California Roth Conversion

[Guest tcd]

I converted my IRA to a Roth in 1998, spreading the distribution over 4 years. However, I did not exclude IRA contributions prior to moving to CA. Here are my questions:

1. Do I just exclude IRA contributions made in another state, and divide by 4?

2. What about 401K contributions that were rolled over into an IRA while working in another state?

3. Do I need to file amended tax returns for 1998, 1999, and 2000? My 2001 CA tax return is due 10/15/02. Can I just deduct the out of state IRA contributions on my 2001 CA tax return instead of filing amended returns?

Thank you

[Mary Kay Foss]

California changed the way they calculate basis for IRAs as of 1/1/2002, you are lucky that you made the conversion when you did. The California rule (before 2002) was that your basis in a contributory IRA was the fair market value when you moved to the state. This basis is recovered first. This means the 1998 Form 540 should be amended to reduce the total taxable amount of the Roth conversion and then amend 1999 and 2000 for the share of income picked up in those years. If you can figure this out on time, you can take the adjustment on your 2001 original return.

Califorina has a four year statute of limitations so if you extended the 1998 return until 10/15/99 you have some time to recover 1998 taxes. Even if 1998 is a closed year for you, you should amend it to determine the proper amount of reduced income for 1999, 2000 and 2001.

When a 401k or any employer plan is rolled to an IRA as a nonresident, California has never given any basis to taxpayers. If your rollover IRAs and contributory IRAs were combined before you moved to CA it will be difficult to determine your basis.

Another way that individuals have CA basis in their contributory IRA relates to the years 1982-1986. For those 5 years, an IRA (maximum $2,000) was allowed as a federal deduction if you were covered by an employer plan. CA did not conform to this so taxpayers who took the maximum deductions have a $10,000 ($2,000 for 5 years) basis for state purposes. Also CA residents not covered by an employer plan could only deduct $1,500 for those 5 years; taxpayers in that category have a possible $2,500 basis for CA. This basis is also recovered first, before any IRA is subject to state tax.

IRA basis arising in 1987 or later is recovered pro-rata using Form 8606 just like on the federal return.

Good luck. Too bad you didn't think about his earlier.

[Guest tcd]

Thank you Mary Kay Foss, CPA

I spent some time this weekend going thru all my prior tax returns and brokerage statements. I agree, wish I thought about this earlier. However, better late than never. I did keep my contributory IRA separate from my rollover IRA. I would appreciate any additional thoughts. To keep this simple, assume the following:

1983 - 1987 Contributory IRA $10,000

4/1988 - moved to CA (FMV of Contributory IRA = $16,000)

1990 - 1991 Non Deductible IRA = $4,000

1998 Contributory IRA FMV Distribution (to Roth) = $40,000

1998 Rollover IRA FMV Distribution (to Roth) = $60,000

Form 8606:

Total Distribution $100,000

Non Deductible (4,000)

Conversion 96,000

4 years /4

1998 Form 1040 $24,000

It seems that Schedule CA (540) Total IRA Distributions subtraction would be $4,000 per year ($16,000/4). Is this correct?

I see where FTB Pub. 1005 states that "you recover your California basis before any of the distribution is taxable." However, it appears (to me) that this does not apply if you are using the 4 year spread. CA FTB Pub. 1005A (NEW FEB 1999) Worksheet to Figure CA Basis Adjustment to Federal AGI divides the California Basis by 4.

I also have some additional questions:

1. Where does it state that the CA basis in a contributory IRA is the FMV when you moved to the state? I see that you add earnings to the CA basis, but I don't see FMV.

2. I'm not sure what you mean by "the share of income picked up in those years"?

3. How can 1998 be a closed year? If I file in 1/99 to 10/99, statute ends 1/03 to 10/03. Your right, I did file the the 1998 return in 10/99.

Thanks again and have a nice weekend.

[Mary Kay Foss]

1998 could be a closed year for California if you filed your 1998 return before 10/15/99. Since you extended the return, 1998 is still open.

What California means by recovering basis first is that the out-of-state basis is taken off before you start Form 8606. That means that the conversion is $84,000 then you take into account the after-tax basis on Form 8606 of $4,000 to determine the taxable conversion.

The examples in FTB Pub. 1005 assume that your IRA consists totally of contributions plus earnings. The way the examples work the excess over the contributions is treated as earnings. If your IRA was totally invested in bank CDs, that's the answer that you would get.

By "share of income picked up in those years" I meant the taxable portion of the Roth conversion.

[Guest tcd]

Thanks again Mary Kay Foss, CPA.

1. It still seems that Schedule CA (540) Total IRA Distributions subtraction would be $4,000 per year ($16,000/4). This $16,000 is the difference between the IRS ($96,000) and CA ($80,000) taxable conversion. In your opinion, is this correct?

2. I don't see how 1998 could be closed. If I filed on 10/13/99, I would have until 10/13/03 (4 years) to file an amendment.

3. "Even if 1998 is a closed year for you, you should amend it to determine the proper amount of reduced income for 1999, 2000 and 2001. " I don't see how the filing in 1998 matters if the adjustment is $4,000 per year in 1998, 1999, 2000 and 2001. (The taxable conversion adjustment calculation is not included on the CA return, only on IRS Form 8606)

4. Thanks for the explanation on earnings in FTB Pub. 1005. Earnings usually does not include appreciation, but I guess you could mark to market. The "Change of Residency" portion of FTB Pub 1005 seems to imply that earnings include appreciation. However, its not very clear.

Another CPA I spoke with did not think any adjustment was allowed until I pointed out FTB Pub. 1005. I'm sure many filers missed this one.

Appreciate your responses.