Taxable Conversion or no? | Ed Slott and Company, LLC

Taxable Conversion or no?

I have a client who thought he converted an IRA to a ROTH in 2001. He actually changed his mind that year because he needed the deduction. Ever since, he has been contributing to what he thought was a ROTH but was actually a traditional IRA. As such, he has never taken a deduction since 2001. He wants to convert to a Roth now and isn't sure of the tax effect for the contribution part of the conversion or the contribution AND the earnings. He is NOT yet 59 1/2. Any thoughts on the taxation of this transaction?

What he did with the conversion is a separate issue from the regular contributions he has been making. If he can accurately determine how much he contributed each year in REGULAR contributions to a TIRA and is sure that these amounts were not deducted, he can file a Form 8606 for each such year starting with the oldest year to report the non deductible contributions. The last 8606 will show the total non deductible contributions has has made, and if he now wants to convert some amount of his TIRA, the pro rate rules of Form 8606 will result in part of his conversion being non taxable. Starting with 2012, he also has the choice to deduct his contributions if eligible and could claim deductions by amending his 2012-2014 returns.  If he does that, his non deductible contributions ended in 2011. He also could recharacterize his 2015 contribution to a Roth IRA if he wants to instead of leaving it as a non deductible TIRA contribution. A direct Roth contribution is always preferable to a non deductible TIRA contribution.

Thanks Alan! Much appreciated.

Would he be subject to the 10% penalty since he isn't 59 1/2? If so, on the whole conversion or just the contibutions? I'm assuming the IRA doesn't care if it was deducted or not, only that an IRA was converted.

  • There is no 10% penalty on conversions. But if he converts and then withdraws the conversion from the Roth IRA before 5 years, then there is a penalty on the taxable portion of the conversion. But if he reaches 59.5 before the conversion is withdrawn there is no penalty.
  • Also, withdrawal of his regular contributions are not subject to tax or penalty either.
 

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