Roth IRA basis

[Guest Baumer01]

I was sent a letter from the IRS back in June that stated I owed them over $4,000 as I had taken a contribution of over $14,000 in 2005. What occured was I closed an account at a brokerage and had the 14K sent to me then I put 7K in another brokerage. I had originally put 2K a year in a traditional IRA back in the early '90's for 5 years then converted to a Roth IRA in '98. I paid taxes over the next couple of years so I assumed that my distribution was legal. Now the IRS wants to collect interest before my dispute is settled. Would my basis be 10K as this my total amount that I've contributed?

[jevd]

Did you file form 8606 for the year of the distribution. The form will determine the basis for you. Also, how old are you? Was this a qualified Roth distribution?

[masteff]

In addition to jevd's two key questions above.... You said you opened a 2nd brokerage account. Was it a Roth IRA account or just a normal non-IRA account? If it was a Roth, then that money might count as a rollover (if you did it in a timely manner).

IRS Publication 590 might be helpful: http://www.irs.gov/pub/irs-pdf/p590.pdf

Also see Form 4972: http://www.irs.gov/pub/irs-pdf/f4972.pdf

And the instructions for form 8606: http://www.irs.gov/pub/irs-pdf/i8606.pdf

And lastly that form itself: http://www.irs.gov/pub/irs-pdf/f8606.pdf

If you didn't report the distribution and possible rollover correctly, you may need to file an amended return for 2005.

[John G]

Let me rephrase your story in time sequence:

- You worked in the 90s and had earned income that allowed you to contribute 2K a year to a traditional IRA. (You did not indicate if you claimed any deductions for contributions)

- In 1998, you converted all (?) of these funds to a Roth IRA and apparently paid taxes over four years. (What was the total amount converted? 14K or something between the 10K (2 x 5 yrs) and 14K.

- Then in 2005, you took a distributions of 14,000 from your Roth which was at a brokerage.

- What is not clear is if you then rolled over 7K into a different Roth or just a different taxable account at a brokerage. If you rolled over to a Roth, you had to complete this transaction in 60 days. (please clarify if the second brokerage was a Roth or just a taxable account and the number of days between exit and redeposit).

My first thoughts: If your IRA contributions were legal and you subsequently were eligible to make a Roth conversion and paid all the taxes, then you may have no tax obligation related to a 2005 distribution. But, we would need to know your age, the amount you converted in 1998, and if you only took a 7K or the full 14K as a distribution. If all your transactions were done correctly, then the conversion math would determine your basis. But as jevd pointed out, your age my erase any tax obligation.

[Guest Baumer01]

Let me rephrase your story in time sequence:

- You worked in the 90s and had earned income that allowed you to contribute 2K a year to a traditional IRA. (You did not indicate if you claimed any deductions for contributions)

- In 1998, you converted all (?) of these funds to a Roth IRA and apparently paid taxes over four years. (What was the total amount converted? 14K or something between the 10K (2 x 5 yrs) and 14K.

- Then in 2005, you took a distributions of 14,000 from your Roth which was at a brokerage.

- What is not clear is if you then rolled over 7K into a different Roth or just a different taxable account at a brokerage. If you rolled over to a Roth, you had to complete this transaction in 60 days. (please clarify if the second brokerage was a Roth or just a taxable account and the number of days between exit and redeposit).

My first thoughts: If your IRA contributions were legal and you subsequently were eligible to make a Roth conversion and paid all the taxes, then you may have no tax obligation related to a 2005 distribution. But, we would need to know your age, the amount you converted in 1998, and if you only took a 7K or the full 14K as a distribution. If all your transactions were done correctly, then the conversion math would determine your basis. But as jevd pointed out, your age my erase any tax obligation.

[Guest Baumer01]

I contributed 2K in '91-'95 for a total of 10K in a traditional IRA. In '98 I converted to Roth and took the 4 years to pay my tax on the 10K. I then had the 14K sent to me to rollover within the 60 days to a different broker still in a Roth. I keep 7K and rolled over 7K. My mistake was not sending in Form 8606 which I understand will automatically cost me $50.00 bucks. I was 36 in '05 but my age shouldn't matter with the distribution since it has been a converted Roth. I believe my basis should be 10K since this was the amount I rolled over in '98 and paid the taxes on. Thanks, Baumer01

Let me rephrase your story in time sequence:

- You worked in the 90s and had earned income that allowed you to contribute 2K a year to a traditional IRA. (You did not indicate if you claimed any deductions for contributions)

- In 1998, you converted all (?) of these funds to a Roth IRA and apparently paid taxes over four years. (What was the total amount converted? 14K or something between the 10K (2 x 5 yrs) and 14K.

- Then in 2005, you took a distributions of 14,000 from your Roth which was at a brokerage.

- What is not clear is if you then rolled over 7K into a different Roth or just a different taxable account at a brokerage. If you rolled over to a Roth, you had to complete this transaction in 60 days. (please clarify if the second brokerage was a Roth or just a taxable account and the number of days between exit and redeposit).

My first thoughts: If your IRA contributions were legal and you subsequently were eligible to make a Roth conversion and paid all the taxes, then you may have no tax obligation related to a 2005 distribution. But, we would need to know your age, the amount you converted in 1998, and if you only took a 7K or the full 14K as a distribution. If all your transactions were done correctly, then the conversion math would determine your basis. But as jevd pointed out, your age my erase any tax obligation.

[Guest mjb]

How about telling us what section of the IRC the IRS accuses you of violating. Or providing us with a description of what the IRS said you did wrong.

[masteff]

How about telling us what section of the IRC the IRS accuses you of violating. Or providing us with a description of what the IRS said you did wrong.

By not filing for 8606, the IRS presumes the rollover was fully taxable, as they have no other way to know that part of the money was Roth. They likely were going thru 1099-R's and matching them to returns and found nothing on line 15 of Baumer's return which would immediately have triggered the tax and letter.

The key now is to file an amended return w/ the 8606 and the rollover properly shown.

[Guest mjb]

If he only converted 50% of the IRA to a Roth IRA in 1998 how does he get the benefit of the 4 yr stretchout for taxes and avoid 10% penalty tax on the amount not converted? I think he needs to retain a tax advisor.

[John G]

I think he implied that he converted 100% in 1998. The 14K getting split 7 + 7 with half rolling over was I believe in 2005.

It sounds like the conversion was done properly, but the rollover was poorly documented. It appears to meet that he would not owe taxes on the 7K kept, but has to battle with IRS to document what he did. Part of the problem was that he apparently used the 60 day option (First WARNING: Avoid this kind of 60 day rollover option. They can cause great pain), instead use direct custodian to custodian transfers.

Note the author never mentioned is why he took out the 7K. I believe there were a number of reasons for withdrawing that were allowed in 2005.... but I will let our accountants confirm that. My usual question - why mess with your excellant tax shelter by taking out funds? The whole purpose of a Roth is to keep $$$ sheltered for the max amount of time. Money has been "on sale" for the past few years - HELOCs, margin loans, family loans (yes, you can beat the CDs rates of your parents/aunt/uncle) and signature lines are all possible ways to avoid tapping a Roth.

Second WARNING! Please, folks, don't work the high wire without a net. When doing these kinds of transactions, spend the $100 or 150 (Colorado rates) and consult a tax advisor or accountant. You do not want to be your own brain surgeon. Shoot, even the professionals have trouble understanding our tax code. You do not want to trigger penalties, taxes, or your time cleaning up a mess. An hour of professional time up front can save you money and aggevation. {I am not an accountant or tax advisor, so I am not making some selfserving plea for my profession.}

[masteff]

I believe there were a number of reasons for withdrawing that were allowed in 2005.... but I will let our accountants confirm that.

If not consulting an accountant, Form 4972 is the proper place to look. Current version is linked above. The IRS website has prior years.

[Guest Baumer01]

Thanks to all of you for your input. I am going to seek some professional help as well as an accountant. The 10K was all that I had in '98 and I converted the whole thing then spent the next 4 years paying taxes on it. Over the next few years it had grown to 14k and that's when I did the rollover. Yes, I had the check sent to me and had the conversion done in 32 days, well within the 60 day limit but I kept 7K to pay off a car and our HELOC. You can say what you want about robbing Peter to pay Paul but the only payment we have left at this time is a small amount on our home and then we hope to invest like no other. As Dave Ramsey says: "Live today like no other so you can live tomorrow like no other." Debt Free Thanks again and I'll make sure I talk to an accountant before making moves like this again. Baumer01

[John G]

OK. I think we have narrowed it down to get some help in the future and work to document what you did so the IRS will be satisfied. I believe from what you have said, you have no tax liability.

On credit:

Depending upon the interest rate you were paying, you might have been better off to stay with the Roth and pay off the loans. Not everyone qualifies for a Roth every year. Congress can change the rules.

Car loan debt typically has the interest front end loaded (which most people do not realize), so you rarely want to pay off a car loan after making payments for a couple of years. HELOC rates tend to be close to the bottom (only some college loans, mortgages, some brokerage margin rates and front end credit card teases are likely to be that level or lower). If you had said credit card debt or other high cost debt, I think you would have been absolutely right. To be debt free is fine, but a well disciplined household can often take advantage of very low cost debt. You got simplicity and hit a goal, which also has its rewards.

Good luck with the "invest like no other" part. That puts you miles ahead of your cohorts.