Is a Roth conversion (from rollover IRA to Roth) covered by the standard deduction?

[PickledPizza]

Is a Roth conversion (from rollover IRA to Roth) covered by the standard deduction? 

I received no job income this year. I found many online posts saying I could take advantage of this by doing a Roth conversion and if the conversion amount was less than the standard deduction it would be essentially free. So I did this. Turbotax read in all my Vanguard documents, ran the numbers, and showed that I owed no tax.

The IRS sent me a collection for $1000 or so, it looks to be about 10% of the conversion amount. I called them and their representative said this is because Roth conversions are not subject to the standard deduction and so I immediately pay taxes on the conversion amount.

I searched online here and found just one old post related to this, which seems to indicate the IRS is wrong in this case. 

So is the IRS wrong and I should challenge this? Or are they right and my standard deduction doesn't apply to the Roth conversion.

Edit:

* Age: late 40s.

* This was for tax year 2019

[macuser_22]

If you were under age 59 1/2 then there is a 10% early distribution penalty that is applied to the tax owed after the standard deduction is taken.   That is separate form the normal tax that is at your tax rate and becomes part of your AGI.   If the standard deduction reduced the AGI so that it is not taxable the  there is no tax to pay other than the 10% penalty.

[VolvoGirl]

I don't think there is a penalty on a conversion to ROTH.  Maybe the IRS didn't know it was converted to a ROTH.   Did you do this in 2019?  You should have received a 1099R from Vanguard.  What code is in box 7?  Did you get a check and put it into the ROTH or did they do a direct transfer?

[PickledPizza]

It was a direct transfer from my Vanguard Rollover IRA to my Roth IRA.

I did receive a 1099 R from Vanguard. Box 7 code = 02.

[PickledPizza]

My age is under 59.5. I edited my original post to reflect that.

[macuser_22]

A code 2 indicates that there is no penalty.      It seems a bit early for the IRS to send a letter for 2019 since the due date just passed.   Are yiu sure that it is for 2019 and not 2018 (2018 letters are being sent now usually a year after the close of the tax year.)

Look at your 1040 line 4 a & 4b.   The box 1 amount should be on 4b.  Your total AGI on line 8a  and that taxable amount after the deduction on line 11b.    If 11b is non-zero then there is a taxable amount.

[macuser_22]

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@VolvoGirl wrote:

I don't think there is a penalty on a conversion to ROTH.  Maybe the IRS didn't know it was converted to a ROTH.  

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That is true but I was thinking that perhaps it was reported incorrectly.

[PickledPizza]

At the top of the form it says Tax Year 2019. I just verified that. I filed in early March.

And thanks for the help, by the way. I find taxes mind boggling, which is why I like TurboTax.

[PickledPizza]

In response to:

"Look at your 1040 line 4 a & 4b.   The box 1 amount should be on 4b.  Your total AGI on line 8a  and that taxable amount after the deduction on line 11b.    If 11b is non-zero then there is a taxable amount."

Boxes:

1) blank, as no w2 income for 2019

4a) blank 4b) 10,295

8a) blank 8b) 12,204

11b) 4

(The rest of my income is from the dividends and capital gains boxes)

This is from the 2019 submission using the TurboTax program

[macuser_22]

Unless there was other tax on line 15 then  your tax liability should  be $4.00.     The IRS letter should tell you the reason for the change and tell you how to dispute it if you think the IRS is wrong.

[dmertz]

Download your tax return transcript for your 2019 tax return to see where the IRS Automated UnderReporter system might have flagged a difference between what you reported on your tax return and what the IRS system calculated:  https://www.irs.gov/individuals/get-transcript

There is certainly no penalty on a Roth conversion, but the conversion does add to your AGI.  The standard deduction (or itemized deductions if you were to itemize) is then subtracted to AGI to get taxable income on which income tax is calculated.  If there had been a transaction that was subject to a 10% early-distribution penalty, the penalty would be added to the income tax liability.  For example, if before 5 years from the beginning of 2019 you subsequently took a distribution of an amount attributable to a taxable conversion to Roth, that distribution would be subject to a recapture of the 10% early-distribution penalty even though it would not be subject to income tax.

[PickledPizza]

Thanks again for the help. 

There is no "other income" on line 15. 

The IRS form is CP22-A. It says "we made the changes you requested to your 2019 Form 1040 to adjust your pensions and annuities." I made no changes after filing in March. I called their phone (waited over an hour...ugh) and they told me even though I made no changes this is the appropriate letter because Roth conversions aren't subject to the standard deduction.

From what you're telling me, and the result of me doing fresh internet searches, I am strongly doubting that he is right, so it seems worth it for me to dispute it. He told me would give me two weeks to do research. I ordered an IRS transcript today. Unfortunately I couldn't get the online to work, so it will be 5-10 days to deliver it.

My plan is to dispute it. Hopefully I get the transcript within the 2 week window and can then call them to tell them I'm disputing it, armed with better information about what they flagged. There seems to be no other way to indicate my wanting to dispute to them. If there is please let me know (and save me another hour in the phone queue).

[fanfare]

If your income is low or zero that is a good time to convert an IRA to a Roth, assuming that is what your goal is, up to the amount of your standard deduction.

Then it will be a tax free conversion.