IRA Recharacterization Tax Questions

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Kintora
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IRA Recharacterization Tax Questions

Post by Kintora »

Due to an unusual 2020, my AGI was much higher than a normal year. The result was that I was only eligible to contribute $4,720 to a Roth IRA in 2020, but I contributed $6,000. For the overcontribution of $1,280, I performed a Roth IRA to Traditional IRA recharacterization with Vanguard who calculated the earnings as well and transferred ($1,280 + $222.26 = $1,502.26) from my Roth IRA to my Traditional IRA.

My tax preparer ended up submitting my taxes in, I believe, an incorrect way. Ultimately, I know I am responsible and need to check closer next time.

She did not include a statement explaining the recharacterization. She also did not complete and submit a 8606 form. Instead, it appears she submitted a "Return Carryover Summary" showing a $1,280 carryover to 2021 for "Roth IRA Contribution Basis." To me, this sounds like she is "fixing" the overcontribution in a different way (carry forward of contribution to 2021) instead of presenting it as a recharacterization for 2020. I performed the recharacterization in 2021, but it was for tax year 2020.

Looking for some feedback on how I can fix this. Wondering if I can submit just an additional statement and form 8606 or if I need to do an amended return. I could see sending the IRS just the recharacterization explanation statement and 8606 form, but not sure that would "undo" the carryover summary that she included, even if I explain in the statement.

I am going to try and have her fix this for me, but now I feel like I need to second guess what she does. So, a couple questions please related to form 8606 before I meet with her again.

1. In Part 1, line 1 (Enter your nondeductible contributions to traditional IRAs for 2020, including those made for 2020
from January 1, 2021, through April 15, 2021.), should I enter only the $1,280 overcontribution amount or do I need to include the earnings as well that Vanguard also transferred?

2. In Part 1, line 2 (Enter your total basis in traditional IRAs.), if my existing Traditional IRA is an old 401k rollover with nothing but pre-tax contributions to it prior to the recharacterization, would my total basis then be zero dollars for this line?

In line 3 it has you add lines 1 and 2 and then asks if any distributions were taken or conversions made in 2020 which for me is a no. It then says to enter that line 3 total down on line 14 (your total basis in traditional IRAs for 2020 and earlier years) and done.

Any feedback or answers to my two questions above would be appreciated.
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celia
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Re: IRA Recharacterization Tax Questions

Post by celia »

The tax-preparer and you are solving the over-contribution problem in different ways. She is applying the excess to 2021 so you have that much less to contribute in 2021. But that will be a problem if you over-contribute again this year. (The custodian may not recognized it as a 2021 contribution if you need to recharacterize $6,000.)

Meanwhile, you are looking to do a recharacterization which would make it the same as if you had made a non-deductible contribution to an IRA all along. Please read the Backdoor Roth wiki page, paying close attention to the pro rata rule. Then decide which way you want to solve the over-contribution problem.

If you want to recharacterize, Form 8606 would have 1280 on line 1, 0 on line 2 (amount of basis carried forward from earlier years). Line 6 would have 1502.26 added to the 2020 ending balances of all your IRAs. Before you convert, you should move all the pre-tax money (not your basis of 1280) to an employer tax-deferred account (see wiki).
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Kintora
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Re: IRA Recharacterization Tax Questions

Post by Kintora »

celia wrote: Tue Apr 20, 2021 2:10 pm The tax-preparer and you are solving the over-contribution problem in different ways. She is applying the excess to 2021 so you have that much less to contribute in 2021. But that will be a problem if you over-contribute again this year. (The custodian may not recognized it as a 2021 contribution if you need to recharacterize $6,000.)

Meanwhile, you are looking to do a recharacterization which would make it the same as if you had made a non-deductible contribution to an IRA all along. Please read the Backdoor Roth wiki page, paying close attention to the pro rata rule. Then decide which way you want to solve the over-contribution problem.

If you want to recharacterize, Form 8606 would have 1280 on line 1, 0 on line 2 (amount of basis carried forward from earlier years). Line 6 would have 1502.26 added to the 2020 ending balances of all your IRAs. Before you convert, you should move all the pre-tax money (not your basis of 1280) to an employer tax-deferred account (see wiki).
Thanks for your reply.

Just to further clarify, I have already contributed $6,000 to my Roth IRA this year, so I do not want the carryover to 2021. Also, I already performed the recharacterization of the $1,280 at Vanguard from my Roth IRA to an existing traditional IRA, so that is the actual method that has been used to correct the excess contribution.

Thanks for clarifying those points related to form 8606.
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Kintora
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Re: IRA Recharacterization Tax Questions

Post by Kintora »

And now my tax preparer is ignoring me. I am getting ready to just finish this on my own.

From my research, I believe I can just submit the completed Form 8606 and the statement explaining the recharacterization.

However, how can I retract the "return carryover summary" that shows a carryover to 2021 of Roth IRA contribution basis? Does anyone know if I can just include instructions to disregard that in a statement along with the Form 8606, or will retracting that "return carryover summary" require an amended return?
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celia
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Re: IRA Recharacterization Tax Questions

Post by celia »

Kintora wrote: Sat Apr 24, 2021 1:28 pm And now my tax preparer is ignoring me. I am getting ready to just finish this on my own.

From my research, I believe I can just submit the completed Form 8606 and the statement explaining the recharacterization.

However, how can I retract the "return carryover summary" that shows a carryover to 2021 of Roth IRA contribution basis? Does anyone know if I can just include instructions to disregard that in a statement along with the Form 8606, or will retracting that "return carryover summary" require an amended return?
First, you should figure out if that form impacts the rest of your return financially. Were any penalties being paid that are no longer due? Do any lines on that form carry over to the 1040? Or does the 1040 look like it would be exactly the same had that form not been generated?

If the 1040 would have remained the same, you don’t need to amend your return. Just add a note to the back of the 8606 near where you sign that the carryover calculation no longer applies.

Of course, if the 1040 changes for any reason, you need to send in an amended return.

And if you return to the same place for your taxes next year, you need to let them know about these changes, since they usually start by importing your previous years’ return.
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Kintora
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Re: IRA Recharacterization Tax Questions

Post by Kintora »

celia wrote: Sat Apr 24, 2021 2:27 pm
Kintora wrote: Sat Apr 24, 2021 1:28 pm And now my tax preparer is ignoring me. I am getting ready to just finish this on my own.

From my research, I believe I can just submit the completed Form 8606 and the statement explaining the recharacterization.

However, how can I retract the "return carryover summary" that shows a carryover to 2021 of Roth IRA contribution basis? Does anyone know if I can just include instructions to disregard that in a statement along with the Form 8606, or will retracting that "return carryover summary" require an amended return?
First, you should figure out if that form impacts the rest of your return financially. Were any penalties being paid that are no longer due? Do any lines on that form carry over to the 1040? Or does the 1040 look like it would be exactly the same had that form not been generated?

If the 1040 would have remained the same, you don’t need to amend your return. Just add a note to the back of the 8606 near where you sign that the carryover calculation no longer applies.

Of course, if the 1040 changes for any reason, you need to send in an amended return.

And if you return to the same place for your taxes next year, you need to let them know about these changes, since they usually start by importing your previous years’ return.
I have been looking closely at my return, and I do not think the form will impact my return financially. No lines carry over to the 1040. I also cannot see anywhere that she applied a penalty related to the carryover.

I believe the 1040 will not change, so I will proceed with submitting the Form 8606 and statement.

I will not be returning to this preparer again.

Thanks for your feedback. I appreciate it.
Alan S.
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Re: IRA Recharacterization Tax Questions

Post by Alan S. »

There must have been a miscommunication between you and the preparer since her filing indicates she did not know of the recharacterization or your intent to recharacterize the excess. If the supporting worksheets show the excess carried over to 2021, then there should have been a Form 5329 filed with the 2020 return charging you a 6% excise tax on the excess amount.
If there is no such form attached, then she did not even handle the carryover correctly if you had elected that option instead of recharacterizing.

While the return should have had an explanatory statement for the recharacterization, this is not essential enough to warrant your filing a 1040 X to include one now. The IRS will probably receive the 1099R issued next January before they can react to the return, but if they happen to send you an inquiry first, just plan to deal with that at the time.

So for now all you need to is file the 8606 by itself for 2020, and find a new preparer for next year.
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Kintora
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Re: IRA Recharacterization Tax Questions

Post by Kintora »

Alan S. wrote: Sat Apr 24, 2021 3:01 pm There must have been a miscommunication between you and the preparer since her filing indicates she did not know of the recharacterization or your intent to recharacterize the excess. If the supporting worksheets show the excess carried over to 2021, then there should have been a Form 5329 filed with the 2020 return charging you a 6% excise tax on the excess amount.
If there is no such form attached, then she did not even handle the carryover correctly if you had elected that option instead of recharacterizing.

While the return should have had an explanatory statement for the recharacterization, this is not essential enough to warrant your filing a 1040 X to include one now. The IRS will probably receive the 1099R issued next January before they can react to the return, but if they happen to send you an inquiry first, just plan to deal with that at the time.

So for now all you need to is file the 8606 by itself for 2020, and find a new preparer for next year.
Definitely a misunderstanding by the preparer. However, I told her several times that I was doing a recharacterization with Vanguard. I even sent her the completed recharacterization form that Vanguard uses and gave her all the details of the recharacterization. It just didn't sink in with her apparently, and she just submitted a summary of carryover, but no Form 5329, so I cannot see anywhere that I paid the 6% excise tax.

Thanks for your feedback. I will make sure a Form 8606 is submitted.
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Re: IRA Recharacterization Tax Questions

Post by Katietsu »

Wait. Did the traditional IRA have have any other funds than the $1502.86? It sounds like you have had pre tax dollars in it. If so, you will be affected by the pro rata rule. Does your 8606 reflect that? That would impact your tax liability.

The best option might have been to do what your tax preparer described. But if that is not what you did then the tax documents need to reflect what you did do.
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Re: IRA Recharacterization Tax Questions

Post by Kintora »

Katietsu wrote: Sat Apr 24, 2021 4:33 pm Wait. Did the traditional IRA have have any other funds than the $1502.86? It sounds like you have pre tax dollars in it. If so, you will be affected by the pro rata rule. Does your 8606 reflect that?

The best option might have been to do what your tax preparer described. But if that is not what you did then the tax documents need to reflect what you did do.
Yes, it was an existing traditional IRA with funds already in it, all pre-tax. So, on Form 8606, Part 1, Line 1 I am entering the recharacterized contribution of $1,280. Line 2 is $0, since I had no existing basis (all pre-tax). Line 3 is the total of Lines 1 and 2 ($1,280). Since I did not take a distribution from the traditional IRA in 2020, I then just entered the amount from Line 3 on Line 14 and did not complete the rest of Part 1 per the instructions. I hope that is correct.

I see what you mean about if I had done it the other way and then not being affected by the pro rata rule, but the recharacterization has already been done, so I guess it is water under the bridge.
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Re: IRA Recharacterization Tax Questions

Post by Alan S. »

Bringing up the pro rata rule seems to imply that you were going to convert the recharacterized contribution, but you never mentioned converting. You already had a rollover IRA with 0 basis and now you have an IRA with 1280 of basis. So now the question has expanded into what you plan to do with your 1280 of TIRA basis to avoid always having a very small basis in the TIRA.

If you wanted to do back door Roths in the future including converting the 1280, you could roll the pre tax amount of the IRA to your present employer plan, if that plan accepts rollovers and does not have high fees. You would leave 1280 in the TIRA, and then convert that 1280 tax free to a Roth IRA. You could do that this year or in the future.

If you decide that you cannot or do not want to roll your pre tax IRA value to your employer plan, and you do not want to deal with 1280 basis in your TIRA, you could still request a return of your 2020 (now TIRA contribution) of 1280 from the TIRA. You have until 10/15/2021 to do that if you wish. Do not send in the 8606 if you plan to do this because you will then not have made a 2020 non deductible TIRA contribution.
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Re: IRA Recharacterization Tax Questions

Post by Katietsu »

Kintora wrote: Sat Apr 24, 2021 4:41 pm
Katietsu wrote: Sat Apr 24, 2021 4:33 pm Wait. Did the traditional IRA have have any other funds than the $1502.86? It sounds like you have pre tax dollars in it. If so, you will be affected by the pro rata rule. Does your 8606 reflect that?

The best option might have been to do what your tax preparer described. But if that is not what you did then the tax documents need to reflect what you did do.
Yes, it was an existing traditional IRA with funds already in it, all pre-tax. So, on Form 8606, Part 1, Line 1 I am entering the recharacterized contribution of $1,280. Line 2 is $0, since I had no existing basis (all pre-tax). Line 3 is the total of Lines 1 and 2 ($1,280). Since I did not take a distribution from the traditional IRA in 2020, I then just entered the amount from Line 3 on Line 14 and did not complete the rest of Part 1 per the instructions. I hope that is correct.

I see what you mean about if I had done it the other way and then not being affected by the pro rata rule, but the recharacterization has already been done, so I guess it is water under the bridge.
Sorry. I picked up on the recharacterization to an IRA with pre tax dollars. But I assumed a conversion which you did not do. Please read Alan’s post about your options. When my DH was in your situation, he just withdrew the money. We did not want to pay taxes on the $1280 twice, or have our heirs do so. And we did not want deal with tracking this small non deductible deposit. Basically, we just decided a return of the contribution was easier.
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Re: IRA Recharacterization Tax Questions

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Alan S. wrote: Sat Apr 24, 2021 5:25 pm Bringing up the pro rata rule seems to imply that you were going to convert the recharacterized contribution, but you never mentioned converting. You already had a rollover IRA with 0 basis and now you have an IRA with 1280 of basis. So now the question has expanded into what you plan to do with your 1280 of TIRA basis to avoid always having a very small basis in the TIRA.

If you wanted to do back door Roths in the future including converting the 1280, you could roll the pre tax amount of the IRA to your present employer plan, if that plan accepts rollovers and does not have high fees. You would leave 1280 in the TIRA, and then convert that 1280 tax free to a Roth IRA. You could do that this year or in the future.

If you decide that you cannot or do not want to roll your pre tax IRA value to your employer plan, and you do not want to deal with 1280 basis in your TIRA, you could still request a return of your 2020 (now TIRA contribution) of 1280 from the TIRA. You have until 10/15/2021 to do that if you wish. Do not send in the 8606 if you plan to do this because you will then not have made a 2020 non deductible TIRA contribution.
I had no plans to convert the recharacterized contribution. I just mentioned the pro rata rule in thinking that I would eventually have to file a form 8606 each year that I eventually start drawing from the traditional IRA in retirement since it would be a mix of pre-tax and after-tax contributions.

I contributed $6,000 to my Roth IRA for 2021, as my AGI will be much lower this year, and I should be eligible to contribute the full amount.

As you say, now I have a traditional IRA with $1,280 of basis. So, you are saying that one option may be to roll the pre-tax amount of the TIRA to my employer 401k leaving just the $1,280 in the Vanguard TIRA and then convert that back to my Roth IRA tax free? That conversion would not count against my 2021 Roth IRA contribution limit, correct?

If I choose to just leave the $1,280 basis in my TIRA, is it just an annoyance then when it comes time to take distributions? Because I need to submit Form 8606 each year that I do so? Any other downside to just leaving it in there?
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Re: IRA Recharacterization Tax Questions

Post by retiredjg »

Kintora wrote: Sat Apr 24, 2021 5:54 pm As you say, now I have a traditional IRA with $1,280 of basis. So, you are saying that one option may be to roll the pre-tax amount of the TIRA to my employer 401k leaving just the $1,280 in the Vanguard TIRA and then convert that back to my Roth IRA tax free?
Yes. If you do that, all your post tax money will end up in Roth IRA and there will be no pro-rating.

That conversion would not count against my 2021 Roth IRA contribution limit, correct?
Correct. A conversion is not counted as part of your annual contribution.

If I choose to just leave the $1,280 basis in my TIRA, is it just an annoyance then when it comes time to take distributions? Because I need to submit Form 8606 each year that I do so? Any other downside to just leaving it in there?
Yes, it is simply an annoyance. Any time you take money out of the tIRA the amount that is taxable will be pro-rated between the pre-tax and post tax amounts in the IRA.

You do not need to submit a new 8606 every year unless something else triggers the form. You must keep up with that old 8606 if you ever want to avoid paying tax on that $1,280 a second time. If you lose it or forget or just choose to abandon the basis, nothing happens except paying tax a second time on that amount...if you will never empty the IRA, it may not matter anyway.
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Re: IRA Recharacterization Tax Questions

Post by Kintora »

retiredjg wrote: Mon May 03, 2021 9:01 am
Kintora wrote: Sat Apr 24, 2021 5:54 pm As you say, now I have a traditional IRA with $1,280 of basis. So, you are saying that one option may be to roll the pre-tax amount of the TIRA to my employer 401k leaving just the $1,280 in the Vanguard TIRA and then convert that back to my Roth IRA tax free?
Yes. If you do that, all your post tax money will end up in Roth IRA and there will be no pro-rating.

That conversion would not count against my 2021 Roth IRA contribution limit, correct?
Correct. A conversion is not counted as part of your annual contribution.

If I choose to just leave the $1,280 basis in my TIRA, is it just an annoyance then when it comes time to take distributions? Because I need to submit Form 8606 each year that I do so? Any other downside to just leaving it in there?
Yes, it is simply an annoyance. Any time you take money out of the tIRA the amount that is taxable will be pro-rated between the pre-tax and post tax amounts in the IRA.

You do not need to submit a new 8606 every year unless something else triggers the form. You must keep up with that old 8606 if you ever want to avoid paying tax on that $1,280 a second time. If you lose it or forget or just choose to abandon the basis, nothing happens except paying tax a second time on that amount...if you will never empty the IRA, it may not matter anyway.
Thanks, retiredjg. I appreciate your reply. I will likely do the rollover and conversion to consolidate and simplify things.
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