Confusion on IRA Information Entry

[jdlloyd1]

I do my daughter's taxes using TurboTax for the past several years.  She remarried last year and also turned 50 in 2022.  She files jointly with her spouse and their combined income disallows Roth but does allow Traditional IRA nondeductible contributions up to the limit which is their intended goal each year.  For their 2021 tax return, I had an extension until October 2022 to finalize her return.  She mailed in a final Joint return on July 17, 2022, so met the extended time limit.  That is the background.

I reported her maximum IRA contribution as a $6000 Traditional (nondeductible) IRA.  I reported that her spouse also maxed his Traditional nondeductible for $7000.  Unbeknownst to me they both contributed to Roth IRAs in those same amounts. So the IRAs were reported correctly but the investments were incorrect.

In early January 2022, they both contributed again directly to an ineligible Roth each in the amount of $7000 as she became "of age." She then realized in April 2022 the error. She recharacterized the 2021 Roth to a Traditional non deductible in early April 2022.  She recharacterized her $7000 2022 contribution to Roth in early May (Her spouse recharacterized his as well but for sake of simplicity, I will from now on report only what she did to ask my questions.  )  She then transferred the Traditional IRA contributions of $13000 for both years into a back door Roth and that has remained until the present.

She received 3 form 1099Rs from her investment company.  The first, in chronological order, is one for $6110.81 coded R as a recharacterization of IRA contributions ($6000) made for 2021 and recharacterized for 2022.  I presume her $6 K contribution appreciated by $110.81 since her contribution   Her second 1099R is for $6471.16 coded N for a recharacterized contribution of $7000 for 2022 and recharacterized for 2022. These two represented the recharacterization of the ineligible Roths to a Traditional non-deductible IRA which would be a proper contribution.  And lastly, a single form 1099R coded 2 for $12411.92 which is an early distribution (exception) exception applies due to the fact she is less than 591/2 years old.  I believe this represents the $13000 sum of the 2021 and 2022 Roth "excess" contributions as these were transferred back to a Roth account in the back door transfer transaction. The boxes for "tax amounts not determined" and "total distribution" are both checked on this form as is the box for "IRA?SEP?SIMPLE"   I am presuming that the first two 1099Rs negate the ineligible Roth contributions in 2021 and 2022 respectively and the last 1099R records the transfer of the Traditional non-deductible IRA back into a Roth using the "back door technique." In effect, the ineligible Roth contributions were recharacterized and then transferred back into a Roth IRA. The recharacterization action negates the original Roth contribution errors as if they were not made.  I am understanding that there should be no tax consequence in the tax year 2022. Correct? That is there should be no extra tax paid due to the transactions as there is no money made in 2022 (actually it was lost).  There might be a small tax consequence in 2021 due to $110.81 in earnings on the ineligible Roth contribution.  I will likely need to amend the 2021 return to pay the tax on that.  I have not been able to complete the contribution and information worksheets for IRAs in TurboTax such that there is no tax implication in 2022.  I have used both step-by-step and fill-in-the-blanks direct methods and I get wildly different totals for the federal tax due.  With the information I have provided, is there a simple way to complete the worksheets?  I have tried to follow several examples in this community but they do not seem to fit the exact circumstances I am reporting.  I believe the 2021 tax year return was reported correctly after all but it was not because I knew anything about the recharacterizations which negated the ineligible Roth contributions made in early 2021.  As I understand it, those Roth IRAs are considered to have never happened in theory so I do not believe the transactions in 2021 or 2022 would be subject to the 6% penalty for making excess contributions to an IRA.  Thank you for whatever advice you might be able to provide.

[DanaB27]

Yes, they shouldn't have the 6% penalty in 2021 and 2022 since they recharacterized the amounts before the due dates of the 2021/ 2022 tax returns.

No, the earnings of $110.81 are deemed to have been earned in the traditional IRA not in the Roth IRA because of the recharacterization.

They should have reported the recharacterization on their 2021 tax return and have a 2021 Form 8606 with the $6,000 basis on line 14 (which has to be entered on the 2022 tax return):

1. Open your return
2. Click “Deductions &Credits” on the top
3. Click "I'll choose what to work on"
4. Scroll down to “Traditional and Roth IRA Contributions” and click “Start”
5. Select “Roth IRA”
6. Answer ‘Yes” on the “Roth IRA Contribution” screen
7. Answer “No” to “Is This a Repayment of a Retirement Distribution
8. Enter the Roth contribution amount ($6,000)
9. Answer “Yes” to the recharacterized question on the “Switch from a Roth To a Traditional IRA?” screen and enter the contribution amount of $6,000 (no earnings or losses) on the next screen.
10. TurboTax will ask for an explanation statement where it should be stated that the original $6,000 plus $110.81 earnings were recharacterized.
11. On the screen "Choose Not to Deduct IRA Contributions" answer "Yes" (if you are thinking about doing a backdoor Roth. If you have a retirement plan at work and are over the income limit it will be nondeductible automatically and you only get a warning and then a screen saying $0 is deductible)

You will get a 2022 Form 1099-R  for the recharacterization with code R-Recharacterized IRA contribution made for 2021 and this belongs on the 2021 return. But a Form 1099-R with code R will do nothing to your return. You can only report it as mentioned above. Therefore, you can ignore the 2021 Form 1099-R with code R.

On the 2022 tax return, you will report the recharacterization of the contribution for 2022 with the steps below and make it nondeductible (if it isn't automatically nondeductible).

1. Open your return
2. Click “Deductions &Credits” on the top
3. Click "I'll choose what to work on"
4. Scroll down to “Traditional and Roth IRA Contributions” and click “Start”
5. Select “Roth IRA”
6. Answer ‘Yes” on the “Roth IRA Contribution” screen
7. Answer “No” to “Is This a Repayment of a Retirement Distribution
8. Enter the Roth contribution amount ($7,000)
9. Answer “Yes” to the recharacterized question on the “Switch from a Roth To a Traditional IRA?” screen and enter the contribution amount of $7,000 (no earnings or losses) on the next screen.
10. TurboTax will ask for an explanation statement where it should be stated that the original $7,000 minus $528.84 loss were recharacterized.
11. On the screen "Choose Not to Deduct IRA Contributions" answer "Yes" (if you are thinking about doing a backdoor Roth. If you have a retirement plan at work and are over the income limit it will be nondeductible automatically and you only get a warning and then a screen saying $0 is deductible)

To enter the Form 1099-Rs (for conversion and the 2022 recharacterization) on the 2022 tax return:

1. Click "Federal Taxes" on the top and select "Wages & Income"
2. Click "I'll choose what to work on"
3. Scroll down and click "Start" next to "IRA, 401(k), Pension Plan (1099-R)" 
4. Answer "Yes" to the question "Did You Have Any of These Types of Income?"
5. Click "I'll Type it Myself"
6. Choose "Form 1099-R, Withdrawal of Money from 401(k) Retirement Plans, Pensions, IRAs, etc."
7. Click "Continue" and enter the information from your 1099-R for the conversion (code 2)
8. Answer questions until you get to “What Did You Do With The Money” and choose “I moved it to another retirement account”
9. Then choose “I did a combination of rolling over, converting, or cashing out money.” and enter the amount next to "Amount converted to a Roth IRA account"
10. On the "Your 1099-R Entries" screen click "add Form 1099-R"
11. On the "Your 1099-R Entries" screen click "continue" (after all Form 1099-Rs are entered)
12. Answer "yes" to "Any nondeductible Contribution to your IRA?" if you had any nondeductible contributions in prior years.
13. Answer the questions about the basis from line 14 of your 2021 Form 8606 and the value of all traditional, SEP, and SIMPLE IRAs

Since she converted less than her basis in 2022 she should have a basis left on her 2022 Form 8606 line 14.

Please be aware, if she had any pre-tax funds in her traditional/SEP/SIMPLE IRAs then the pro-rata rule applies. This means that with each distribution/ conversion, you will have a taxable and nontaxable part.

[jdlloyd1]

Thank you for taking the time to go through the details of how these data are entered.  It is confusing at best.  I have advised her that in the future when making her contributions to bear in mind she is limited due to her income levels.  Thank you again for untwisting this for me.