Trad. IRA to Roth IRA in same year - Tax Reporting

[SobeCane]

Situation:

I contributed $5,000 to my traditional IRA at Vanguard earlier this year. As the year is winding down, my income will be lower than previously anticipated so I do not need the $5,000 deduction any more to stay in the 15% bracket. Therefore, I would like to switch my contribution this year from traditional to Roth. But herein lies my confusion.

I called Vanguard and they said this is a Roth Conversion. They will issue me a 1099-R. Therefore, I guess I would have to report the $5,000 as income and also take the $5,000 as a deduction on the bottom half of page 1 so that it is a net wash?

I tried to play with it in last year's Turbo Tax and Turbo Tax seems calls the switch a "re-characterization"

Turbo Tax asks : How much of the $5,000 you contributed to a traditional IRA for the year did you switch or "re-characterize" (this does not include conversions or rollovers, to a Roth IRA?"

When I answer that the full $5,000 was switched it asked for an IRA explanation statement. I guess I could just put that I changed my mind? Or I could write that Bogleheads such as Livesoft and the Finance Buff told me to manage my marginal tax rates. j/k.


So my question is: Was the vanguard representative wrong? I think that this is a re-characterization and not a conversion because it is done in the same year. Also, if Vanguard issues a 1099, what would be the appropriate code? Has anyone else changed their mind about their traditional IRA and changed it to Roth in the same year and how was it handled?

[Alan S.]

The difference in taxation is based on whether you decide to convert 5,000 vrs the request to recharacterize your 2012 TIRA contribution as a Roth IRA contribution. Perhaps the rep did not understand which request you were making. The 1099R forms are coded very differently and there may also be tax ramifications.

It sounds like your contribution was to an existing TIRA account. If you deduct the contribution and convert and if your TIRA is all pre tax, you would get a deduction in 2012. If your conversion was also in 2012, the taxable income would offset the deduction. But if you wait until next month to convert, the taxable income will be in 2013. This would result in reducing your taxable income by roughly 5,000 in 2012 and increasing it by the same amount in 2013, ie a transfer of taxable income to 2013. If you have basis in your TIRA (Form 8606), then pro rate rules would reduce the taxable amount of your conversion.

But if you just want your 2012 contribution to be a Roth contribution, ask VG to recharacterize your 2012 TIRA contribution as a Roth contribution. For tax purposes, you would not get a deduction OR an increase in taxable income for 2012. You would need to include an explanatory statement with your return explaining the contribution and recharacterization (dates and amounts).

Note that if you have positive earnings on your TIRA contribution, recharacterizing it will result in those earnings moving to your Roth IRA tax free. There will also be no 5 year holding period in the Roth for a regular contribution, but there would be for a taxable conversion. Finally, note that the earnings on your contribution are calculated using the entire TIRA account you made your contribution to, not just the investment you may have made with the contribution.

[SobeCane]

Alan S. - When I made this post I was secretly hoping you would see it and provide guidance.

To answer your question:

I do have a pre-existing Traditional IRA before i made this year's $5,000 contribution. But I just want the current $5,000 current year contribution to be re characterized to a Roth contribution for 2012 and leave the rest of the previous money in the Trad IRA alone. I will try to call Vanguard again and hopefully the representative will realize this is a re characterization and not a conversion. Did I understand you correctly? Also, which code on the 1099-R form will I receive?

[Alan S.]

Just make sure Vanguard understands you want to recharacterize the full amount of your 2012 TIRA contribution. They will calculate the earnings allocated to your contribution.

If you complete this before year end, you will get a 1099R in late January showing the earnings adjusted amount transferred to your Roth IRA. The code in Box 7 should be "N". Form 8606 would not apply. The only impact on your 2012 return will be the explanatory statement indicating what you did.