After-tax to ROTH

Submitted by IRAQuestion5 on Tue, 2018-04-10 07:41

Hello-

Client has an Indiana PERF account with both taxable and non-taxable funds. We elected a rollover yesterday to another custodian. There was nowhere to indicate that the taxable was going to one account and the non-taxable to another account so we recorded the entire amount was going to the client’s traditional IRA with the intention of directing the rollover custodian to split the deposit – non-taxable to ROTH and taxable to traditional IRA.

Will this be a problem come tax time? For example, will the 1099 issued by IN PERF not reflect what we want it to?

Thanks!



Submitted by Alan - IRA critic on Tue, 2018-04-10 16:39

  • Alot of things can go wrong here, the most serious being that the total distribution is deposited in the TIRA, as that would defeat the isolation of basis and subject the client to the pro rate rules for all future IRA distributions including conversions. If your recording results in a single direct rollover check made out to the TIRA FBO client, and if it is mailed to the client for delivery, I would ask the client to return it for re issue. The IRA custodian will normally not be willing to deviate from the intent of the check, which also reflects the future 1099R form next January.
  • It is best to have two separate direct rollover checks issued, one for each IRA type. This is clear and transparent to all parties.
  • If the IRA custodian does split the rollover into two parts, the 1099R will still not be correct. Box 2a would be 0 and that is fine but the basis recovery will not show in Box 5 and entering this into a tax program will be problematic. There have been problems with the client reporting these split rollovers into tax programs in many cases where the plan does not issue two separate 1099R forms, one for each destination.
  • To summarize, the most serious issue is if the total is deposited into the TIRA. If that does not happen, then the only problem should be carefully dealing with the 1099R issued next January, probably splitting it into two forms, one for each destination account. The Roth IRA money should have 0 in 2a and the Box 1 amount also shown in Box 5. The pre tax TIRA 1099R should show 0 in 2a and nothing in 5. Both Box 7s should show G.

Submitted by IRAQuestion5 on Tue, 2018-04-10 20:44

Thank you for your help! This discussion forum is super helpful. Keep up the good work!So to confirm. As long as the deposit is made correctly and they record it correctly on their tax return, it is okay if it all shows up on one 1099?

Submitted by Alan - IRA critic on Tue, 2018-04-10 21:03

It’s OK, but may present a challenge with respect to entering the data into a tax program to get the correct result reflecting the destination accounts. Therefore it is very helpful to know how the 1040 reports the rollover before filing. It is not clear how much this issue reflects any IRS challenges when they enter the 1099R into their own programs. But if a problem does arise, it can be resolved with some documentation should the IRS inquire about it. To date, there are probably far more plans reporting these rollovers on a single 1099R than there are that separate the distributions.

Submitted by IRAQuestion5 on Mon, 2018-04-23 13:07

Both the after-tax and pre-tax came in one check but there is a statement indicating the separate amounts. It is my understanding it is okay it is one check as long as the custodian actually splits it between the two accounts (after-tax to Roth and pre-tax to Traditional). Am I understanding correctly?I have received confirmation twice that if a letter of instruction is sent with the check they will split it between the two amounts.

Submitted by Alan - IRA critic on Mon, 2018-04-23 14:56

Yes, that is correct. After the rollover contributions are made the taxpayer should verify that the correct amounts were contributed to each type of IRA account. The remaining issue is the 1099R being correct and correctly reported on the tax return. After all is said and done, the desired amount should be contributed to each IRA type, the 1099R should reflect where the rollovers were made and the 1040 should also reflect the 1099R.

Submitted by IRAQuestion5 on Mon, 2018-04-23 21:32

Sorry for my ignorance. Your last comment “the 1099R should reflect where the rollovers were made” made me nervous. We requested a complete rollover to the traditional IRA from PERA. The client requested the new custodian to split the rollover check between the Roth (after-tax money) and Traditional (pre-tax money). Therefore, per PERA the client rolled the entire balance to the traditional IRA (even though they didn’t). My understanding is this will not affect what is reported on the actual 1099R (it would be reported the same if they rolled it all to the Traditional or split the two between the Roth and Traditional). Is that correct? Therefore, the concern at this point is making sure they report that they split the contribution (after-tax to Roth and pre-tax to Traditional) correctly on their tax return. Does that sound correct? Or do I need to make sure PERA knows we split the rollover between the accounts?

Submitted by Robin Ross on Mon, 2018-04-23 23:42

I commented on another NUA issue I was having, and then came across this pertinent comment which relates to a separate client issue/question.  Similar to the original poster, we completed a rollover in 2017 with a client who had after tax contributions in his 401K.  We instructed the administrator to direct his after-tax basis to his ROTH IRA, and then rolled over the remainder (less some low basis NUA shares) to his TIRA.  All of the distributions were done correctly and deposited into the appropriate accounts (i.e. after-tax into ROTH, pre-tax into TIRA, etc).  They did however, issue a single 1099R for the ROTH & TIRA rollovers, with box 5 indicating the after-tax amount, and box 1 indicating the total gross distribution.  Since we will be providing the client with 5498s showing where each rollover was directed, shouldn’t that be sufficient?  Granted, 5498s aren’t issued until after the tax filing deadline, but as long as the IRS sees the correct paper trail I would think this is satisfactory, correct?

Submitted by Alan - IRA critic on Tue, 2018-04-24 16:17

  • Yes, this will probably end up OK, since the funds went to the correct accounts and the 5498 forms will confirm that. While it would be preferable for separate 1099R forms to have been issued, the IRS is apparently most concerned with Box 2a and as long as it is 0 there is not likely to be an IRS issue. However, there still code be a tax return entry problem since boxes 2a and 5 are not coordinated correctly. It has been shown that when an incorrect output from certain tax programs occurs it can be resolved by entering these direct rollovers as if they were separately reported on two 1099R forms. The Roth amount would include Box 5 and the TIRA amount would not.  
  • There is some added complexity in this case since there will be another 1099R for the distribution of NUA shares. In that situation plan accounting rules will determine what portion of the after tax amounts is applied to the taxable cost basis of the NUA shares. Amounts allocated to reduce the cost basis (Box 2a of the NUA 1099R) are not available to be rolled into the Roth IRA.

Submitted by Robin Ross on Tue, 2018-04-24 21:36

Interesting commentary about the 2nd 1099R that was issued for the NUA shares.  Since the value reported in Box 2a reflects the pre-tax NUA cost basis only, I’m assuming that the plan separated all of the after-tax basis for distribution to the ROTH, as no value is reflected in Box 5 of the 2nd 1099R.  In any case, all information has been supplied to our client’s tax preparer, and I’ve not yet heard of any issues/difficulties reporting either of the transactions.  As always, I sincerely appreciate your input, as the detailed insight displayed in this forum is like no other I’ve participated in.  Thanks again!  

Submitted by Richard Seery on Tue, 2018-04-10 17:15

A recently married couple bought a condo in 2017.Now they want to buy a starter house and rent the condo.They have not exercised the $10,000 withdrawal benefit from his ROTH.Questions:  Was the condo considered his first (1st) home purchase, or can he now take $10k to buy a “house?”I know I am splitting hairs…But how is this withdrawal feature monitored?Thank you for your reply.Dick 

Submitted by Alan - IRA critic on Tue, 2018-04-10 17:46

The first dollars distributed from a Roth IRA come from regular contributions and are therefore tax and penalty free, so most people would not need to use the 10,000 lifetime benefit unless their Roths do not have a large enough balance of regular contributions or conversions held over 5 years. This is a moot question here because the condo was the first home and they didn’t take a distribution in 2017. The condo would not have been a first home if they had rented it out from the start. After renting themselves for 2 years, they would qualify again for the first home exception but probably are not interested in renting for 2 years.  Either way, for a Roth IRA the first home exception is overblown and usually not even necessary since a fairly large portion of the Roth can probably be withdrawn tax free without the exception.

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