I misunderstood and converted an IRA to a ROTH in 2021 without paying the IRA RMD first. I did have enough taxes withheld to cover the RMD. My credit union says they cannot reverse the conversion and offer no solution. Is there a solution or do I try to explain to the IRS after I file the 2021 taxes?
@PCM43 wrote:
I misunderstood and converted an IRA to a ROTH in 2021 without paying the IRA RMD first. I did have enough taxes withheld to cover the RMD. My credit union says they cannot reverse the conversion and offer no solution. Is there a solution or do I try to explain to the IRS after I file the 2021 taxes?
An RMD is not eligible for a rollover or conversion and the RMD must be satisfied before taking out more then the RMD which could be converted, so you have an "excess contribution in the Roth that must be removed as a "return of contribution plus earnings" before the 2021 due date which is April 15, 2022.
The withholding is immaterial - it does not pay the tax, yiu do that when yiu file 2021 tax and if not enough withheld then you owe additional. You still must pay the tax on the IRA distribution.
The credit union cannot "undo a conversion" however since the conversion was not permitted by law it becomes an excess contribution and not a conversion, which they are required by law to return to you plus any earnings attributed to the excess. They should issue a 2021 1099-R with a box 7 code "J8" if returned in 2021 or code "JP" if returned in 2020 before the due date. Only the earnings (if any) will be taxable.
Credit union personal often do not know how to handle this so you might need to escalate to upper management.
Simplest solution is to take out the RMD now to satisfy the requirement. The IRS doesn't care when the distribution takes place during the year as long as it happens and it is reported on the return and enough was distributed overall and NOT converted. The amount withheld that was not available for the conversion is considered part of the RMD.
The tax law says that the RMD must be satisfied BEFORE any additional distributions are taken. You "might" get away with it but if the IRS checks then the penalty is 50% of the amount of the RMD. (Would you want to risk it?)
Since the IRS just gets an annual form 5498 and 1099-R the chances of getting caught by the computers are minimal off a filed tax return especially since the IRS are so short handed they cannot even process the returns they need to attend to and getting out stimulus payments, advance CTC payments and recalculating return for late tax law changes. Even if you do get audited and caught you probably will be able to get out of the penalty by showing you saw the issue and took immediate steps to negate the error. Make sure to do this ASAP in the same tax year ... don't try to fix it after the end of the tax year.
Only the amount of the RMD, less the amount already withheld for tax, plus some extra allowance for "earnings" now accruing on that excess contribution have to be taken out of the Roth IRA.
The rule for earnings calculation is complex.
@Critter-3 wrote:
Simplest solution is to take out the RMD now to satisfy the requirement.
The way I read the question, the OP converted the entire traditional IRA to a Roth IRA (except for the tax withheld). He just said he "converted an IRA to a ROTH." If that's what he did, there is nothing left in the traditional IRA that could be taken out to satisfy the RMD. The OP, @PCM43, will have to clarify the situation.
If my understanding is correct, treating it as an excess contribution to the Roth IRA may be the only solution.
@rjs wrote:
@Critter-3 wrote:
Simplest solution is to take out the RMD now to satisfy the requirement.
The way I read the question, the OP converted the entire traditional IRA to a Roth IRA (except for the tax withheld). He just said he "converted an IRA to a ROTH." If that's what he did, there is nothing left in the traditional IRA that could be taken out to satisfy the RMD. The OP, @PCM43, will have to clarify the situation.
If my understanding is correct, treating it as an excess contribution to the Roth IRA may be the only solution.
If any part of the RMD was converted to a Roth then by law, that amount is an excess contribution regardless of how much non-RMD money was converted.
The real question is, will the IRS catch it since distributions are reported on a yearly basis, but whether you get caught or not is immaterial to tax law.
The FIRST money distributed from the IRA is the RMD so the RMD has already been taken, you cannot take it again after the fact - it is what was done with the RMD money is the problem since it cannot be used for a rollover or conversion.