After Tax 401k Distribution rolled over with Pre Tax Distribution
I have a tax client who received a retirement distribution that was rolled over into an IRA account. The distribution included pre-tax (non-Roth) amounts. The employer plan issued the payment in one check. The entire amount was deposited into the rollover IRA and then a check for the pre-tax amount was written to the client from the brokerage. The brokerage issued a 1099R with the entire amount shown as taxable. Unfortunately, this happened in 2022 and I was just made aware of the 1099R and the circumstances.
It is my understanding the client is stuck with basis in the IRA and that it must now be prorated with future IRA distributions. The client is very upset and did not intend on paying taxes on the after tax amount. My question is if anyone has any idea if there is a way to get around the fact that the after tax amount was deposited in the IRA before being distributed to the client. In other words, is there a way that can I apply the 100% basis to the 2022 distribution? I know it is a long shot but I thought I would reach out. I heard good things about this forum.
Permalink Submitted by Alan - IRA critic on Wed, 2024-07-31 15:01
This would have been very easy to avoid. The client should have requested split direct rollovers with the after tax amount going to a Roth IRA.
But at this point, this basis is in the TIRA and subject to pro rating for each distribution. The only fix for this is for the client to be able to roll the pre tax value of the IRA into a qualified plan that accepts IRA rollovers. But this typically requires the client to participate currently in a 401k or 403b plan that accepts IRA rollovers. Former employer plans rarely accept IRA rollovers. If a plan accepts the pre tax value, the remaining basis in the IRA can be converted tax free to a Roth IRA.
The 2022 IRA distribution should have been reported using Form 8606, to which the after tax basis is entered on line 2. What was then left in the IRA remains partially post tax and the remaining basis will show on line 14 of the 8606.
Most likely, the 2022 rollover to the IRA was mostly pre tax and it is odd that client then withdrew that entire pre tax amount from the IRA. If client reported that entire distribution as taxable on the 2022 return, it should be amended to apply the basis and get a refund.
Finally, the IRA custodian must be IRS rules to report the 1099R as 100% taxable, but that amount is overridden by the taxpayer on Form 8606.
Permalink Submitted by Sandra Stem on Wed, 2024-07-31 15:56
Thank you for your response. We have not amended 2022 yet as I was waiting on confirmation from the advisor that the entire distribution was rolled over into the TIRA. The taxpayer did not withdraw the entire distribution, only partial but did withdraw the after tax amount believing that they would not be subject to tax on that amount. I will be tracking the TIRA basis on Form 8606.
I agree, this could have easily been avoided, but one can’t go backward.