Tax Question
A gentleman – based on faulty advice – rolled the after tax dollars from his 401k to a regular IRA and then to a Roth and recognized $0 taxable income on the Roth conversion (despite having ‘other’ regular IRA money at the time of the conversion). This happened in 2005.
Later he discovered IRA distributions of after tax dollars must be proportionate to all IRAs. He then tried to re-characterize back to a traditional IRA but was too late. The custodian told him the only option was to take a distribution.
He therefore, in 2007, took the money out of the Roth.
Other stats…
1 – 58 years old now.
2 – Money gained $3,000 while in the Roth – in otherwords, the after tax dollars put into the Roth (approx $60K had grown to $63k and was withdrawn).
What is tax implication / how is it treated for taxes?
Permalink Submitted by Alan Spross on Wed, 2007-12-05 03:24
Alot of bad advice here. First, starting in 2002 there is no problem rolling over after tax employer plan money to an IRA, but Form 8606 must be completed to report the added basis. He should have filed an 8606, but can still file it retroactively to report the added basis. He also needs to amend his 2005 return to report the conversion correctly using the correct pro rated taxable amount over all his TIRAs. Part of the conversion will be taxable depending on the pro rate factor.
That’s all he needed to do, as the custodian was correct that it was too late to recharacterize the conversion unless this was prior to 10/15/06. He does not have an excess contribution unless he was not eligible for conversion in the first place, and therefore the distribution was totally unnecessary because it does not relieve him of his 2005 tax bill and just depletes his Roth. The distribution is taxed as an early Roth distribution under the ordering rules for distributions. If he has never made regular Roth contributions, then he has withdrawn his conversion money, NOT taxable but subject to 10% early withdrawal penalty because he was not yet 59.5 and had not held the conversion for 5 years. The earnings would be taxable plus penalty. This is also reported on Form 8606 for 2007. Form 5329 is needed to report the early withdrawal penalty on the conversion held under 5 years. If he did ever have regular contributions, those amounts come out first without tax or penalty.
I don’t suppose he took the distribution within the last 60 days, so he could roll it back in?
So the net result of all these errors is regular tax on part of the conversion and a 10% penalty on the withdrawal. The IRS will also probably charge interest on the late collection of the 2005 tax. Don’t suppose he has any documentation of all the bad advice so he would have a case if it came from a “professional”?