Roth Conversion | Ed Slott and Company, LLC

Roth Conversion

I have a client that deposited monies into what was thought to have been a Roth Ira but was in fact a Traditional Ira. He did not take the deductions on his taxes for the years he contributed of 2000-2003. What would he need to do to convert to a Roth for this year? The acct was coded incorrectly by the brokerage firm he took the Ira out with.

He should retroactively file Form 8606 for each year starting with the oldest to report the non deductible contributions to his TIRA. The IRS has been accepting these without penalty. At least this will provide him a basis in his TIRA and prevent double taxation. When he is eligible to convert to a Roth IRA (2010 if not income eligible prior to that), the pro rated portion representing his basis will not be taxed for the conversion. If he wants to convert this year, he can do so before sending in the 8606 forms. But he should file those forms ASAP to reduce the tax he will pay on the conversion come April. They can be filed on a stand alone basis without amending prior returns with a 1040X. The IRS should have the 5498 reporting his IRA contributions in those years, so there should be no need to prove he made those contributions. With respect to the "error", at this point there is probably little chance of recourse from the IRA custodian. Even if the client was free of all negligence in the transactions, the burden of checking all the follow up paperwork and statements suggests that he failed to properly check that the transactions were initially handled correctly. He could have recharacterized these contributions had he caught the error up to Oct 15th of the year following each contribution, but those dates are long gone now.

For most people the time limit for amending these years and taking the deduction has past. There are a few exceptions such as mental or physical disability, or combat duty by members of the military. The first thing that needs to be done is to file stand alone Forms 8606 for these years to establish basis in the contributions not deducted. If eligible by income,you can then convert to a Roth. Taxation of the conversion will be on a pro-rated basis of of all TIRAs, SIMPLEs, and SEPs. If this was the only account, then he would be taxed only on the earnings.

I am not a professional so I do not know the ins and outs of the rules. However I had a similar experience a few years ago with Scudder. I filled out the application form correctly for a Roth but they set up a traditional IRA and I did not catch the error until a couple of years later. I then contacted Scudder; I was expecting the worst but they just changed it to a Roth. I did nothing else and haven’t heard anything from the IRS.

The difference here is that your IRA custodian was willing to take responsibility for the error and change their records instead of taking the position that you brought the error to their attention too late. I think you were more fortunate than most in this situation. Since you thought you opened a Roth account, you probably did not take report the contribution on your return, and your recent returns evidently are in accord with the IRA records. However, what may be a concern here is whether Scudder also corrected Form 5498 on which they report contributions to you and the IRS. If Scudder never reported these as Roth contributions, then if you ever take an early Roth distribution, the IRS record of your total regular contributions will differ from years, and the extra money in the Roth would overstate earnings and under state regular contribution, possibly causing an inquiry on your Form 8606 that reports early Roth contributions. If you hold the Roth till distributions are all qualified, then the issue disappears, since all distributions will be tax free.
 

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