Recharacterization of ROTH IRA to Reg IRA and then Roth Conversion

Submitted by Curtis Meusel on Thu, 2022-02-03 12:21

Hello,

I had a question concerning tax reporting of excess ROTH IRA contributions I made in 2020.

I think I have completed the tax forms properly but here it goes.

In January 2021, I noticed that my MAGI was too high to contribute to a ROTH IRA in 2020. I had already contributed $6,994 to my ROTH IRA (Below the $7,000 limit for being over age 50) for all of 2020.

I have my ROTH IRA with Vanguard so on 1/11/21 I created a Regular IRA Account in Vanguard and asked Vanguard to recharacterize $8,534.38 ($6,994 contributions plus the $1,540.38 amount I calculated for earnings based on the formula).

I have no other Traditional IRA accounts.

On 3/9/21 I did a ROTH Conversion for $7,016.34 (The initial recharacterized balance of $8,534.38 had dropped to this lower amount at the time of the ROTH Conversion)

Based on these actions my 2020 tax return included form 8606 with a nondeductible amount shown of $6,994. I also attached a note stating the reason for the recharacterization of the original contributions plus earnings. I did not pay any taxes on the $1,540.38 earnings on my 2020 tax return.

Now in 2022, I have received 2 2021 1099-R documents from Vanguard. One for the $8,534.38 Amount that was recharacterized with code “R” in box 7 and the other 1099-R for the ROTH Conversion which shows the $7,016.34 amount with Code 2 in Box 7.

My question is on my 2021 tax return.

Should I only be showing a tax on the additional amount of $22.34 ($7,016.34 Roth Conversion Amount Less the $6,994 contribution amount and not the $1,540.38 amount calculated at the time of recharacterization ($8,534.38 less $6,994 contributed)?

My tax software is showing just the $22.34 amount on FORM 8606 so I hope I am correct and not having to pay additional taxes on the $1,540.38 amount at time of recharacterization.

Also wanted to confirm that I do not need to file Form 5329 for anything either for 2020 or 2021 and that FORM 8606 is all I need for this issue.

Thanks in Advance

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Permalink Submitted by Alan - IRA critic on Thu, 2022-02-03 17:44

That’s correct. Your taxable amount is only 22, which is the amount by which your conversion (7016) exceeds your IRA basis of 6994. There is never a penalty on conversions, so no 5329 needed. Essentially, 1518 of your 1540 of gain in your Roth IRA just evaporated from investment losses incurred in your Roth IRA after the recharacterization. Since the 1518 was never distributed to you, there is no tax. The 22 which is taxable is the amount left on your gain that was converted to Roth, and that shows up as taxable on your 8606.
Note that the taxable portion of your conversion of 22 is the only portion for which there is a 5 year holding period in the Roth IRA to avoid penalty. Therefore, if you withdrew 22 or more from your Roth IRA attributed to this conversion before 2026, you would owe a 10% penalty on the 22, which is only $2. You would need a 5329 to report that $2 penalty.