Unwinding a ROTH Recharacterization to TIRA, w/Backdoor option unharmed
I mistakenly thought our MAGI would be too high for our 2021 ROTH contributions to qualify. So, I had my wife’s $6,000 2021 Contribution Recharacterized as a 2021 TIRA contribution. This came with a NIA gain of $3,909.03 (I hadn’t gotten to mine yet, thankfully)
Ideally, I would like to get the $9,909.03 back into the ROTH, without tax implications, but I don’t know how to do it – I should not have moved it.
A couple more details:
1. I fully emptied her IRA account by transfer to her Solo-401K prior to the recharacterization of the 2021 ROTH contribution and NIA. So it was at zero when the money was transferred, but since the NIA was so high some dividend stocks came along with it, and $9,909.03 is now $10,117.75 – I’ve since liquidated everything to cash.
2. Any contribution to the 2021 TIRA would be non-deductible – she is covered by a work plan (her Solo-401K).
3. I intend to make a 2022 Non-deductible contribution to the TIRA of $7K (6K+1K catchup), then covert to ROTH. In effect, this account becomes a pass through account for back door conversions going forward
Q What do I do with the $10,117.75 ? – creating the least taxable income, and preserving max IRA balances
Q How does this all get reported (I do all my own taxes, but this is new)
Q Have I created a problem that will prevent using this account for a 2022 backdoor ROTH ($7K)?
Thanks, a Million!
Permalink Submitted by Alan - IRA critic on Sun, 2022-03-13 03:02
A recharacterized contribution cannot be reversed (re-recharaterized back), so she is stuck with a non deductible TIRA contribution with a high % of earnings. If worth the trouble she could roll the 4118 of gain into her solo K, then convert the 6000 of TIRA basis to Roth tax free. If not worth the trouble she could convert the entire 10,118, owing tax on only the gain. While another option would be to request a return of the ND contribution with gains, the gains would be taxable and subject to penalty. With the conversion the gain would be taxable, but no penalty. Therefore, these 3 options are most beneficial in the order described. Tax reporting differs for each option, but the added reporting for each is comparable. The solution to her contribution is independent of your own back door Roth option.
Permalink Submitted by Adam King on Sun, 2022-03-13 05:33
Want to make sure I understand this right. 1) Roll all the $4,118 in gains from the TIRA to the SOLO, is it taxable income? The Recharacterization was a month ago (in 2022), but was based off of the 2021 contribution, what year does the $4118 gains fall in? (or maybe it doesn’t matter – because the IRS considers the contribution and the gain as having always been in the TIRA?) 2) So next, the $6,000 would be a treated as a non-deductible 2021 contribution to the TIRA, to which I can add the $7,000 in ND 2022 contributions, then convert the $13K to a ROTH?
Permalink Submitted by Adam King on Sun, 2022-03-13 18:46
OK, I’ve worked through filling out IRS Form 8606 for 2021 and 2022 (assuming its unchanged next year). I see now that the future conversion from TIRA to ROTH is not affected by the gains (NIA transferred at recharacterization + any growth while in the TIRA), as long as the TIRA (and any SEP or SIMPLE) is empty of all but basis money (Form 8606 Line 3 or less(by way of conversion)) by December 31st 2022.
I’m assuming Part I “You made nondeductible contribution to a traditional IRA for 2021” is a yes because of the ROTH to TIRA rechacterization, regardless of it being done in 2022 because PUB 650-A says: ” If the transfer is made by the due date (including extensions) for your tax return for the tax year for which the contribution was made, you can elect to treat the contribution as having been originally made to the second IRA instead of to the first IRA”
And so the $4118 in gains will end up (by direct transfer) in the Solo 401K and taxable upon withdraw, instead of being in the ROTH and free from tax upon distribution. My mistake
Thanks Alan! this was very helpful
**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**