1099 issue with Rollover IRA and subsequent Roth conversion

Submitted by Babu Rajan on Tue, 2023-08-29 22:26

A friend of mine needs help, he used to work for a very small company (Company A). He left the company last year ( 2022). In early 2023, he moved his 401k from Empower to Fidelity as a rollover IRA. He then did a Roth conversion of the full amount quickly after that. Fast forward to this month, he got a letter from Empower ( reproduced below).
—————————————————————————————————————————————————-
Letter from Empower:
Qualified retirement savings plans are periodically tested to ensure that contributions made by, or on behalf of the plan’s participants comply with statutory, non-discrimination and plan level rules. In order for Company A, to remain in compliance with these rules we have been instructed to distribute to you, or forfeit back to the plan, any excess or ineligible contributions. However, our records indicate that in 2023 a rollover of your account balance was taken from one or more of this employer’s qualified plan accounts before this correction could be made. As a result all, or a portion of your rollover reported on form 1099-R has been corrected by an amount equal to the excess or ineligible amount(s) which we were unable to process including any attributed earnings. We have reported the total corrective amount to the IRS on a separate Form(s) 1099-R.

Below is a summary of the amounts reported on the original, amended and corrective Forms 1099-R including applicable earnings or losses for each test.
+——————-+———-+———-+——————————————-+
| Tax Year 2023 | Original | Amended | Corrective |
+——————-+———-+———-+——————————————-+
| Gross Amount | 39315.03 | 37184.81 | 2130.22 |
+——————-+———-+———-+——————————————-+
| Taxable Amount | – | – | 2130.22 |
+——————-+———-+———-+——————————————-+
| Distribution Code | G | G | E |
+——————-+———-+———-+——————————————-+
| Description | Rollover | Rollover | Ineligible or Plan limit |
+——————-+———-+———-+——————————————-+
The corrected Tax Forms will be sent to you by January 31st of 2024. If the original amount above represents a rollover to either an IRA or other eligible retirement plan then the amount of total excess or ineligible not paid directly to you was not eligible to be rolled over. You should contact the IRA Custodian or the administrator of the receiving plan to determine if you will need to take a corrective distribution from that account. For more information regarding rollovers to an IRA refer to publication 590 Individual Retirement Arrangements (IRA’s). Please contact your tax advisor for additional information.
Amount that is not eligible for rollover: $2130.22

Some or all employer contributions deemed to be excess or ineligible may be considered protected plan assets and therefore not vested. Please contact the administrator’ of Company A regarding the return of these monies to the plan’s forfeiture account.
Amount which may be owed to the plan : $2130.22
—————————————————————————————————————————————————–
Question :
1) What should he do about this excess ~2k as far as as Fidelity is concerned?
2) Does he have to amend his taxes for 2022 due to this excess or ineligible amount ?



Submitted by David Mertz on Tue, 2023-08-29 23:53

  • The $2,130.22 deposited into the rollover IRA is considered to be a regular contribution, not a rollover contribution, and is an excess contribution to the extent that it exceeds the amount of regular traditional IRA contribution (deductible or not) your friend is eligible to make.  If as a result some portion of the $2,130.22 is an excess contribution, that portion was ineligible for conversion to Roth and now represents an excess contribution to the Roth IRA.  The deadline for removing an excess contribution made in 2023 is the due date of the 2023 tax return, including extensions.  I’m sure that Fidelity has encountered this many times before, so they should be able to assist in whatever action is necessary, even if it’s just to report the $2,130.22 as a regular traditional IRA contribution and only the rest as a rollover to the traditional IRA.
  • If the $2,130.22 was from elective deferrals, the $2,130.22 needs to be added to wages on the 2022 tax return and the additional income tax paid.  If some or all of the $2,130.22 is an employer contribution that must be returned to the employer plan, that portion would not get added to wages on the 2022 tax return.  The summary seems rather ambiguous as to whether $2,130.22 needs to be returned to the employer plan, so your friend needs to contact the plan regarding the return of any of the funds.  I believe that the employer also has the option to treat an excess employer contribution as supplemental wages and not require its return, in which case the amount would be taxable income, but they probably won’t be doing that.  To summarize, any portion of the $2,130.22 that does not end up being returned to the employer is taxable income.


Submitted by Alan - IRA critic on Wed, 2023-08-30 00:23

  • The problematic portion of this is the Roth conversion of an excess amount in the TIRA. Without the conversion of the entire TIRA balance this would be straigtforward, but the 2022 return is not affected.
  • The 1099R forms from the plan can be reported as issued. The taxable 1099R amount of 2130 will be reported on line 5b of the 2023 Form 1040. There is no penalty.
  • The 2130 was not eligible for rollover to an IRA, but if the friend is eligible for an IRA contribution that was not made, the custodian could be asked to treat it as a regular IRA contribution and reflect that on Form 5498 as a 2023 regular TIRA contribution. While this contribution may well be non deductible, it would then be reported on Form 8606 and this would eliminate a partially failed conversion. The full conversion would be reported on Form 8606 and 2130 would be the non taxable portion. This would avoid disturbing the Roth IRA by eliminating a converted excess IRA contribution.
  • If the friend has NO ROOM for any IRA contribution because they have already been made, then they should request a return of contribution of 2130 from that contribution to make room for the 
  • Without having this 2130 treated as a regular TIRA contribution, there would be a failed conversion of the 2130 excess amount. The reported conversion would have to be reduced by 2130, and the 2130 treated  as a regular Roth contribution and possibly an excess Roth contribution. The challenge of this latter treatment is that the FIdelity 1099R forms may not be consistent with friend’s tax return and the Roth IRA will have to be part of this procedural fix.
  • Therefore, it will be easier if the friend can treat the 2130 as a regular non deductible TIRA contribution. That will reduce the tax on the conversion to offset the 2130 being taxable when distributed by the 401k. This cancels out, and the same 8606 reporting the conversion can include the 2130 as a non deductible contribution on line 1. The only action Fidelity will need to take is to code the 5498 to be issued to show 37185 as a rollover contribution to the TIRA and a minimum of 2130 as a regular TIRA contribution. They will not need to process a corrective distribution or any 1099R other than the 39,315 conversion distribution unless they have already made a regular Roth contribution of more than 4370 (6500 less 2130).
  • This is probably confusing, so I would start by asking the friend the amount and type of any TIRA or Roth contributions already made for 2023. Then post back here.


Submitted by Babu Rajan on Wed, 2023-08-30 21:24

Thanks for responding. My friend also did a backdoor Roth conversion for the amount of $7500 ( not with Fidelity but with Vanguard, not that it matters where he did it). so to Alan’s suggestion to treat the excess $2130 as a non-deductible TIRA, will it hit the pro-rata rules ?To add to the story above , my friend called Fidelity and their Retirement Rep said 1) to fill out an Return of excess IRA contributions 2) send a letter of instructions explaing what happenned. The  problem with the Return of Excess IRA contributions forms is that  it asks a) excess contribution date, month, year  ( not sure how to answer) b) Total excess contribution but do not include any earnings or losses ( $2130 is easy to enter but does it include earnings or losses? How to find out?)  All this is so  complex and confusing, I probably need a script to even explain the next steps to my friend and then for him to fidelity. I really appreciate the time you have taken to help.  TIA



Submitted by Alan - IRA critic on Wed, 2023-08-30 00:31

The above two posts essentially agree on what has occurred. I agree that the Code E to be shown on the plan 1099R is an EPCRS distribution code and the accompanying letter is not clear as to what limit has been exceeded to create this excess amount. It it’s an excess deferral, then Box 12 of the W-2 could trigger taxable income for 2022……….



Submitted by Alan - IRA critic on Wed, 2023-08-30 22:16

  • No, the 7500 back door Roth conversion (I assume with a 2023 IRA contribution) only makes the situation worse because the 2023 contribution space has been used and also fully converted. Rather than involving VG and their conversion in this situation, it would be better to follow the advice from Fidelity told to your friend for removal of the 2130 as an excess Roth IRA contribution after an excess TIRA contribution was converted.
  • The excess contribution form should only show 2130 as the excess. Fidelity will then calculate the gain or loss on that excess contribution while in the TIRA and Roth IRA and return the adjusted amount. Any gains returned will be taxable. The date of contribution is the date that the 401k rollover was credited to the TIRA before the conversion. The amount of gain in the 2130 distributed by the 401k does not matter with respect to the excess contribution removal from the Roth IRA. The written request to Fidelity should be carefully worded to describe the chronology of events. A copy of that plan letter about the 2130 should be included.
  • There were two conversions, 37,185 and 7500. The total of 44,685 will be reported on Form 8606 and the taxable amount will be 37,185. Because the 2130 was a failed conversion, it is not treated as a conversion and Fidelity should not report it as a conversion. It must be treated now as an excess Roth IRA contribution and removed from the Roth IRA. Again, no need to contact Vanguard or to advise Fidelity of the VG transactions. 


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