Recharacterization of Roth IRA contributions to increase deductions

[Dieselfreak7]

For 2022, I filled out my wife and I's W-4s incorrectly and we owe significantly more in taxes than I had estimated.

We both made Roth IRA contributions out of each paycheck throughout the year, and in order to increase our deductions and lower the tax due, I am thinking of recharacterizing some or all of our Roth IRA contributions to a traditional IRA, but I am have a question.

The contributions I am looking to recharacterize have been made weekly out of each paycheck, so as I understand it I would have to calculate the gains/losses on 52 individual contributions.  Is this correct?  Alternatively, can I take a distribution for the amount of the contributions and then deposit it into my traditional IRA?  I have not been able to find any rules about doing this, just that you can withdraw from your Roth without penalty.

For further detail, my wife's Roth IRA contributions total about $5300 and I plan to use those plus some cash to contribute the max $6000 into the traditional IRA.  I am covered by a work retirement plan and can only deduct $280 of traditional IRA contributions, so I will do that out of savings.

[DanaB27]

You can calculate the earnings like this (but you can check if your custodian can calculate it for your when you request the recharacterization or the return of contribution):

Contribution x (Adjusted Closing Balance -Adjusted Opening Balance)/ Adjusted Opening Balance

(26 CFR § 1.408-11)

It seems the recharacterization would fit best for your intent but I will give you instructions for both.

You will enter the recharacterization when you enter the contribution to the Roth IRA:

1. Login to your TurboTax Account 
2. Click on "Search" on the top right and type “IRA contributions” 
3. Click on “Jump to IRA contributions"
4. Select “Roth IRA”
5. Answer “No” to “Is This a Repayment of a Retirement Distribution
6. Enter the Roth contribution amount 
7. Answer “Yes” to the recharacterized question on the “Did You Change Your Mind?” screen and enter the contribution amount (no earnings or losses)
8. TurboTax will ask for an explanation statement where it should be stated that the original $xxx.xx plus $xxx.xx earnings (or loss) were recharacterized.
9. 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 Form 1099-R  for the recharacterization with code R-Recharacterized IRA contribution made for 2022 and this belongs on the 2022 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 Form 1099-R with code R when you get it in 2024. The box 1 on the 1099-R will report the total recharacterized amount (contribution plus earnings) but it does not separately report the earnings and box 2a must be zero.

If you request the return of contribution plus earnings then the earnings will be taxable in the year the contribution was made for (a contribution for 2022 the earnings will be taxable in 2022).

You will get a 2023 Form 1099-R  in 2024 with codes P and J for the withdrawal of contributions and earnings. This 1099-R will have to be included on your 2022 tax return and you have two options:  

• You can wait until you receive the 2023 Form 1099-R in 2024 and amend your 2022 return or
• You can report it now in your 2022 return and ignore the 1099-R when it comes unless there is Box 4 Federal Tax withholding and/or Box 14 State withholding. Then you must enter the 2023 Form 1099-R into the 2023 tax return since the withholdings are reported in the year that the tax was withheld. The 2023 code P will not do anything to the 2023 tax return but the withholdings will be applied to 2023.

To create a Form 1099-R in your 2022 return please follow the steps below:

1. Login to your TurboTax Account 
2. Click on the "Search" on the top right and type “1099-R” 
3. Click on “Jump to 1099-R”
4. Answer "Yes" to "Did you get a 1099-R in 2022?"
5. Select "I'll type it in myself"
6. Box 1 enter total distribution (contribution plus earning)
7. Box 2a enter the earnings
8. Box 7 enter J and P
9. Click "Continue"
10. On the "Which year on Form 1099-R" screen say that this is a 2023 Form 1099-R.
11. Click "Continue" after all 1099-R are entered and answer all the questions.
12. Continue until "Did you use your IRA to pay for any of these expenses?" screen and enter the amount of earnings under "Another reason" if you are over 59 1/2 (if you are under 59 1/2 click "Continue")

Please be aware, code P will say in the drop-down menu "Return of contribution taxable in 2021" you can ignore that since the follow-up question will tell TurboTax that it will be taxable in 2022.

Please keep in mind IRA deduction limits.

[Mike9241]

yes, with a traditional IRA you save takes now but when you start taking RMDS you pay takes on them at your highest marginal rate.  they also add to your income which can increase the medicare premiums you pay.

there are no RMDs with a ROTH account but if you do take distributions when you retire they are tax free and are not reported for tax purposes which therefore don't affect your medicare premiums.  just something to consider. 

[fanfare]

Don't unwind your Roth IRA because your W-4 was wrong. It is too valuable.

You'll be a lot happier in retirement with a Roth IRA that is totally tax-free

rather than a Traditional IRA that is taxed and makes your social security taxed also.

@Dieselfreak7 

[Dieselfreak7]

Moving this money from my Roth for 2022 saves me about $1400 in taxes due and decreases my underpayment penalty as well.  I'm 28 and my wife is 30, so we have a long, long time before I can withdraw this money and our future savings will go into our Roth. 

I have no idea what our income or our tax rates will be like in 2051, so it's practically impossible to say if this move will help or harm us at that time.

@Mike9241 @fanfare 

[Dieselfreak7]

I am still a little confused on calculating loss/earnings and the explanation statement.

The form asks for the "Original Date of the Contribution".  Since the contributions were paid weekly with each paycheck, which date should I use?

Additionally, when determining Adjusted Closing Balance and Adjusted Opening Balance, since the contributions were made multiple times throughout the year, can I just use the balances on 1/1/22 and on 12/31/22?

@DanaB27 

[fanfare]

since the calculation is so  complex, it is best to have the custodian do the calculation.

[fanfare]

if you are doing the calculation, you must make the custodian know that otherwise you will get a 1099-R with the wrong code in Box 7.

[DanaB27]

I agree with fanfare that it might be best to contact your custodian first and let them do the calculations since these calculations can be complex.

Please see this calculation example with only one contribution for additional information: How to Calculate Excess Contributions. But your calculation would be more complex.

[Edited 2/14/2023 |4:45 am PST]

 @Dieselfreak7