Recharacterization - Reporting documents Question

Submitted by Jeanette LoPiccolo on Thu, 2022-04-21 21:01

Our client, age 33, made a $6,000 IRA contribution in 2021 and immediately converted to his Roth (back door Roth contribution). He had no IRA account balance before the contribution or after the conversion. The 5498 for the IRA shows $6,000 contribution, the IRA 1099-R shows $6,000 gross taxable code 2 (penalty exception applies), and the Roth 5498 shows $6,000 conversion into the account.

The client’s CPA determined that our client had only $4,135 earned income in 2021. I know that we can’t undo a Roth conversion. The CPA suggested we remove the $1,865 excess contribution ( +/- earnings or loss) from the Roth. Can we do this?

Also, the CPA included an $1,865 non-taxable rollover on the client’s 2021 return. If this is a legit, please help me understand the process to get to this result. Thanks in advance!

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Permalink Submitted by Alan - IRA critic on Thu, 2022-04-21 21:48

It’s correct that the 1865 must be treated as a failed conversion and excess regular contribution to the Roth IRA that must be removed as such with allocated earnings. Any earnings returned will be taxable and subject to penalty on his 2021 tax return, so if that has been filed it will have to be amended if there are earnings.
Client’s conversion should only be reported as 4135 on Form 8606, with the other 1865 as a non taxable distribution. A regular contribution to the Roth IRA is not reported (unless on Form 8880), so there should be no rollover reported for the 1865. It’s not rollover eligible because it is an excess contribution which is why the Roth conversion partly failed in the first place.
While the Roth custodian will not be reissuing any of the 5498 forms, client needs to explain why 1865 must be treated as an excess Roth IRA contribution and returned with allocated earnings. It would be nice if client is on extension so he can get the excess returned and then file one time with an explanatory statement regarding the excess contribution. Otherwise, if there are earnings returned, a 1040X will be needed. The deadline to process the return of excess is 10/17/2021, but there is no reason to wait.