Roth IRA Recharacterization

[fliszt]

Just wondering if someone might give me a hand with something I’ve never done before. Client contributed $5k to Roth IRA January 2006. His income was over max so on October 13, 2007 he recharacterized to traditional IRA. Interest earned from Jan 2006 to Oct 2007 was $1,561 which was converted to IRA also. Do I just send in 8606 with $5k listed on line 1, 3 and 14 along with an explanation? Report the interest % when he retires and begins to withdrawal basis + taxable portion? Or do I wait until Trustee sends a 1099R for 2007 with the 2006 recharacterization?
Any help would be appreciated very much. I’m really lost even though I’ve read Pub 590 and instructions for the 8606.
Thanks much.

[skhyatt]

Maybe I'm thinking of something else, but off the top of my head, I believe the interest will be currently taxable. If it was rolled into another IRA that is non-deductible, then wouldn't it just be part of his/her basis?

[fliszt]

Thanks for

the reply. Yes, I too think the interest will be taxable. But I think it will be on the 2007 return since that's when it was "received" and will be put on the 1040 line 15b. At that point then, the $5k + interest will be in the traditional IRA as 'after tax basis". At least that's what I'm doing for lack of a better understanding.
Thanks again
Larry

[Kram BergGold]

Disagree

The interest is not taxable as it never left either IRA. I would attach an explantion to the 2006 return and do an 8606. Then in 2007, if there is a 1099R do what you have to do to make the amount show on the a line for an IRA distribution and attach an explantion.

[fliszt]

Kram, thank

you very much for the help. I have prepared an 8606 with an explanation and will send it in with a 1040X (even though there is no change to the 1040). Then when preparing the 2007 return, I will do what ever is appropiate with the 1099R. Client is coming in this evening to pick up the paperwork.
Thanks again.
Larry

[ChEAr$]

form 5498

Just wondering if someone might give me a hand with something I’ve never done before. Client contributed $5k to Roth IRA January 2006. His income was over max so on October 13, 2007 he recharacterized to traditional IRA. Interest earned from Jan 2006 to Oct 2007 was $1,561 which was converted to IRA also. Do I just send in 8606 with $5k listed on line 1, 3 and 14 along with an explanation? Report the interest % when he retires and begins to withdrawal basis + taxable portion? Or do I wait until Trustee sends a 1099R for 2007 with the 2006 recharacterization?
Any help would be appreciated very much. I’m really lost even though I’ve read Pub 590 and instructions for the 8606.
Thanks much.

And what's the amount for 12/31/2006 shown on form 5498?

I would think these earnings WOULD be taxable for 2006 since the ability to
contribute was impaired.

[fliszt]

The contribution

made in Jan 2006 was $5k each for TP and spouse. Removed 10/13/07. Interest generated is $1,561 each. The 5498 received by TP for end of year 2006 simply shows the $5k plus FMV of account $41,938 but no 2006 earnings listed.

[skhyatt]

I believe those earnings are taxable since the money was actually pulled from the account. Wouldn't this fall under the rule for excess contributions having to be withdrawn together with earnings to avoid the excise tax??

[fliszt]

skhyatt, yes

the earnings are taxable. I called Vanguard and talked with their "retirement" experts. They said there will be documents sent to client for prep of their 2007 return which will reflect the interest earned in 06 rolled over in 07. The interest will be reported somehow on their 2007 tax return. So sorry that I don't know more about this. Since Old Jack left the board, I think I am now the oldest and being that, I can say my brain just doesn't function the way it did when I younger.
But thanks all who have helped me. I really appreciate it!!!

[Kram BergGold]

money not pulled from acct

The money went from a Roth IRA directly to Traditional non deductible IRA. It never left an IRA type acct. If the Roth contribution was pulled out and not transfered to a Traditional then the interest would be taxable. If you taxed the interest, the taxpayer would be taxed now and then when the money was withdrawn from the Traditional IRA.

[skhyatt]

The money went from a Roth IRA directly to Traditional non deductible IRA. It never left an IRA type acct. If the Roth contribution was pulled out and not transfered to a Traditional then the interest would be taxable. If you taxed the interest, the taxpayer would be taxed now and then when the money was withdrawn from the Traditional IRA.

Kram, isn't that avoided by completing form 8606 and showing it as part of the basis in the IRA?

[joanmcq]

It can't be part of the basis, or else there is an excess contribution. The limit for a contribution is $5,000.

[les grans]

IRS's Pub 590 says the interest isn't taxed, since it's

...treated as earned in the "second" IRA, the one into which the original contribution is treated as having been made, because of the recharacterization. If the entire balance in the IRA was transferred and thus recharacterized, the interest is *not* taxable*. The recharacterization causes "everything" to be treated as if the contribution had gone into the "second" IRA way back when it - the contribution - was first made, to the "first" IRA. Please don't report the interest as taxable; it was earned in an IRA and is still in an IRA and isn't taxable yet and will be taxed twice if you report it now as taxable. Mark Goldberg is right and should be decorated.


Here's what the IRS publication says:

Recharacterizations
You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the contribution.

To recharacterize a contribution, you generally must have the contribution transferred from the first IRA (the one to which it was made) to the second IRA in a trustee-to-trustee transfer. If the transfer is made by the due date (including extensions) for your tax return for the year during which [I would have said "for which"] the contribution was made, you can elect to treat the contribution as having been originally made to the second IRA instead of to the first IRA. If you recharacterize your contribution, you must do all three of the following.

Include in the transfer any net income allocable to the contribution. If there was a loss, the net income you must transfer may be a negative amount.

Report the recharacterization on your tax return for the year during which the contribution was made.

Treat the contribution as having been made to the second IRA on the date that it was actually made to the first IRA.


Is this what's being done? I'm "leaving it to the reader" to figure out how the 5498 and 1099 and 8606 play out...

[les grans]

Look out for the "experts" at Vanguard!

Was the entire balance in the IRA moved to another Vanguard IRA vehicle, and does the transfer satisfy the requirements for a "recharacterization"? If so, there's nothing taxable here.

I politely but firmly must disagree with the "experts" - and I use the quotations intentionally but without malice - at Vanguard. In my experience, these experts often have difficulty spelling "IRA" and "recharacterization". They are not all experts in the tax consequences of what they do with their clients' retirement money.

Trust Mark Goldberg.

[fliszt]

les grans, thank you

for your msg. Yes, I agree that some "experts" are not so. The recharacterization was valid. The entire 2006 amount (principle, after tax & interest, before tax) were transferred. Somewhere along the line they will have to pay tax on the interest transferred won't they? Next year on their 2007 return? Or maybe when they start withdrawing at age 70-1/2 the percent basis vs non-basis? Luckily I'll be underground by that time.