Recharacterizing a Recharacterization - new twist on old question

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Topic Author
radd2
Posts: 3
Joined: Thu Jun 17, 2021 5:26 pm

Recharacterizing a Recharacterization - new twist on old question

Post by radd2 »

I've looked through the legendary @Alan S. 's responses on recharacterizing recharacterizations and am currently living a scenario not directly addressed elsewhere. Hoping to get some insight:

- On 3/6/20, contributed regular $1500 to a TIRA, newly set up for this purpose. Only reason not in Roth is because at that time, we made the estimation we would exceed the Roth income contribution limit for 2020.
- On 4/9/20, after doing 2019 taxes (with somewhat lower 2019 income than expected) and in light of covid, we changed course, thinking we would probably not exceed the Roth income contrib limit for 2020.
- On 4/9/20 we recharacterized this $1500 TIRA contribution into a 2020 Roth contribution along with its $14 in earnings (actually did a whole account balance recharacterization. NOT A CONVERSION/ROLLOVER)
- For the rest of 2020, she contributed $500/mo directly as normal Roth contributions, and hit exactly $6000 total 2020 contributions by December (the orig recharacterized $1500 plus normal $4500 contributions)

In April 2021, I do our taxes, say No, we did not contribute to TIRA's (other than this recharacterization) and thought it was ok we weren't asked about Roths, as 'there's no tax implication for Roth anyway, plus she didn't contribute to any other IRAs, so she's all set on the $6000 limit'...
:oops: Turns out, thanks to unexpected bonuses and Covid market, we (married jointly) well exceeded the 2020 Roth income limit for contributing. I realized this a week or two ago.

- What is the best way to handle this considering I filed weeks ago and it's now June 17th? Do I have til October to fix this (though I want to ASAP)?
Should I:
- For the $4500 in regular 2020 Roth contributions, I can Recharacterize them into 2020 TIRA contributions correct? With no harm done?
- Treat the original $1500 plus earnings differently somehow, since it was already recharacterized once over a year ago, and if so how?
- Or can I treat the original $1500 the same and just recharacterize a total of $6000 out of the Roth and into TIRA for 2020? Does it matter if its it the same (now empty) TIRA or needs to be a new one? Plus let our custodian calculate and move all earnings along with it into the TIRA? This complies with the contribution limit.. and hopefully has no tax implications because we're well above the TIRA deductibility income limit anyways... it's tempting to think this but it seems too simple.


thank you SO MUCH for any insight
Alan S.
Posts: 10720
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Recharacterizing a Recharacterization - new twist on old question

Post by Alan S. »

radd2 wrote: Thu Jun 17, 2021 8:15 pm I've looked through the legendary @Alan S. 's responses on recharacterizing recharacterizations and am currently living a scenario not directly addressed elsewhere. Hoping to get some insight:

- On 3/6/20, contributed regular $1500 to a TIRA, newly set up for this purpose. Only reason not in Roth is because at that time, we made the estimation we would exceed the Roth income contribution limit for 2020.
- On 4/9/20, after doing 2019 taxes (with somewhat lower 2019 income than expected) and in light of covid, we changed course, thinking we would probably not exceed the Roth income contrib limit for 2020.
- On 4/9/20 we recharacterized this $1500 TIRA contribution into a 2020 Roth contribution along with its $14 in earnings (actually did a whole account balance recharacterization. NOT A CONVERSION/ROLLOVER)
- For the rest of 2020, she contributed $500/mo directly as normal Roth contributions, and hit exactly $6000 total 2020 contributions by December (the orig recharacterized $1500 plus normal $4500 contributions)

In April 2021, I do our taxes, say No, we did not contribute to TIRA's (other than this recharacterization) and thought it was ok we weren't asked about Roths, as 'there's no tax implication for Roth anyway, plus she didn't contribute to any other IRAs, so she's all set on the $6000 limit'...
:oops: Turns out, thanks to unexpected bonuses and Covid market, we (married jointly) well exceeded the 2020 Roth income limit for contributing. I realized this a week or two ago.

- What is the best way to handle this considering I filed weeks ago and it's now June 17th? Do I have til October to fix this (though I want to ASAP)?
Should I:
- For the $4500 in regular 2020 Roth contributions, I can Recharacterize them into 2020 TIRA contributions correct? With no harm done?
- Treat the original $1500 plus earnings differently somehow, since it was already recharacterized once over a year ago, and if so how?
- Or can I treat the original $1500 the same and just recharacterize a total of $6000 out of the Roth and into TIRA for 2020? Does it matter if its it the same (now empty) TIRA or needs to be a new one? Plus let our custodian calculate and move all earnings along with it into the TIRA? This complies with the contribution limit.. and hopefully has no tax implications because we're well above the TIRA deductibility income limit anyways... it's tempting to think this but it seems too simple.


thank you SO MUCH for any insight
You are correct. That would be too simple.
You will have to treat the direct Roth contributions differently from the already recharacterized ones.

For the 4500 of direct Roth contributions, a recharacterization can be done to a TIRA (existing TIRA account OK).
For the 1500 of recharacterized contributions, a return of excess Roth contributions with applicable earnings will be needed or you will incur a 6% excise tax for 2020, and it is too late to recontribute as a 2020 regular TIRA contribution.

Because you presumably filed your 2020 return by 5/17, you have until the extended due date (10/15/2021) to remove the excess contribution and also to recharacterize the 4500 contribution, so there is no current time crunch.

If you do both these operations, there will be no excise tax due, but you will have to amend the 2020 return with a 1040X as follows:
1) File an 2020 8606 to report 4500 non deductible TIRA contribution.
2) Report the withdrawn earnings on the return of the 1500 contribution as 2020 income because the original contribution was made in 2020. The taxable earnings will also be subject to the 10% penalty if under 59.5. So you will end up with a 2020 contribution limited to 4500.
3) Include an explanatory statement with the 1040 X regarding the recharacterization and the removal.

However, there is also a "Plan B" possibility that I only mention because the original contribution was made in early 2020, so it you have been invested in stocks you might have large gains on the 1500 recharacterized contribution. If you do, you might save by leaving the Roth contribution alone and paying the 6% excise tax of $90 on it for 2020 if that $90 is less than the tax and penalty on the earnings you would receive. To hold the excise tax to just 2020, you would then request a distribution of 1500 (no earnings) late in the 2021. To see if the option is better you would have to figure what this contribution has gained since first made to the TIRA. You could also do this for the entire 6000, but since the other contributions were made later in 2020 on a monthly basis, the gains would be much less and probably not enough to use this for the other 4500. The challenging part is determining if you want to go the extra mile to consider this Plan B, or just do the return of the 1500 and recharacterize the 4500.
Topic Author
radd2
Posts: 3
Joined: Thu Jun 17, 2021 5:26 pm

Re: Recharacterizing a Recharacterization - new twist on old question

Post by radd2 »

Alan S. wrote: Fri Jun 18, 2021 8:19 pm
radd2 wrote: Thu Jun 17, 2021 8:15 pm I've looked through the legendary @Alan S. 's responses on recharacterizing recharacterizations and am currently living a scenario not directly addressed elsewhere. Hoping to get some insight:

- On 3/6/20, contributed regular $1500 to a TIRA, newly set up for this purpose. Only reason not in Roth is because at that time, we made the estimation we would exceed the Roth income contribution limit for 2020.
- On 4/9/20, after doing 2019 taxes (with somewhat lower 2019 income than expected) and in light of covid, we changed course, thinking we would probably not exceed the Roth income contrib limit for 2020.
- On 4/9/20 we recharacterized this $1500 TIRA contribution into a 2020 Roth contribution along with its $14 in earnings (actually did a whole account balance recharacterization. NOT A CONVERSION/ROLLOVER)
- For the rest of 2020, she contributed $500/mo directly as normal Roth contributions, and hit exactly $6000 total 2020 contributions by December (the orig recharacterized $1500 plus normal $4500 contributions)

In April 2021, I do our taxes, say No, we did not contribute to TIRA's (other than this recharacterization) and thought it was ok we weren't asked about Roths, as 'there's no tax implication for Roth anyway, plus she didn't contribute to any other IRAs, so she's all set on the $6000 limit'...
:oops: Turns out, thanks to unexpected bonuses and Covid market, we (married jointly) well exceeded the 2020 Roth income limit for contributing. I realized this a week or two ago.

- What is the best way to handle this considering I filed weeks ago and it's now June 17th? Do I have til October to fix this (though I want to ASAP)?
Should I:
- For the $4500 in regular 2020 Roth contributions, I can Recharacterize them into 2020 TIRA contributions correct? With no harm done?
- Treat the original $1500 plus earnings differently somehow, since it was already recharacterized once over a year ago, and if so how?
- Or can I treat the original $1500 the same and just recharacterize a total of $6000 out of the Roth and into TIRA for 2020? Does it matter if its it the same (now empty) TIRA or needs to be a new one? Plus let our custodian calculate and move all earnings along with it into the TIRA? This complies with the contribution limit.. and hopefully has no tax implications because we're well above the TIRA deductibility income limit anyways... it's tempting to think this but it seems too simple.


thank you SO MUCH for any insight
You are correct. That would be too simple.
You will have to treat the direct Roth contributions differently from the already recharacterized ones.

For the 4500 of direct Roth contributions, a recharacterization can be done to a TIRA (existing TIRA account OK).
For the 1500 of recharacterized contributions, a return of excess Roth contributions with applicable earnings will be needed or you will incur a 6% excise tax for 2020, and it is too late to recontribute as a 2020 regular TIRA contribution.

Because you presumably filed your 2020 return by 5/17, you have until the extended due date (10/15/2021) to remove the excess contribution and also to recharacterize the 4500 contribution, so there is no current time crunch.

If you do both these operations, there will be no excise tax due, but you will have to amend the 2020 return with a 1040X as follows:
1) File an 2020 8606 to report 4500 non deductible TIRA contribution.
2) Report the withdrawn earnings on the return of the 1500 contribution as 2020 income because the original contribution was made in 2020. The taxable earnings will also be subject to the 10% penalty if under 59.5. So you will end up with a 2020 contribution limited to 4500.
3) Include an explanatory statement with the 1040 X regarding the recharacterization and the removal.

However, there is also a "Plan B" possibility that I only mention because the original contribution was made in early 2020, so it you have been invested in stocks you might have large gains on the 1500 recharacterized contribution. If you do, you might save by leaving the Roth contribution alone and paying the 6% excise tax of $90 on it for 2020 if that $90 is less than the tax and penalty on the earnings you would receive. To hold the excise tax to just 2020, you would then request a distribution of 1500 (no earnings) late in the 2021. To see if the option is better you would have to figure what this contribution has gained since first made to the TIRA. You could also do this for the entire 6000, but since the other contributions were made later in 2020 on a monthly basis, the gains would be much less and probably not enough to use this for the other 4500. The challenging part is determining if you want to go the extra mile to consider this Plan B, or just do the return of the 1500 and recharacterize the 4500.

Thanks so much for the guidance, makes total sense. Really appreciate it.
Topic Author
radd2
Posts: 3
Joined: Thu Jun 17, 2021 5:26 pm

Re: Recharacterizing a Recharacterization - new twist on old question

Post by radd2 »

Alan S. wrote: Fri Jun 18, 2021 8:19 pm You are correct. That would be too simple.
You will have to treat the direct Roth contributions differently from the already recharacterized ones.

For the 4500 of direct Roth contributions, a recharacterization can be done to a TIRA (existing TIRA account OK).
For the 1500 of recharacterized contributions, a return of excess Roth contributions with applicable earnings will be needed or you will incur a 6% excise tax for 2020, and it is too late to recontribute as a 2020 regular TIRA contribution.

Because you presumably filed your 2020 return by 5/17, you have until the extended due date (10/15/2021) to remove the excess contribution and also to recharacterize the 4500 contribution, so there is no current time crunch.

If you do both these operations, there will be no excise tax due, but you will have to amend the 2020 return with a 1040X as follows:
1) File an 2020 8606 to report 4500 non deductible TIRA contribution.
2) Report the withdrawn earnings on the return of the 1500 contribution as 2020 income because the original contribution was made in 2020. The taxable earnings will also be subject to the 10% penalty if under 59.5. So you will end up with a 2020 contribution limited to 4500.
3) Include an explanatory statement with the 1040 X regarding the recharacterization and the removal.

However, there is also a "Plan B" possibility that I only mention because the original contribution was made in early 2020, so it you have been invested in stocks you might have large gains on the 1500 recharacterized contribution. If you do, you might save by leaving the Roth contribution alone and paying the 6% excise tax of $90 on it for 2020 if that $90 is less than the tax and penalty on the earnings you would receive. To hold the excise tax to just 2020, you would then request a distribution of 1500 (no earnings) late in the 2021. To see if the option is better you would have to figure what this contribution has gained since first made to the TIRA. You could also do this for the entire 6000, but since the other contributions were made later in 2020 on a monthly basis, the gains would be much less and probably not enough to use this for the other 4500. The challenging part is determining if you want to go the extra mile to consider this Plan B, or just do the return of the 1500 and recharacterize the 4500.
:happy
Thanks again Alan -
A couple quick questions in case you see this - the gains were substantial and the 6% excise on $1500 principal of $90 does look like less than the 10% penalty + income tax on the associated earnings:
a) In order to take plan B and pay the 6% excise tax on the 1500 contribution and leaving it in the account, is that done by filing an amended return in order to report and mail in payment?
b) Is the reason for waiting til late in the year to get solidly past the October extended filing deadline - what's the purpose or goal? Just want to make sure I do this right in a few months. And so this request at that time is just a 'return of principal' from the Roth which as such isn't supposed to trigger anything?
Alan S.
Posts: 10720
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Recharacterizing a Recharacterization - new twist on old question

Post by Alan S. »

radd2 wrote: Mon Jun 21, 2021 1:41 pm
Alan S. wrote: Fri Jun 18, 2021 8:19 pm You are correct. That would be too simple.
You will have to treat the direct Roth contributions differently from the already recharacterized ones.

For the 4500 of direct Roth contributions, a recharacterization can be done to a TIRA (existing TIRA account OK).
For the 1500 of recharacterized contributions, a return of excess Roth contributions with applicable earnings will be needed or you will incur a 6% excise tax for 2020, and it is too late to recontribute as a 2020 regular TIRA contribution.

Because you presumably filed your 2020 return by 5/17, you have until the extended due date (10/15/2021) to remove the excess contribution and also to recharacterize the 4500 contribution, so there is no current time crunch.

If you do both these operations, there will be no excise tax due, but you will have to amend the 2020 return with a 1040X as follows:
1) File an 2020 8606 to report 4500 non deductible TIRA contribution.
2) Report the withdrawn earnings on the return of the 1500 contribution as 2020 income because the original contribution was made in 2020. The taxable earnings will also be subject to the 10% penalty if under 59.5. So you will end up with a 2020 contribution limited to 4500.
3) Include an explanatory statement with the 1040 X regarding the recharacterization and the removal.

However, there is also a "Plan B" possibility that I only mention because the original contribution was made in early 2020, so it you have been invested in stocks you might have large gains on the 1500 recharacterized contribution. If you do, you might save by leaving the Roth contribution alone and paying the 6% excise tax of $90 on it for 2020 if that $90 is less than the tax and penalty on the earnings you would receive. To hold the excise tax to just 2020, you would then request a distribution of 1500 (no earnings) late in the 2021. To see if the option is better you would have to figure what this contribution has gained since first made to the TIRA. You could also do this for the entire 6000, but since the other contributions were made later in 2020 on a monthly basis, the gains would be much less and probably not enough to use this for the other 4500. The challenging part is determining if you want to go the extra mile to consider this Plan B, or just do the return of the 1500 and recharacterize the 4500.
:happy
Thanks again Alan -
A couple quick questions in case you see this - the gains were substantial and the 6% excise on $1500 principal of $90 does look like less than the 10% penalty + income tax on the associated earnings:
a) In order to take plan B and pay the 6% excise tax on the 1500 contribution and leaving it in the account, is that done by filing an amended return in order to report and mail in payment?
b) Is the reason for waiting til late in the year to get solidly past the October extended filing deadline - what's the purpose or goal? Just want to make sure I do this right in a few months. And so this request at that time is just a 'return of principal' from the Roth which as such isn't supposed to trigger anything?
a) In most cases you can file a 2020 5329 by itself and send it in with the $90 excise tax. A 5329 is itself a return and it has a place for your signature and SSN. Every so often an IRS agent will request a 1040 X unnecessarily, but this is fairly rare.

b) You do not have to wait, but waiting provides two benefits. First, it is more time for the 1500 to generate tax free gains, and second it prevents errors where a taxpayer mentions an excess contribution and it gets returned with earnings. If ordered after the 10/15 deadline, this cannot happen. November is a good time for the request. You should not mention an excess contribution or any particular year when you request the distribution of 1500, just request a distribution of 1500. You will get a 1099R and have to report the distribution on a 2021 Form 8606, but it will be tax free as it comes from your basis of regular Roth contributions you will show on line 22 of the 8606. You will also need a 2021 5329 to close out the excess amount with respect to the excise tax. It will show that the 1500 was removed an leaves an excess balance of 0, and therefore no excise tax due for 2021. Total cost will be $90, and possibly a small IRS interest charge for late payment of the 2020 excise tax if the IRS cares to bill for that.
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