemed to be under two years. After digging deeper, I realized that although we started the SIMPLE IRA in October 2015, my client did not open his individual account until April 2016, and his wife didn’t open hers until January 2017 (she also converted). This was clearly an error on my part. Is there anything we can do to undo this? Do I need to file an E&O claim? HELP!!!!

Josh



Submitted by Alan - IRA critic on Tue, 2018-03-20 16:14

  • Unfortunately, I don’t believe there is any relief available for this client, although if client or spouse qualifies for a penalty exception for IRA distributions, the 25% penalty would be waived. However, the funds will still lose IRA status because they are not eligible for rollover to any account other than another SIMPLE IRA in the two year period. That means the distributions are taxable, subject to 25% penalty, and the conversion is an excess Roth contribution that must be removed from the Roth with allocated earnings.
  • Rev Procedure 2016-47 which extends the 60 day rollover period requires that the distribution be eligible for rollover in the first place. While a direct transfer could have been made to another SIMPLE IRA, client took a distribution and converted it, so I think it’s too much of a stretch to remove the conversion from the Roth and attempt to apply the RP when a distribution was taken that was not eligible for rollover in the first place. Further, client wanted to do a conversion, not transfer to another SIMPLE IRA.
  • For the 2017 return, the distribution should be reported, but not a conversion since the conversion of a non rollover eligible distribution is an excess regular Roth contribution to the Roth and must be removed by having the custodian treat it as a regular Roth contribution. If client was eligible for a regular Roth contribution and did not make a TIRA or Roth contribution, only the amount in excess of the regular contribution limit would be excess. The custodian would also have to distribute allocated earnings with the conversion money and these earnings would be taxable in 2017 because the contribution was made in 2017. Earnings would be subject to 10% penalty in the Roth IRA corrective distribution. In summary, a nasty situation, probably even worse than you thought since the funds are lost to any IRA.
  • Perhaps client contributed to this error if he let you assume that he contributed to the SIMPLE IRA when it was established. However, client now has this money (less tax and penalty), and if he can contribute to any other retirement accounts in the next couple of years that he would not have been able to afford, he can replace the IRA funds and get a tax break that would partially offset the cost of this error. It will be pretty subjective to try and determine the dollar cost of this error. I don’t know enough about the E&O coverage, whether this loss would fall under any deductible or not, or what filing a claim would do to future premiums.

 

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