Mistaken IRA Contributions

[A Shot in the Dark]

On behalf of a CPA friend of mine I am posting this question. Quite frankly I am not sure there is an answer.

Ten years ago an individual opens what he believes was ROTH IRA with a local institution. Each of the 10 years, the individual makes an annual contribution to the IRA. Each annual contribution is accounted for as a Roth Contribution for tax purposes, etc.

The individual changes CPA's and the new CPA doing his applicable due dilligence in taking over a new client discovers that the supposed Roth IRA established ten years ago was in fact established as a traditional IRA and not a Roth IRA.

The CPA tells me he can amend returns for a period of three years.

Any idea how to handle the other 7 years of incorrectly reported contributions?

[QDROphile]

I would be inclined to correct the other direction and maintain the Roth IRA. A cooperative local institution would be helpful.

[masteff]

I agree. Correct the IRA's designation. Might have to show a few years of tax returns to the local institution to prove it was being treated as Roth.

If that can't be accomplished then your CPA friend needs to stop and think thru what the consequences are otherwise... namely that instead of Roth contributions these would be non-deductible traditional contributions (keep in mind that I can elect to make non-deductible traditional IRA contributions even if I'm below the phase out limits).

Second, the 3 year limit pertains to claiming credits and refunds. It does not preclude amending all 10 years. Since the taxpayer did not deduct the contributions then he has zero tax effect. All he'd be doing is fixing a paperwork error (ie Form 8606) that has relevance because it would establish basis in the non-deductible contributions. Only two problems, one: he'll want to attach a letter explaining that he mistakenly thought the money was going in as Roth rather than non-deductible to try to avoid the penalty for not filing the old 8606s, and two: there's a slight but real audit risk.

But first and foremost is to try getting the IRA correctly designated as Roth.

[A Shot in the Dark]

QDROphile and masteff, thank you for the input. I will pass this along.

[mbozek]

Whether or not a tax return can be amended after the 3 year s/l has expired, it would not be possible to change the designation of the TIRA to a Roth IRA because of the Doctrine of Consistency which the tax courts apply to prevent a taxpayer from taking advantage of a tax benefit after the S/L expires to avoid tax on a provision which has expired. A taxpayer retroactively changing the designation of a TIRA with AT funds contributed more than 7 years ago to a Roth IRA would avoid taxation of earnings in the TIRA under IRC 408(a) and application of the pro rata rule.

Secondly a conversion can only be accomplished by redesignation of the TIRA as a Roth IRA which requires inclusion of all income in the year of conversion. Retroactivley redesignating the TIRA as a Roth for years beyond the statute of limitation would violate the doctrince of consistency because the effect would be to eliminate taxation on those earnings.

Third taxpayers are responsible for determining how an investment will be treated under the tax law and to confirm its correctness. There is no redo other than by amending a tax return.

[Jim Chad]

I think Mbozek is right on everything he says about a redo. The question is: is this a redo or correcting a screw up at the financial institution?

If the IRA owner has any paper work or correspondence showing the the original instructions were for Roth, I would push them to fix their mistake. Whether this is one year old or 10 years old, the mistake needs to be fixed. If all of the original paperwork says traditional IRA, than I think Mbozek is right.