My wife made a contribution with post-tax funds (no deduction taken) to a new Traditional IRA in early 2019. We then asked our custodian to recharacterize that contribution as to being into a Roth IRA. Rather than recharacterize, they did a full account conversion.
On her 2019 1099-R for the Traditional IRA, Box 7 has a distribution code of 2. I believe that this is an error and should instead (maybe) be code N? Code 2 conveys that it is a Roth conversion of pre-existing funds (where a deduction was taken in a prior year) and that they are taxable. Code N conveys that it was a same-year recharacterization which it was intended to be. When toggling this value from Code 2 to Code N, I see a substantial decrease in our TurboTax federal tax due which is what I would expect.
The 2019 contribution originally to the Traditional IRA was with already taxed dollars and we have not taken a deduction against them.
The custodian's response was:
To summarize what happened, we submitted a conversion instead of a recharacterization in 2019. When performing a conversion, this is an irreversible action as of October of 2018.
Am I understanding this correctly? If this is an error, how do we address this on our tax return if we are not able to receive a revised 1099-R? What should the code be for a same-year conversion?
Thanks.
Yes. The accidental backdoor Roth will be nontaxable as long as the amount converted was no more than your wife's basis in nondeductible traditional IRA contribution and she had no other money in traditional IRAs on December 31, 2019. The taxable amount will be calculated on Form 8606 Parts I and II. (With nondeductible traditional IRA contributions and distributions occurring in the same year, TurboTax might do part of the calculation on a separate worksheet, indicated by asterisks on lines 13 and 15 and blank lines 6 through 12 of the Form 8606).
The custodian seems to be indicating that you requested a Roth conversion, not a recharacterization, so there really isn't anything can be done to change this. Code 2 is correct for what happened. You'll report the traditional IRA contribution and Roth conversion separately.
If you feel that you requested a recharacterization yet the custodian mistakenly performed a Roth conversion (which under the law is irrevocable), you might have a legal case against the custodian, but you might have a hard time showing any actual damages resulting from this mistake. There are circumstances where this mistake could actually be advantageous.
Thanks, @dmertz .
So, even if the conversion was agreed upon (still reviewing my notes), we should not be taxed on the conversion because the funds in the Traditional IRA were made in the same year as the conversion to the Roth IRA with post-tax dollars and had not been deducted. How do we reflect this in our tax return?
Thanks.
Oh, so essentially the original contribution would be categorized being to a Non-Deductible IRA. The conversion to the Roth IRA is essentially an accidental Backdoor conversion?
Yes. The accidental backdoor Roth will be nontaxable as long as the amount converted was no more than your wife's basis in nondeductible traditional IRA contribution and she had no other money in traditional IRAs on December 31, 2019. The taxable amount will be calculated on Form 8606 Parts I and II. (With nondeductible traditional IRA contributions and distributions occurring in the same year, TurboTax might do part of the calculation on a separate worksheet, indicated by asterisks on lines 13 and 15 and blank lines 6 through 12 of the Form 8606).
This is a question for dmertz, since I have a case that is almost the same as the one described in this post, only big difference is there were other funds in Traditional IRAs.
I mistakenly made a contribution to a Traditional IRA in April 2019 for year 2018, filed taxes and IRS disallowed the deduction because I had a 401k at work. I got a notice and paid the corresponding tax due. TurboTax CPA advised to "recharacterize" the contribution to Roth. Financial institution argued that this was a conversion, not a recharacterization, even though they were made for the same year and a few days apart.
I received the 1099-R in January with a "2" in Box 7 and the full amount as "taxable". If entering "as is" in TurboTax, it is taxing the entire amount of the conversion again and more, due to the preexisting IRA balances.
Any suggestions?
silabbate, macuser_22 already provided an answer here:
The Form 1099-R indicates that you did a Roth conversion, not a recharacterization.
A recharacterization would only have been appropriate if you MAGI for a Roth IRA contribution was below the limit, otherwise your only choice was to convert or not. But what you did was a Roth conversion, not a recharacterization, and unless you actually did request a recharacterization and it was Vanguard's mistake to perform a conversion instead, which they claim is not the case, there is nothing you can do but report the Roth conversion. Since you have other funds in traditional IRAs, your Roth conversion will be partly or mostly taxable, with future distributions from your traditional IRAs being partially nontaxable as your basis in nondeductible traditional IRA contributions is consumed gradually until it's finally all distributed in the year that you no longer have a traditional IRA balance at year-end.
Yes, I now realize how it worked. I talked to TurboTax CPA again and she guided me to enter the non deductible IRA contribution and the back door Roth contribution on the 2019 tax return. Mostly all taxed as you said, lesson learned. Thank you and macuser_22 for sharing your wisdom.