Recharacterization and converting back to Roth IRA... aftermath and HELP!

[jeromedawg]

Hey guys,

Back in late 2014 (November timeframe), I foolishly recharacterized [partial] my Roth IRA earnings for 2014 to a tIRA knowing very little about the rules and thinking I could deduct the tIRA contribution (but was well over the AGI limits). Did this for both my wife's Roth and mine. This obviously didn't work out for me, and I was stuck with the tIRA going into 2015. I'll have to look back to see how many contributions I made within the tIRA at that point in time but I think it was just one contribution in each account before I realized the stupidity. Then I decided, in Feb of 2015, that I would go ahead and convert the tIRA back to a Roth IRA thinking I wouldn't or shouldn't get taxed on that...WRONG, I received 1099-R forms and upon entering them in (to Taxact) my taxes owed jumped up quite a bit... it seems I'm getting taxed on the full amount of the conversion (around $7k is in one account and $5k in the other).

Can't believe I dragged myself into this mess... :( Is there any recourse or anything I can do about this? Or am I SOL? I'm such an idiot when it comes to taxes and all this crap. I should probably just hire a CPA :(

EDIT: I think *some* of the funds in my account were actually traditional 401k rollovers from an old company, so I believe I should expect taxes on those. However, my wife's account seems to have incurred significant taxes in a pure "recharacterize Roth IRA to tIRA, then convert tIRA back to Roth IRA" scenario... I'm not sure what possessed me to go this route, but I must have for whatever reason thought this wouldn't trigger a taxable event. I should have done more homework :T

[NoStacheOhio]

A tIRA to Roth conversion is always going to be a taxable event. It's probably too late now, but you probably could've recharacterized some of the contributions instead of converting the full amount.

[jeromedawg]

A tIRA to Roth conversion is always going to be a taxable event. It's probably too late now, but you probably could've recharacterized some of the contributions instead of converting the full amount.

Agh, I had a sinking feeling in my stomach this was the case after I entered the forms. What a stupid and expensive mistake :(

EDIT: I just spoke with a rep at Fidelity and he did mention that "de-conversion" (essentially recharacterization) of the Roth IRA back to a tIRA appears to be possible with no restriction. I think this is because there is one recharacterization available per year. So either way I guess I'd be screwed - the question is: do I want to convert back to a Roth IRA and get hit with those taxes *now* or do I want to recharacterize the $5k-6k for both accounts back to a tIRA to avoid the taxable event this year which is just deferring the taxable event to whenever I decide to convert or withdraw from the tIRA in the future?

[dandarc]

So here's the run down:

1.  You (each) have 1 tIRA as far as the IRS is concerned - you can't segregate tIRA funds even if held in accounts at many brokers for figuring tax
2.  When you convert from tIRA to Roth IRA, the amount is pro-rated between taxable and non-taxable amounts.
3.  You have to keep the records as to after-tax contributions - your broker has no way to know if you took the deduction or not.

Anyway, if I'm right in that it sounds like these were the only funds in any tIRA held in your wife's name at the time of the conversion, you should only be taxed on any earnings that happened between the original Roth IRA contributions that were recharacterized to traditional and the conversion date.  Maybe it is just finding the right spot in the software to say "the contribution was after-tax back in 2014"?

Your account would be pro-rated, so you can have tax on earnings as above as well as the portion attributable to your "old 401K" money.

For future reference - you can recharacterize up to your tax filing deadline (April 15th of following year, absent an extension), so if you're inclined to recharacterize, wait until after your tax documents are in and you can be sure that you want to do it and of the amount.  The correct way to fix this in Feb. 2015 was not a conversion, but a recharacterization, as NoStacheOhio pointed out.

[jeromedawg]

So here's the run down:

1.  You (each) have 1 tIRA as far as the IRS is concerned - you can't segregate tIRA funds even if held in accounts at many brokers for figuring tax
2.  When you convert from tIRA to Roth IRA, the amount is pro-rated between taxable and non-taxable amounts.
3.  You have to keep the records as to after-tax contributions - your broker has no way to know if you took the deduction or not.

Anyway, if I'm right in that it sounds like these were the only funds in any tIRA held in your wife's name at the time of the conversion, you should only be taxed on any earnings that happened between the original Roth IRA contributions that were recharacterized to traditional and the conversion date.  Maybe it is just finding the right spot in the software to say "the contribution was after-tax back in 2014"?

Your account would be pro-rated, so you can have tax on earnings as above as well as the portion attributable to your "old 401K" money.

For future reference - you can recharacterize up to your tax filing deadline (April 15th of following year, absent an extension), so if you're inclined to recharacterize, wait until after your tax documents are in and you can be sure that you want to do it and of the amount.  The correct way to fix this in Feb. 2015 was not a conversion, but a recharacterization, as NoStacheOhio pointed out.

In speaking with the Fidelity rep, he seemed to indicate that *any* conversion from a tIRA to a Roth IRA would *always* be a taxable event and based on the full amount in the tIRA. If what you say per point #2 is true, then I should only be taxed on whatever I contributed and whatever gains there were *after* the initial recharacterization from Nov 2014 to Feb 2015?

I was also reminded that recharacterization can only happen once a year. I went on to ask him, that assuming I do the deconversion back to a tIRA this year, if it's possible to recharacterize the tIRA to a Roth IRA in 2017 and thus avoid a taxable event but he mentioned that's not possible to do.

EDIT: as far as only being taxed on the portion of the tIRA that wasn't an after-tax contribution, I see this in TaxAct -
"Retirement Plan Income - Boxes 9, 10, and 11

Enter your percent of total distribution and total employee contributions if applicable. Also enter the amount allocable to an in-plan Roth rollover and the designated Roth contribution year if applicable." - not sure if that's where I need to input per your point #2. I'm on hold with TaxAct phone support in hopes of finding out.

[dandarc]

In speaking with the Fidelity rep, he seemed to indicate that *any* conversion from a tIRA to a Roth IRA would *always* be a taxable event and based on the full amount in the tIRA. If what you say per point #2 is true, then I should only be taxed on whatever I contributed and whatever gains there were *after* the initial recharacterization from Nov 2014 to Feb 2015?

I was also reminded that recharacterization can only happen once a year. I went on to ask him, that assuming I do the deconversion back to a tIRA this year, if it's possible to recharacterize the tIRA to a Roth IRA in 2017 and thus avoid a taxable event but he mentioned that's not possible to do.

Not the date of the original recharacterization - the original contribution(s).  The recharacterization makes it as if that was traditional all along.

Point #2 illustrated.  Say I had 100K in a tIRA to start with.  I then wanted to do a backdoor Roth IRA, so I contributed $5500, did not take the deduction, and converted $5500 to Roth.  Everything is in cash, so no earnings to worry about.  When I fill out my taxes, I am shocked to find that over $5200 of my conversion amount is subject to income tax, because the non-taxable $5500 is only about 5% of my account balance and the conversion is pro-rated.

A conversion is always a taxable event, but the tax is figured only on taxable amounts of the conversion.  The well-documented Backdoor Roth IRA strategy is predicated on the fact that non-deductible contributions are not subject to tax on conversion to Roth, except to the extent there are earnings.

I'm not sure that recharacterization can only happen once.  There are 2 types of recharacterizations - 1 changes the type of the contribution.  The other undoes a Roth IRA conversion.  Possible different rules for each type of recharacterization.  I could see the first type of recharacterization working as many times as your broker is willing to do it, but the 2nd type can only happen once, I'm pretty sure.  Not sure of the law on that

There is no such thing as a "deconversion".  You can recharecterize the conversion back to traditional since it happened in 2015.  That would fix your immediate tax problem, but you still have your money in a tIRA in that case, and the only way to get it out of the tIRA is to convert.


You are well beyond the deadline's to change the contribution type.  Unless this tax bill (once figured correctly) is hugely problematic for you, I would not go with an "undo the conversion" recharacterization either.  Get all the information, and do your taxes, pay any amount owed and be done with it.

[dandarc]

Take a look at form 8606 and the accompanying instructions.

Your tax-year 2014 return should have been filled out with part I due to having made non-deductible contributions.  If this form wasn't included with your return, you may need to file an amended return for 2014 to fix that problem.

For 2015, form 8606 part I is blank if you converted the whole amount of your tIRA, and you move on to part 2.  If you only did a conversion of some of the $$$ then part I is filled out before part 2. 

In the simple case where you converted 100% of all of your tIRA money in Feb. 2015, you just fill out part 2 - the amount converted goes on line 16.  On line 17, you input your basis.  The instructions are a bit convoluted, but ultimately, it winds up being the amount you reported in 2014 as a non-deductible contribution.  Subtract, and that is your taxable amount of the conversion.

[dandarc]

EDIT: as far as only being taxed on the portion of the tIRA that wasn't an after-tax contribution, I see this in TaxAct -
"Retirement Plan Income - Boxes 9, 10, and 11

Enter your percent of total distribution and total employee contributions if applicable. Also enter the amount allocable to an in-plan Roth rollover and the designated Roth contribution year if applicable." - not sure if that's where I need to input per your point #2. I'm on hold with TaxAct phone support in hopes of finding out.

That reads like it is for 401Ks and similar.  Tell them you need to know where to go to fill out form 8606 - that is where you figure the taxable amount from the conversion.

[jeromedawg]

Hm, looks like 8606 might be what I need to get the taxes appropriately filed (so I'm not taxed on the full conversion since the initial money was after-tax per it all being in a Roth IRA from 2014)?

I mucked around a bit with the 8606 entries in TaxAct and noticed the tax owed went down. I'm going through the 8606 PDF form now to try to come up with the right numbers

[jeromedawg]

Ok, so just wanted to run this by... I'm going through the TaxAct 8606 e-form (which hides a lot of whats on the actual 8606 pdf form) and am at this prompt:

Confirm (or enter) your basis in the $7,574 amount that was converted from a traditional IRA, SEP or SIMPLE IRA to a Roth IRA in 2015. If your basis in the amount converted to a Roth is zero, leave the entry blank and click Continue.

For the entry, I went back to look at what my recharacterization amount was in 2014, and it's $5,285, so I entered that in. Once I did that I noticed the taxes owed dropped dramatically.

The $5285 is originally the Roth IRA contributions in 2014 which I recharacterized (and only that amount for 2014 up until that point) to the tIRA in November 2014. This $5285, I believe, would be considered nondeductible since when recharacterizing to a tIRA I was unable to deduct it because I was outside the AGI limits for deducting tIRAs. So is *that* the correct number to be reporting as my basis?    

[dandarc]

So $7574 was the amount converted, yes?  Value reported on your 1099R / account value on the day the conversion happened.  And this was ALL of your tIRA money at the time of conversion?  There wasn't another account off to the side from rolling over an old 401K?  Nothing like that?  To me that's the place you're most likely to have a problem - "I sure did convert all of the tIRA money at Fidelity."  "Oops, I've also got a tIRA at Vanguard and a SEP-IRA with American Funds."  Or something like that.  SEPs and SIMPLEs are also IRAs for this purpose, so hopefully you don't have anything going on in those types of accounts.

And $5285 was the amount of the contribution in 2014 that was recharacterized to traditional and not deducted?  You mention it was partial, but this is darn close to 100% of the limit which was at $5500 in 2014, so just wanted to clarify.

If you're 100% sure on both of these, then yeah, sounds right to me.  Lots of little gotcha's here, so you'll want to be sure on everything before you file.  Also review your 2014 return that you filed last year - be sure that form 8606 was submitted with it and amend it if necessary.

[jeromedawg]

So $7574 was the amount converted, yes?  Value reported on your 1099R / account value on the day the conversion happened.  And this was ALL of your tIRA money at the time of conversion?  There wasn't another account off to the side from rolling over an old 401K?  Nothing like that?  To me that's the place you're most likely to have a problem - "I sure did convert all of the tIRA money at Fidelity."  "Oops, I've also got a tIRA at Vanguard and a SEP-IRA with American Funds."  Or something like that.  SEPs and SIMPLEs are also IRAs for this purpose, so hopefully you don't have anything going on in those types of accounts.

And $5285 was the amount of the contribution in 2014 that was recharacterized to traditional and not deducted?  You mention it was partial, but this is darn close to 100% of the limit which was at $5500 in 2014, so just wanted to clarify.

If you're 100% sure on both of these, then yeah, sounds right to me.  Lots of little gotcha's here, so you'll want to be sure on everything before you file.  Also review your 2014 return that you filed last year - be sure that form 8606 was submitted with it and amend it if necessary.

Correct, $7574 was converted from tIRA to Roth IRA. I failed to mention that there in fact was some funds from an old 401k that rolled into this as you alluded to. Either way, I confirmed with Fidelity (on a second call with a more knowledgable person) that $5500 would have been my basis from 2014 moving into 2015. I maxed out my IRA contributions in 2014 under a [recharacterized] tIRA. In 2015, I made no more contributions to the tIRA and then just converted it over to a Roth.

The $5285 I put down is wrong, because that includes capital gains, which is what the Fidelity rep pointed out to me. Really, it would have been a $4995 basis recharacterized + $505 more because I made one last contribution to max out the IRA in 2014.

In looking at the 2014 return I filed last year, now I'm thinking I botched *something* up - I put $505 as the nondeductable amount thinking that only thing needed. My total basis for traditional IRAs in the previous year I think was $0 though. Either way, the total basis ended up as $505 factoring in that last contribution to the tIRA that I made in Dec 2014.

[dandarc]

I see - you had made $4995 in Roth contributions.  Thought "I should go traditional!" and recharacterized that $4995.  Then made another $505 contribution to the traditional IRA to top it off.  Then converted your whole tIRA to Roth in 2015 in an attempt to correct things once you realized you couldn't take the deduction.  Now you're trying to get the tax treatment right on the conversion.

Yeah - you should amend your 2014 return to correct that non-deductible contribution to a traditional IRA amount, and then file for 2015 with the correct basis of $5500.  Amending the return shouldn't change the taxes owed - you didn't take the deduction for 2014 after all, but it is better for you for the IRS to have the correct information - seems this would be a somewhat easy thing to check for them, so you might be at a higher likelihood of audit if this piece of info is inconsistent. 

Tax on $2000 of conversion income is quite a bit less than tax on $7500 or $7000.

[jeromedawg]

I see - you had made $4995 in Roth contributions.  Thought "I should go traditional!" and recharacterized that $4995.  Then made another $505 contribution to the traditional IRA to top it off.  Then converted your whole tIRA to Roth in 2015 in an attempt to correct things once you realized you couldn't take the deduction.  Now you're trying to get the tax treatment right on the conversion.

Yeah - you should amend your 2014 return to correct that non-deductible contribution to a traditional IRA amount, and then file for 2015 with the correct basis of $5500.  Amending the return shouldn't change the taxes owed - you didn't take the deduction for 2014 after all, but it is better for you for the IRS to have the correct information - seems this would be a somewhat easy thing to check for them, so you might be at a higher likelihood of audit if this piece of info is inconsistent. 

Tax on $2000 of conversion income is quite a bit less than tax on $7500 or $7000.

Yes, that is an accurate summary of my situation! As far as amending is concerned, what is involved with that? I've never amended any past returns (though I probably should have considering how prone to mistakes I am!). As far as the basis is concerned when amending, I'm assuming that the $5500 would be considered the basis for the traditional IRA then?

Also you mentioned I should make the amendments first before filing 2015 taxes? Is that simply just mailing in the amended return and then proceeding with filing 2015 taxes? Or do I need to wait for some sort of confirmation that the IRS has processed the amendments before proceeding with filing? I ask this because the tax deadline is coming up soon and I wouldn't want to be late, so would I then want to file for an extension?

[dandarc]

I see - you had made $4995 in Roth contributions.  Thought "I should go traditional!" and recharacterized that $4995.  Then made another $505 contribution to the traditional IRA to top it off.  Then converted your whole tIRA to Roth in 2015 in an attempt to correct things once you realized you couldn't take the deduction.  Now you're trying to get the tax treatment right on the conversion.

Yeah - you should amend your 2014 return to correct that non-deductible contribution to a traditional IRA amount, and then file for 2015 with the correct basis of $5500.  Amending the return shouldn't change the taxes owed - you didn't take the deduction for 2014 after all, but it is better for you for the IRS to have the correct information - seems this would be a somewhat easy thing to check for them, so you might be at a higher likelihood of audit if this piece of info is inconsistent. 

Tax on $2000 of conversion income is quite a bit less than tax on $7500 or $7000.

Yes, that is an accurate summary of my situation! As far as amending is concerned, what is involved with that? I've never amended any past returns (though I probably should have considering how prone to mistakes I am!). As far as the basis is concerned when amending, I'm assuming that the $5500 would be considered the basis for the traditional IRA then?

I've also never amended a return.  Perhaps a CPA member will stumble and be able to better advise on the ins and outs.  I think that 2014 form 8606 should show $5500 as your 'basis' on line 14, ultimately - "this is your total basis in tIRAs for 2014 and earlier years".

[jeromedawg]

I see - you had made $4995 in Roth contributions.  Thought "I should go traditional!" and recharacterized that $4995.  Then made another $505 contribution to the traditional IRA to top it off.  Then converted your whole tIRA to Roth in 2015 in an attempt to correct things once you realized you couldn't take the deduction.  Now you're trying to get the tax treatment right on the conversion.

Yeah - you should amend your 2014 return to correct that non-deductible contribution to a traditional IRA amount, and then file for 2015 with the correct basis of $5500.  Amending the return shouldn't change the taxes owed - you didn't take the deduction for 2014 after all, but it is better for you for the IRS to have the correct information - seems this would be a somewhat easy thing to check for them, so you might be at a higher likelihood of audit if this piece of info is inconsistent. 

Tax on $2000 of conversion income is quite a bit less than tax on $7500 or $7000.

Yes, that is an accurate summary of my situation! As far as amending is concerned, what is involved with that? I've never amended any past returns (though I probably should have considering how prone to mistakes I am!). As far as the basis is concerned when amending, I'm assuming that the $5500 would be considered the basis for the traditional IRA then?

I've also never amended a return.  Perhaps a CPA member will stumble and be able to better advise on the ins and outs.  I think that 2014 form 8606 should show $5500 as your 'basis' on line 14, ultimately - "this is your total basis in tIRAs for 2014 and earlier years".

Thanks... Hm I just stumbled across this regarding amending an 8606 - https://www.bogleheads.org/forum/viewtopic.php?t=113477

Sounds like I should be able to just mail the *corrected* 8606 form perhaps with a cover letter directly to the IRS - no need for a 1040x?... EDIT: NM didn't read the full thread. I think it will depend on if making changes in the 8606 affects any numbers of the 1040. From what you were saying earlier, it *shouldn't* but I think I may have to confirm that. Agh, this whole thing is a major headache.

[jeromedawg]

One other general question, if I am intending to make the amendment for 2014 and want to send that in prior to filing for 2015 taxes, would I be in the clear if I just mailed out the amendment say tomorrow and then waited to file 2015 taxes closer to the 4/18 deadline?

Or, is it recommended that I mail the amendment and then file for an extension to file taxes pending whenever the IRS processes the amendment (how will I know that the amendment was processed?)

I see here that it may take up to 16+ weeks for processing amended returns:
https://www.irs.gov/Filing/Individuals/Amended-Returns-(Form-1040-X)/Wheres-My-Amended-Return-1