Rollover Error

Submitted by Heywood Turner III on Fri, 2019-12-13 20:36

History:
On August 15, 2017, two rollover checks from the investor’s prior employer 401(k) plan were deposited to an existing NFS IRA brokerage account. One check represented the investor’s pretax contributions in the amount of $126,202.03 and the other represented her Roth 401(k) contributions in the amount of $19,542.30. Both checks were payable to NFS FBO XXXX with no additional supporting information to identify that the check for $19,542.30 was Roth 401(k) monies. My assistant processed both checks to the investor’s NFS IRA brokerage account. In September of 2017, the investor transferred her NFS IRA brokerage account to a Morningstar managed money account. Then, in October of 2018, the error became apparent when the investor had additional Roth 401(k) monies from another prior employer 401(k) plan that she wanted to rollover to her Roth IRA which at that time did not exist. Through discussion with the investor and additional documentation that she was able to provide me the error from August 2017 became clear that the check for $19,542.30 was Roth 401(k) monies. In October 2018, I attempted to reverse the error of August 2017, however, the market was down and the original $19,542.30 had incurred loss. The investor decided at that time to wait to make up the loss before attempting to reverse the error. At this time, the investor wishes to reverse this incorrect deposit by having a check payable to her now established NFS Roth IRA in the amount of $19,542.30 (original amount).

Question:
1) Can this reversal be done without tax issues for the investor?
2) Can she reverse only the original amount ($19,542.30) leaving any gains in the Traditional IRA?
3) Should this be done as reversal or recharacterization?



Submitted by Alan - IRA critic on Sat, 2019-12-14 00:26

  • Scroll down to a thread titled “Roth transfer mistakenly put it IRA”. Those posts describe how difficult if not impossible it is to correct this costly error. A possible window existed between the error and the end of 2017, but by now there has been 5498 tax reporting and tax returns filed for 2 years. If the custodian chose to reconstitute the rollover, it would also require amended forms, If there was an H coded 1099R for 2017 issued, there has been no matching 5498 from a Roth IRA custodian. 
  • How were these direct rollovers executed?  Is there a copy of the checks available, and were they mailed to the investor for delivery?  How was your assistant involved in the rollover process?  The payee on each check should have specified “FBO investor’s IRA” or “FBO investors ROTH IRA” respectively. If the Roth check stated that and if the investor had opened a Roth IRA at the receiving firm to receive that rollover, it would appear that NFS (or perhaps your assistant) is responsible for the error. That would be a start, but they are still likely to resist based on the delay in bringing this to their attention. How far did you get in 2018 in getting this reversed? Investor should never have called a halt to that effort and now another year has passed and NFS does not even hold the account anymore. 
  • Worse yet, the investor now has an excess TIRA contribution for 2017 because Roth money is not eligible for rollover to a TIRA account. This creates an excess TIRA contribution for 2017 and 2018, and is about to for 2019 unless the original amount of the transfer is withdrawn from the TIRA by year end. 
  • What authority IRA custodian have to make this type of change is carefully guarded, and I do not know if the IRS has provided guidance to these custodians on making such retroactive account changes. Certainly, there is no template for correction as the circumstances will all differ somewhat and NFS will not be motivated now that they do not hold the IRA, and certainly the new custodian that was not a party to the error will not want to get involved.

 

Submitted by Heywood Turner III on Mon, 2019-12-16 23:56

The rollover process was executed via a conference call by the investor with the prior employer 401(k) custodian. The checks were delivered to the investor’s home address and the investor then delivered the checks to my office for processing. Both check were payable to NFS FBO XXXX (no notation of Roth or Traditional IRA on either check of which I have copies).  It was only later in 2018 that this error was uncovered and then I asked the investor if she had any additional paperwork that would give additional details on what was pretax vs. Roth.   

Submitted by Alan - IRA critic on Tue, 2019-12-17 01:46

  • The direct rollover checks were not made out properly. The TIRA rollover check should have been made payable “NFS FBO (investor name) IRA” and the Roth check payable in the same manner, but to Roth IRA. While the payee did not even show “IRA”, just “IRA” by itself would default to a traditional IRA. Therefore, the payee format was incorrect for two different reasons. There were probably other errors and there is no way to know for sure if this would have occurred had the checks been issued properly. The chances for a custodian correction would have been much better had the checks been issued correctly.
  • SInce a year passed, the odds of a correction in 2018 was low since tax forms had already been issued for 2017. However, the low chances then were still better than a year later, and investor should not have backed off requesting correction at that time.
  • Other than custodian reformation which at this point is not going to happen unless the investor has a few milllon on deposit there, there is no way out other than the technically correct way, which is costly and perhaps worse than paying taxes twice on the 20k. As indicated before, the Roth 401k is not eligible to be rolled over to a non Roth account per Sec 402A(c)(3). Therefore, the rollover of the 20k into a TIRA is an excess regular IRA contribution. It must be removed WITHOUT earnings and the excise tax paid for 2017 and 2018 on Form 5329.
  • What remains is the taxation of the 20k distribution from the Roth 401k plan for 2017. There is a small chance that the rollover certification process might work by allowing an extension of the 60 day rollover period to allow the investor to now roll the excess contribution that has been distributed from the TIRA to investor’s Roth IRA. The reason per Rev Proc. 2016-47 would be “the distribution was deposited and remained in an account that the taxpayer mistakenly thought was an eligible retirement plan”. In other words, the investor thought that the deposit was made to his Roth IRA, not his TIRA. The hurdle with this is that the Rev Proc. also requires the taxpayer to make the rollover contribution as soon as practicable after the error is discovered, but the investor allowed the error to go another year and still has not corrected the excess and made the rollover contribution. Investor might have to explain that the extra time was spent attempting to get the custodian to correct the error directly because it was caused by various custodians. The certification form must be completed and provided to the Roth IRA custodian who will have to accept the late rollover contribution, and issue a 5498 reporting that the certification process was used to complete the late rollover. The IRS will then eventually determine whether to challenge the late rollover or not. Investor will not know if this flys with the IRS for many months, perhaps over a year. However, if this works, it would restore the rollover to his Roth IRA and eliminate taxation of the original distribution. Investor would be left with the excise taxes for 2017 and 2018. If the excess is removed before 12/31/2019 the investor will avoid the excise tax for 2019. The investor will also have to explain to the TIRA custodian that the distribution of the 20k is for excess contributions after the due date of the return per Sec 408(d)(5). The distribution will then not be shown in Box 2a (taxable), and the Taxable amount not determined box should be checked.
  • This is probably the best approach as I see it, but is complex and will require careful implementation. The first thing to do is to remove the 20k (actually 19,542) excess amount from the TIRA per the above point. That will eliminate an additional year of excise taxes for 2019.

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