Roth Conversion

[Burke]

Remember the 2010 treatment of converting IRA's to Roth's and spreading the taxable distribution over subsequent tax years 2011 and 2012? Well, along comes a client who did this -- only reported the distributions in 2010 and 2011!
Do I leave well enough alone? It seems the IRS should be satisfied. They got their money early; if amended, they will have to pay a big refund and interest on the 2010 reported income! I am going to run the numbers, but I think it will be pretty much of a wash.

[Matt Sova]

Roth conversion

Your option in 2010 was report 100% in 2010 or spread it 50% in 2011 and 50% in 2012. I do not believe (could be wrong) that you could elect to report 50% in '10 and spread the remaining 50% over two years. If that is the case, to do it correctly would be report 100% in '10 and amend '11 or amend '10 reporting 0 and pick up the other 50% in '12.

[Nashville]

Matt is Right

I think the option existed for the taxpayer to rollover in 2010 (extended to 04/15/11) and take 50% in 2011 and 50% in 2012. If they didn't want this option, then they had to report the rollover as taxable in the year it happened. If the total rollover occurred in 2010, I believe their choices were:

1) 50% in 2011, 50% in 2012.
2) 100% in 2010.

So if it happened as you say it did, to repair the damage, amended returns would have to be reported for 2010 and 2011 under either scenario.

Please correct me if I'm wrong. I would hate for someone to depend on bad advice.

[FEDUKE404]

Repairing the errors

Matt is indeed correct.

You had Option 1 - Report distribution in 2010 and pay all taxes at that time or Option 2 - Report distribution in 2010, pay zero taxes at that time, and later pay 50% of the taxes both in 2011 and in 2012.

As for getting the jargon correct, I'm not quite sure there would ever be any "distribution" per se to report in calendar years 2011 and 2012 but rather only a carried forward (my software had a worksheet) amount from the original 2010 "distribution" (supported by Form 1099-R) that lands on line 15b of Form 1040 for both the 2011 and 2012 tax returns.

I don't see how your client could have PAID TAX in both 2010 and in 2011. It would have had to be either no tax in 2010 and 50% tax in 2011 and 50% tax in 2012, or 100% tax in 2010 and none thereafter. You need to take a very close look at the 2010 Form 8606, Part II, lines 19 and 20. You might even be looking at two sets of amended returns!!

Not knowing the tax skill level of the client, or his software, I can't see how this error could have easily occurred. After reading this original post I went back to check on a similar 2010 client return. There is no taxable amount shown on the Form 8606 and a goose egg on line 15b of the Form 1040. On the 2011 return, 50% of the taxable amount is shown (relief!!) and on the 2012 return waiting to be started there already appears the other 50% of the taxable amount as shown on the 2010 Form 8606 (line 20b). For both 2011 and 2012 there is only a number entry on line 15b, and a suitable statement/worksheet appears with a "print return" instruction.

IF it appears he paid 50% in 2010 and 50% in 2011, that is plain wrong (but fixable!!). In today's world of enhanced Circular 230 awareness, I don't see any way you could possibly consider an option to "leave well enough alone" without putting yourself at some risk. Even if the client walks, you also are still obligated to explain the errors and any potential consequences.

Just my 2¢ worth.

FE

[Roland Slugg]

Isn't it amazing how some taxpayers (or tax preparers or advisers) manage to misinterpret things? This case reminds me of a new client I got last year. In reviewing her two prior year returns I noticed that in 2009 she withdrew from her IRA, and reported on her 2009 return, her RMD ... about $30,000. In 2010, however, she withdrew nothing from her IRA. Zero. Upon inquiry she explained that the RMD requirement was waived for 2010. When I explained that the waiver was for 2009, not 2010, she argued (of course), until I showed it to her in writing. So far ... knock on wood ... she hasn't received a CP2000 or any other notice from the IRS about the missing IRA/RMD income on her 2010 return. If she does, we plan to write a letter explaining the misunderstanding and appealing to the IRS's sense of fairness. I believe there is a fairly good chance she will prevail, but she understands that she may owe significant penalties.

The facts in this post probably do not pose significant tax and/or penalty issues. The worst case is that the IRS takes the view that since 50% of the distribution was reported in 2010, then 100% of it should have been reported on that year's return. The T/P, however, might successfully argue that by reporting 50% of the distribution on his 2010 return, he was thereby electing to NOT defer the tax on that half to 2011 and 2012, and by not reporting the other half he WAS electing to defer on that part. (I'm not aware of any sort of "all-or-nothing" rule in effect regarding such conversions, although the 2010 F-8606 instructions do seem to imply otherwise.) That leaves the other 50% that the T/P reported entirely on his 2011 return instead of reporting half on the 2011 return and half on his 2012 return ... resulting in the pattern: 50%, 25%, 25%. This means that the T/P might be in a position to amend his 2011 return, reducing the IRA conversion reported that year by 50%, then reporting that same amount on his 2012 return. If the T/P was/is in the same tax bracket both (or all three) years, it really doesn't make much difference. Look at F-8606 in his 2010 and 2011 returns, if he completed that form, and everything may become clear ... at least regarding his intent.

If this were my client, I would discuss all this with him, then either, (A) recommend he do nothing, or (B) recommend that he file an amended return for 2010, removing the IRA income reported early, then reporting that same income on his 2012 return. The decision would depend partly on what was reported on F-8606, and partly of the T/P's tax brackets for the years involved.

[Nashville]

Another Two Cents

Burke - most of the time you are infinitely more knowledgeable than myself, so.....

Hope you don't feel like we are "piling on" with a bunch of criticism, but I would like to discuss this mindset that the IRS "has already been reported all their money so they shouldn't care." Because the idea has enormous appeal, and leaves people with the impression that any amount due is settled even if the timing is wrong. Maybe if you owe me for losing a bet on the Ravens-Broncos game and paid me in a different year, you feel like we are settled. Not so the IRS.

I have known a few auditors that would indeed pass this by but only if there was very little money to be had, and not worth the time and effort writing up adjustments. But the overwhelming number would hold the feet to the fire.

It matters what year income is reported, especially if the foregone year is at a 28% tax bracket and the reported year is at a 10% bracket. Big-time money for them. And if the numbers are reverse, you can claim the "big money" and they shouldn't be able to stop you if a proper amendment is filed.

And if the timing will allow an assessment for an earlier year and give-back in a later year, the IRS will almost always calculate a large penalty on the earlier year plus interest. On the later give-back, they will add interest only (no penalty) and it will be a years' less interest.

The idea of "being settled" with the IRS has understandable appeal with the general public. But we should know better.
Of course, if you didn't prepare 2010 and 2011 returns, you are not under obligation to do anything with them, but the matter should be explained to them, and they should be given the option of an amended return (for a fee of course).

When I approach a client about revisiting prior years, they are inclined to just "let the sleeping dog lie". Sometimes he just lays on the front porch and sleeps, but often he wakes up in a few months with an ugly letter, and is ravenously hungry for $$.