tIRA --> Roth conversion, but can't recharacterize?

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a__
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tIRA --> Roth conversion, but can't recharacterize?

Post by a__ »

Hi everyone,

I've made a terrible mistake... :shock: I live outside the US and have a complicated earnings history (moving from low tax to high tax countries, generous expat benefits, to local contracts, promotions, etc) It means I've struggled to thread the needle on Roth IRA contributions with the best effect. Sometimes I need the backdoor, others not. While the reasons are complicated, I think I find myself in a pretty normal situation, I just can't seem to find the perfect answer to my questions:

Q1 2020,
1. I made a tIRA contribution of $6000
2. I converted to Roth IRA (expecting I would need the backdoor) - at conversion, the value was smaller (~$5,500)
3. tIRA is empty

Now, preparing my 2020 taxes, it's clear that with FEIE, I don't have earned income, so the tIRA contribution is not allowed. Since recharacterization isn't allowed anymore, I do think I'm looking at removing excess contributions. Since I'm still young, also a 10% penalty :oops: Lesson learned, I guess. This will be a little painful.

My question is two fold:
1. I understand I'm supposed to withdrawal from the account that had the excess, but how can I do that to an empty tIRA, when Roth --> tIRA recharacterizations are not allowed?

2. If I withdrawal from the Roth, do I take the full $6,000, or the $5,500 which is reported on the the 5498 of my Roth IRA
(I know earnings on top also must be withdrawn - this is calculated automatically by the brokerage when I fill out their form)

In retrospect, I should have contributed directly to the Roth.. since the income limits for those purposes add back in the FEIE, that would have been fine. The best news would be that the IRS considers the conversion the same as having contributed directly?.. Anyone know anything about that?


Thanks for pointing me in the right direction! :sharebeer
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Dale_G
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Re: tIRA --> Roth conversion, but can't recharacterize?

Post by Dale_G »

a__ wrote: Sun Jun 13, 2021 3:13 pm In retrospect, I should have contributed directly to the Roth.. since the income limits for those purposes add back in the FEIE, that would have been fine.
Can you clarify the highlighted statement?

Dale
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jeffyscott
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Re: tIRA --> Roth conversion, but can't recharacterize?

Post by jeffyscott »

This might be part of the answer :?:
https://www.thetaxadviser.com/issues/20 ... -iras.html

The distribution part of the failed Roth conversion is an ordinary distribution and is taxable to the same extent it would have been if the Roth conversion had not failed.

Sounds like it may be that you have effectively withdrawn the TIRA contribution and made a Roth contribution, since the money was not eligible for conversion.
The two greatest enemies of the equity fund investor are expenses and emotions. ― John C. Bogle
Topic Author
a__
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Re: tIRA --> Roth conversion, but can't recharacterize?

Post by a__ »

Dale_G wrote: Sun Jun 13, 2021 4:08 pm
a__ wrote: Sun Jun 13, 2021 3:13 pm In retrospect, I should have contributed directly to the Roth.. since the income limits for those purposes add back in the FEIE, that would have been fine.
Can you clarify the highlighted statement?

Dale
In 2020, I have $0 earned income, since the exclusions covers all of my earnings. But for the Roth IRA, I add back in my foreign earnings since the limits are calculated based on modified AGI.
Katietsu
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Re: tIRA --> Roth conversion, but can't recharacterize?

Post by Katietsu »

a__ wrote: Sun Jun 13, 2021 11:49 pm
Dale_G wrote: Sun Jun 13, 2021 4:08 pm
a__ wrote: Sun Jun 13, 2021 3:13 pm In retrospect, I should have contributed directly to the Roth.. since the income limits for those purposes add back in the FEIE, that would have been fine.
Can you clarify the highlighted statement?

Dale
In 2020, I have $0 earned income, since the exclusions covers all of my earnings. But for the Roth IRA, I add back in my foreign earnings since the limits are calculated based on modified AGI.
I do not think this is right. You do add back in foreign earnings to determine if your income is too high to make a direct Roth contribution. But, my understanding is that you must still have earned income that has not been excluded to make a Roth contribution just like the traditional. So a direct Roth contribution would also be in excess with no un excluded income.

I know that utilizing the FEIE is a choice not a requirement. Are you allowed to choose how much to exclude? In other words , could you choose to treat $5500 (or $6000- I could not figure out what you contribute) as un excluded income? Do you have enough in earned income that such an election would lead to increased tax liability? I do not know if this is an option. Just throwing it put there.
Topic Author
a__
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Re: tIRA --> Roth conversion, but can't recharacterize?

Post by a__ »

jeffyscott wrote: Sun Jun 13, 2021 4:20 pm This might be part of the answer :?:
https://www.thetaxadviser.com/issues/20 ... -iras.html

The distribution part of the failed Roth conversion is an ordinary distribution and is taxable to the same extent it would have been if the Roth conversion had not failed.

Sounds like it may be that you have effectively withdrawn the TIRA contribution and made a Roth contribution, since the money was not eligible for conversion.
What a tremendous article. Thank you for this link! But I don't think I'm out of the woods... the following sentences after your quote seem to put me in the corner:
A failed Roth conversion from a qualified plan or traditional IRA is similarly treated. The distribution part of the failed Roth conversion is an ordinary distribution and is taxable to the same extent it would have been if the Roth conversion had not failed.8 However, unlike a valid Roth conversion, the earnings portion of the distribution may also be subject to the early-distribution penalty, unless an exception applies.9 The contribution part of the failed rollover is subject to the 6% excise tax to the extent it exceeds the statutory limitations on regular contributions to Roth IRAs (i.e., to the extent it is an excess contribution).10
ivk5
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Re: tIRA --> Roth conversion, but can't recharacterize?

Post by ivk5 »

a__ wrote: Sun Jun 13, 2021 11:49 pm
Dale_G wrote: Sun Jun 13, 2021 4:08 pm
a__ wrote: Sun Jun 13, 2021 3:13 pm In retrospect, I should have contributed directly to the Roth.. since the income limits for those purposes add back in the FEIE, that would have been fine.
Can you clarify the highlighted statement?

Dale
In 2020, I have $0 earned income, since the exclusions covers all of my earnings. But for the Roth IRA, I add back in my foreign earnings since the limits are calculated based on modified AGI.
I don’t believe so. Source?

In any case, the unspecified details of your situation may be relevant. Are you currently living/working in a low/no income tax justification? If not, how wedded are you to the FEIE? If appropriate, you could consider revoking your FEIE election, claim FTC instead, and have earned income for IRA contribution purposes. But of course you’d be precluded from switching back to FEIE for 5 years (absent consent to re-elect early; unclear to me how difficult/expensive it may be to obtain; I’ve never tried).
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jeffyscott
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Re: tIRA --> Roth conversion, but can't recharacterize?

Post by jeffyscott »

a__ wrote: Mon Jun 14, 2021 12:27 am
jeffyscott wrote: Sun Jun 13, 2021 4:20 pm This might be part of the answer :?:
https://www.thetaxadviser.com/issues/20 ... -iras.html

The distribution part of the failed Roth conversion is an ordinary distribution and is taxable to the same extent it would have been if the Roth conversion had not failed.

Sounds like it may be that you have effectively withdrawn the TIRA contribution and made a Roth contribution, since the money was not eligible for conversion.
What a tremendous article. Thank you for this link! But I don't think I'm out of the woods... the following sentences after your quote seem to put me in the corner:
A failed Roth conversion from a qualified plan or traditional IRA is similarly treated. The distribution part of the failed Roth conversion is an ordinary distribution and is taxable to the same extent it would have been if the Roth conversion had not failed.8 However, unlike a valid Roth conversion, the earnings portion of the distribution may also be subject to the early-distribution penalty, unless an exception applies.9 The contribution part of the failed rollover is subject to the 6% excise tax to the extent it exceeds the statutory limitations on regular contributions to Roth IRAs (i.e., to the extent it is an excess contribution).10
Example 11 there seems relevant, if you are correct that you are eligible to contribute to Roth.

In any case, I think the article answers how this is to be treated. But may not mean you avoid penalties.
The two greatest enemies of the equity fund investor are expenses and emotions. ― John C. Bogle
ivk5
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Re: tIRA --> Roth conversion, but can't recharacterize?

Post by ivk5 »

Re direct Roth eligibility:

I can't quickly find a cite directly from IRS pubs (much less IRC) but secondary sources seem very clear that you cannot contribute FEIE-excluded income to a Roth IRA either - ie, the excluded income is not available as earned income for purposes of determining if you have sufficient earned income for the contribution. The excluded income does get added back for purposes of the income-based eligibility phaseout, which may be the source of confusion.

See, eg, https://www.thebalance.com/ira-for-work ... ad-3193218:
A taxpayer's AGI is modified to add back any foreign earned income exclusion and/or foreign housing exclusion that they might have claimed. This creates a very narrow range of income possibilities for funding a Roth IRA if you live and work abroad.

Note: A single filer claiming the full $108,700 foreign earned income exclusion would have to have foreign wages over $108,700, and modified adjusted gross income not more than $140,000, to be eligible to contribute some money to a Roth IRA.
(and the $140k would become $208k for MFJ)
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jeffyscott
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Re: tIRA --> Roth conversion, but can't recharacterize?

Post by jeffyscott »

ivk5 wrote: Mon Jun 14, 2021 9:11 am Re direct Roth eligibility:

I can't quickly find a cite directly from IRS pubs (much less IRC) but secondary sources seem very clear that you cannot contribute FEIE-excluded income to a Roth IRA either - ie, the excluded income is not available as earned income for purposes of determining if you have sufficient earned income for the contribution.
If that's correct and the OP is ineligible to contribute to Roth, then it seems to me that the "failed" conversion becomes an excess contribution to the Roth. And the excess contribution to the TIRA has already been withdrawn in the failed conversion process. What remains to do is removing the excess contribution from the Roth.

OTOH, if Roth eligible, then it seems to me that a timely recharaterization has already occured.

(Both opinions are based on my interpretation of the article that I linked.)
The two greatest enemies of the equity fund investor are expenses and emotions. ― John C. Bogle
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