Consequences of undoing a Roth conversion

[Guest peterberry]

Does anyone have any thoughts on the following:

In August 2004, expecting again to be eligible to make Roth elections (two Roth accounts were established in 1998 with two separate brokerage firms, Firm A and Firm B), taxpayer went ahead and made Roth elections for two new rollover IRAs (funded from 401(k) distributions) held at different brokerage firms, Firm A, which also is custodian for one of the original good Roth IRAs, and Firm C).

In December, taxpayer established another Roth account with yet another brokerage firm (Firm D). Purpose of the Firm D Roth account was to hold stocks in Canadian listed companies whose shares ("F shares") also trade OTC in the U.S. To consolidate the "F" shares in the various Roth accounts in the Firm D Roth account, Taxpayer instructed Firm A to move the F shares in the 1998 and 2004 Firm A Roth accounts to the Firm D Roth account, instructed Firm B to move the F shares in the 1998 Firm B Roth account to the Firm D Roth account, and instructed Firm C to move the F shares in the 2004 Firm C Roth account to the Firm D Roth account. The transfers all took place as trustee to trustee transfers.

[Clarification: the instructions went to Firm D to initiate the transfers to it from Firms A, B and C. Sorry]

In the meantime, taxpayer discovered that his joint income with spouse would exceed the MAGI level and he therefore was not eligible to make the two Roth conversions. No trades occurred in the Firm D Roth account. One security distributed a royalty payment.

After briefly discussing with Firm A what to do, taxpayer determined that to fully undo the Roth election, it would be necessary to return the F share stocks from the Firm D Roth account to their respective 2004 Firm A and Firm C Roth accounts, and then to make an election to recharacterize the Roth conversion.

The F shares returned first to Firm C and taxpayer made a recharacterization election. Firm C indicated that because the F shares had gone out and come back in, it was necessary for it to perform an earnings calculation. That calculation resulted in less than all of the Roth coversion account being returned to the rollover IRA. About $1300 remains in the 2004 Firm C Roth account.

Once the 2004 Firm A Roth's F shares (including the royalty payment) returned to the 2004 Firm A Roth account, Firm A has taken a different approach, of treating the improper Roth conversion as an excess contribution, which will be withdrawn in time (it is to be hoped) to avoid excess contribution penalty.

Taxpayer is confused. Are both approaches correct? Can taxpayer withdraw the residual amount in the 2004 Firm C Roth IRA by having it returned to the Firm C rollover IRA as an excess contribution? If not, what does taxpayer do with the residual?

Many thanks for you time and patience.

Best regards,