Ira

[Guest RTURNER]

I hope to seek help for a friend she opened a Roth IRA last year, did not know that it was different than Traditional IRA she made a contribution and reported it on her tax reurn. Now she needs to ammend last years return.

Question is how to figure what the penalty is for this mistake and what steps do you adviseshe take?

Can she convert this ROTH to a traditonal and what is the ramifications of that??

Thank You

RT:confused:

[John G]

Your question is not very clear. Let me ask some clarifying questions...

1. Did your friend have earned income? Like paychecks that generated a W2? Did the earned income exceed $2,000 ?

2. What tax filing status did this person elect? Single? Married filing jointly? Claimed by parents?

3. If this persons adjusted gross income is greater than $90,000 you need to give the approximate amount.

4. When you say "last year" are you refering to calander year 2001 or an earlier year?

5. When you say she reported the Roth on her tax return, are you saying that she claimed a deduction? Or do you mean some other way of reporting?

If you answer these questions, I think we can answer IF the Roth was wrong and then what to do about it. You see, your assumption that she could not open a Roth may be wrong. Lets get that squared away first.

[Guest RTURNER]

she files "single" not a dependent of any one else, earned income @ $45,000.00 all this took place for tax year 2000. Yes, she put the contribution/deduction on her form 1040 as if she had opened and contributed to an traditional IRA, (she didnt know that there was a difference). She does not want a ROTH now that she knows the difference.

RT

[papogi]

She should file a form 1040X, Amended Return, for tax year 2000. She can get the form and instructions online at www.irs.com. On it she will end up raising her taxable income for that year by the amount she originally deducted. The IRS does not want 1040X filers to figure any penalty on the form, as they will figure it out themselves and send a bill. Having seen many amended return filed, my opinion is that they won't even blink at this one, and there will probably not be any penalty.

As far as the Roth IRA she currently has, she is stuck with it. She can take the money out, but earnings would be taxed, and she would pay a 10% early withdrawal penalty on top of that. She would, however, be clear of her Roth IRA. I think she should leave it there, and simply open a new Traditional IRA. She still has 5 days to set one up for tax year 2001, or she could start one for 2002. Perhaps she is enticed by the tax deductibility of the regular IRA, but there are few circumstances where they make more sense than a Roth IRA. I think her "mistake" is probably the way she really should be going.

[John G]

I agree with Papogi. The key fact constraining your choices now is that you are talking about the 2000 tax year. If your friend actually opened a Roth but deducted it like a traditional IRA, she needs to correct her prior tax filing.

If you had asked in 2000 which option to elect, most folks would say go with the Roth. You give up a modest initial subsidy (the tax deduction) but gain tax freedom from the accumulated value many years from now. You also have no required schedule for withdrawals with a Roth so you can keep the funds sheltered longer and possibly use it as an inheritance tool. I find it hard to make a rational arguement that taxes are likely to be lower in the future for people that are salting away funds via various retirement programs, especially if they start early. Multi-million dollar accounts 35 years in the future are a strong possibility.

Get your friend a copy of IRS Pub 590. And... congratulate her for planning ahead.

On a different issue: I hope she is more knowledgable about her investment options. Post again if you want input on this too.