QCDs and Roth Conversions: Today’s Q&A Mailbag | Ed Slott and Company, LLC

QCDs and Roth Conversions: Today’s Q&A Mailbag

By Beverly DeVeny
Director of Retirement Education
Follow Us on Twitter: @theslottreport
 
Question:
 
Ed, 
 
I have attended 3 of your 2 day past boot camps and plan to attend in Orlando in Feb. 2018. I NEED YOUR HELP BADLY NOW!!!!
 
I think my broker dealer is not reporting RMDs to charities properly on the 1099Rs they issue. They are putting the same number in Box 1 and Box 2a even though they are issuing the checks to the charities. They also check Box 2b that says taxable amount not determined.  Last tax season I received numerous phone calls from my clients’ CPAs that said that was wrong. I have talked to my broker dealer, LPL Financial and they insist they are correct in their reporting. I went to IRS publication 590-B but they are not detailed enough about the 1099R reporting.
 
My understanding of the law is that the whole purpose of the direct RMD to charity is that the amount given to charities does not appear on page 1 of the 1040 and not on Schedule A. 
 
Do you have a resource for me that I can get back to my broker dealer or are they doing it correctly??
 
This is a big issue to me and I desperately need some guidance.
 
Please HELP!!
 
Edward
 
Answer:
 
Ed,
 
Your broker dealer is reporting the transaction correctly. IRS has never added a code for Qualified Charitable Distributions (QCDs) to the 1099-R. The solution is in how the transaction is reported on the client’s tax return. The instructions for Form 1040, lines 15a and 15b, tell the tax preparer to include the amount on the 1099-R on line 15a, include only amounts that will be taxable to the taxpayer on line 15b, and to explain the QCD amount by entering the letters QCD on line 15b.
 
For example: A client does a QCD for $43,000. It is the only amount she withdraws for the year. The taxpayer will enter $43,000 on line 15a. On line 15b, she will enter $0 and the notation QCD. If, on the other hand, the client sent $20,000 to charity and took a distribution of $23,000, the return would show $43,000 on line 15a and line 15b would show $23,000 and the notation QCD.
 
Question:
 
Greetings,
 
I am a financial advisor in the Annapolis, MD area.  I have a quick question, which I am hoping you can help me figure out.
 
If we withdraw from an IRA, we would have a 10% penalty, if we are under age 59.5.  However, if we converted to a Roth, we would not have the 10% penalty, no matter the age, but if it was a new Roth, we would have to wait 5 years before we could withdraw basis.
 
My question:  If we already have a Roth IRA open for more than 5 years, and we do a Roth conversion into that account, could we then pull that basis immediately?  And if for some reason we could not pull that basis, could we do the conversion and then take other basis?
 
Example:  I have a Roth worth $50K, of which $30K is basis.  I convert $10K from a Traditional into that Roth.  Can I still pull some of my original $30K of basis without the 10% penalty?  Can I also pull the new $10K (or do I have to wait 5 years on those particular funds)?
 
Thank you for any help or insight you can provide.  I signed up for your newsletter, so I look forward to reading and exploring some of your trainings down the road.
 
Sincerely,
 
Brandon
 
Answer:
 
Brandon,
 
A Roth IRA owner always has access to the entire basis in the Roth IRA. However, you cannot avoid the 10% early distribution penalty by doing a Roth conversion.
 
For distributions, all Roth accounts are considered one single account. Roth funds come out in the order explained below, regardless of what Roth account they come out of. The following is an explanation of the Roth distribution rules when the Roth owner is under age 59½. The rules are slightly different if the Roth owner is over age 59½.
 
  • Contributions – Contributions come out first and are always tax and penalty free. No exceptions.
  • Conversions – Conversions come out once contributions are fully distributed, first in, first out. They are income tax free. However, each conversion has its own 5-year holding period for the 10% early distribution penalty. A distribution before the 5-year holding period is up will be subject to the penalty, if no exception applies, as long as the converted amount was taxable at the time of the conversion. Once the 5 years are up for each conversion, a distribution of the converted amount has no 10% penalty.
  • Earnings – Once all the basis in the Roth is gone, then earnings are distributed. Earnings will always be taxable and subject to the 10% penalty, if applicable.

It is important that Roth IRA owners track their contributions and conversions in order to properly report the distribution to IRS when an early distribution is taken. Early Roth distributions are reported on Form 8606 which must be filed with the Roth owner’s tax return for the year.

 
 

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