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  • Roth conversion re-characterization

    Long-time lurker, first-time poster here asking for advice:

    Been using the "backdoor Roth" strategy for years, even before I discovered this site.  In 2016 I made my usually TIRA contribution in January (non-deductible) and immediately converted it to Roth as I have been doing for years.  Unfortunately, late in the calendar year I ran afoul of the "pro-rata rule" when 2 retirement plans in my practice were terminated as part of a practice-sale which resulted in a large amount of my 401k & DBP funds being rolled into my previously zero-balance TIRA.  I really didn't have any better options and yes I did check into it.  Since the TIRA balance on 12/31/16 is what the IRS looks at I realized than my backdoor Roth strategy was now compromised and I would be taxed (again) on the already-taxed non-deductible contribution from January 2016.

    To avoid this I recently re-characterized the Roth conversion, returning the funds back to the TIRA account, along with about $650 in earnings/gains that had resulted over the last 14 months.  I could just leave the funds there but see little reason to, in effect, make a non-deductible TIRA contribution for 2016 and would prefer to avoid co-mingling post-tax and pre-tax money in that account for simplicity's sake.  However, if I reverse the non-deductible contribution altogether (putting the money in my taxable brokerage account for example), it appears from my reading that I have to take out the gains/earnings as well.  From what I can tell, that amount will apparently be taxed as ordinary income and is also subject to a 10% penalty since I'm under 59 1/2 yo.

    Do I have this understood correctly?

    Do I have any other options to reverse the non-deductible TIRA contribution altogether without triggering taxes and penalties on the earnings?

    Thank you very much for your advice.

     

     

  • #2
    You will have to pay taxes on the earnings, of course. You would have had to pay taxes on the earnings at conversion, too. However, since this is pre-April 18, I don't think you have to pay the 10% penalty but I don't have time to search the rules right now. Maybe @spiritrider will step in.

    But you're only talking $65...
    Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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    • #3
      Johanna,

      Thank you for responding.  I'm a little confused about what you wrote.  Just to clarify:

      If I leave the re-characterized sum (~ $6150) in the TIRA, would I still owe taxes on the gains (~ $650) this year?  I don't see why that would be correct.  Wouldn't that tax liability be deferred until I actually withdraw from the account years from now?  I would just have $5500 in non-taxable "basis" within the otherwise fully pre-tax TIRA to account for every year on Form 8606, isn't that correct?

      If I reverse the non-deductible IRA contribution entirely (to my taxable brokerage account for example), I would certainly owe ordinary income tax on the gains only plus possible a 10% penalty, correct?

      Thank you in advance.

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      • #4
        https://www.irs.gov/publications/p590a/ch01.html#en_US_2016_publink1000230671

        You should just be able to put it right back until the traditional from whence it came as a recharacterization, no tax. You can't deduct the contribution, though. There will be a non-deductible basis in the TIRA for 2016.

        This year, you *should* be able to earn some self-employed money to be able to start an individual 401(k) to roll the pretax portion into, and convert any additional amount to Roth including the non-deductible basis, another backdoor Roth contribution for 2017, or any other amount you're willing to pay tax on to convert.

        What Johanna is saying is that if there were earnings in between contributing and converting, they'd be taxed, and if you took a distribution (i.e. put it in taxable), earnings would also be taxed. If nothing yet-untaxed is becoming post-tax cash or Roth, you shouldn't pay tax.

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        • #5




          https://www.irs.gov/publications/p590a/ch01.html#en_US_2016_publink1000230671

          You should just be able to put it right back until the traditional from whence it came as a recharacterization, no tax. You can’t deduct the contribution, though. There will be a non-deductible basis in the TIRA for 2016.

          This year, you *should* be able to earn some self-employed money to be able to start an individual 401(k) to roll the pretax portion into, and convert any additional amount to Roth including the non-deductible basis, another backdoor Roth contribution for 2017, or any other amount you’re willing to pay tax on to convert.

          What Johanna is saying is that if there were earnings in between contributing and converting, they’d be taxed, and if you took a distribution (i.e. put it in taxable), earnings would also be taxed. If nothing yet-untaxed is becoming post-tax cash or Roth, you shouldn’t pay tax.
          Click to expand...


          Thank you for the clarification.  That's what I assumed to be correct but wanted a 2nd opinion.  I also read the IRS publication and I shouldn't owe any penalty if I get it done by the time I file my return, which I will.

          As for the self-employment/individual 401k thing, yes I know about that option but as of yet haven't figured out how to put that into action for me.  I was hoping to use rental income (I have a 2nd/vacation home which I rent out occasionally to friends and such) as the basis for opening an individual 401k but apparently that isn't permitted I'm told.  I don't have any 1099 or other such non-W2 income at this point.

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          • #6
            Rental income is not "earned income" and therefore doesn't satisfy the requirement. WCI recommends people do some online surveys, make a few hundred dollars, and do it that way. Have you ever had self-employment income, moonlighting, etc paid on a 1099? You should be able to use that for eligibility, if so.

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            • #7




              Rental income is not “earned income” and therefore doesn’t satisfy the requirement. WCI recommends people do some online surveys, make a few hundred dollars, and do it that way. Have you ever had self-employment income, moonlighting, etc paid on a 1099? You should be able to use that for eligibility, if so.
              Click to expand...


              Thanks, but I don't have any 1099 income from moonlighting, locums, etc but I agree that's something I could look into.  The online survey thing is more intriguing and I've done a few in the past but it's been a while.  If you know of any specific sites or companies I could sign up for (like POF I'm an anesthesiologist) that would be appropriate please suggest them as I'm very interested.

              Thank you again for your help and advice.

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