recharacterization and backdoor conversion with gain

[impuesto88]

Hi community, please help me with my tax case involveing recharacterization and backdoor conversion, and there is capital gain as well. I tried to make things organized (did some rounding of numbers) and informative as follows.

Timeline

1. In Oct 2020 I moved $6000 directly into my Roth IRA account from Chase Checking, without realizing I wasn't eligible to contribute even a penny (I'm eligible in prior years though)
2. But when I realized that in Nov 2020, there was already $1000 capital gain in the Roth IRA account
3. My broker did a recharacterization in Nov 2020 on the entire 6000 contribution (number expected in line 1 of 8606), and transferred 6000+1000 = 7000 (number in 1099-R) into my brand new traditional IRA account
4. And shortly afterwards (still in Nov 2020) my broker helped me convert all $7000 from trad IRA to my Roth IRA account (to accomplish the backdoor steps), 
5. As the result of the above steps, I received 2 1099-R forms
   1. the one for Roth IRA account has distribution code N, box 2a = 0,  box 1 = 7000
   2. the one for trad IRA has distribution code 2, box 1=box 2a=$7000, and the IRA/SEP/SIMPLE box checked

Questions:

1. How do I properly report all of these in Turbotax? I followed the following steps but I think it is wrong.
   1. I go to Deductions & Credits for Traditional and Roth IRA Contributions interview
   2. I started with only Roth IRA (it is going to ask me about recharacterization to trad IRA)
   3. Afterwards I go to Wages & Income to import the 2 1099-R forms
   4. However when I preview the generated 8606 form it is shown that I'm taxed on 3500 (exactly half) of the 7000 shown in 1099R (line 10 where the ratio is supposed to be calculated has an X instead of a numeric value), line 1,3,5 are all 7000, line 2 is 0 (this is my very first 8606, so no basis from prior years)
   5. Basically what should be the right number on line 18 of form 8606? I think I should pay tax on $1000 (the capital gain)
2. Should I withdraw the $1000 capital gain? The turbotax interview is saying I contributed an excess 1000 dollars and will need to pay 6% penalty.
   1. If I do that before May 17 would I receive some form from my broker to help report such distribution?

Thanks so much for your help !

[macuser_22]

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@impuesto88 wrote:

Hi community, please help me with my tax case involveing recharacterization and backdoor conversion, and there is capital gain as well. I tried to make things organized (did some rounding of numbers) and informative as follows.

Timeline

1. In Oct 2020 I moved $6000 directly into my Roth IRA account from Chase Checking, without realizing I wasn't eligible to contribute even a penny (I'm eligible in prior years though)
2. But when I realized that in Nov 2020, there was already $1000 capital gain in the Roth IRA account
3. My broker did a recharacterization in Nov 2020 on the entire 6000 contribution (number expected in line 1 of 8606), and transferred 6000+1000 = 7000 (number in 1099-R) into my brand new traditional IRA account
4. And shortly afterwards (still in Nov 2020) my broker helped me convert all $7000 from trad IRA to my Roth IRA account (to accomplish the backdoor steps), 
5. As the result of the above steps, I received 2 1099-R forms
   1. the one for Roth IRA account has distribution code N, box 2a = 0,  box 1 = 7000
   2. the one for trad IRA has distribution code 2, box 1=box 2a=$7000, and the IRA/SEP/SIMPLE box checked

Questions:

1. How do I properly report all of these in Turbotax? I followed the following steps but I think it is wrong.
   1. I go to Deductions & Credits for Traditional and Roth IRA Contributions interview
   2. I started with only Roth IRA (it is going to ask me about recharacterization to trad IRA)
   3. Afterwards I go to Wages & Income to import the 2 1099-R forms
   4. However when I preview the generated 8606 form it is shown that I'm taxed on 3500 (exactly half) of the 7000 shown in 1099R (line 10 where the ratio is supposed to be calculated has an X instead of a numeric value), line 1,3,5 are all 7000, line 2 is 0 (this is my very first 8606, so no basis from prior years)
   5. Basically what should be the right number on line 18 of form 8606? I think I should pay tax on $1000 (the capital gain)
2. Should I withdraw the $1000 capital gain? The turbotax interview is saying I contributed an excess 1000 dollars and will need to pay 6% penalty.
   1. If I do that before May 17 would I receive some form from my broker to help report such distribution?

Thanks so much for your help !

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You reported the recharacterization improperly.    ONLY the exact amount of the contribution was recharacterized - not any earnings. 

The proper way to report the recharacterization and earnings which is to enter the  IRA contribution in the IRA contribution interview section and then say yes to "Did you switch from a Roth to a Traditional IRA - recharacterize".

The amount The amount of the original Roth contribution must be entered - not any earnings or losses.

Then TurboTax will ask for an explanation statement where it should be stated that the original $xxx.xx plus $xxx.xx earnings (or loss) were recharactorized.

There is no tax or penalty on the before-tax earnings since the earning were simply switched into the recharactorized account.

[impuesto88]

Thanks macuser_22.

Just to clarify on what you wrote: by IRA contribution I assume you mean traditional IRA right?

"The proper way to report the recharacterization and earnings which is to enter the  IRA contribution in the IRA contribution interview section and then say yes to "Did you switch from a Roth to a Traditional IRA - recharacterize"."

I just went to the trad IRA interview (with the Roth IRA stuff deleted), and here was what happened

1. Did you Contribute To a Traditional IRA?
   1. I selected Yes (although I actually didn't do it directly, it was all through the Roth recharacterization)
2. Is This a Repayment of a Retirement Distribution?
   1. No
3. Tell Us How Much You Contributed, I entered 6000
   1. There is a Note saying "Do not enter any of the following here"
      1. Roth contributions (even if you latter recharaterized them to a traditional IRA)
      2. Rollovers
4. Did You Change Your Mind? This is opposite to what you were saying above
   1. It is however asking  "Tell us if you switched, or recharcteriezed any of the 6000 traditions IRA contribution for 2020 over to a Roth IRA contribution"

[macuser_22]

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@impuesto88 wrote:

Thanks macuser_22.

Just to clarify on what you wrote: by IRA contribution I assume you mean traditional IRA right?

1. 1.  

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No.  You said you contributed to a *Roth* IRA and recharacterized that to a Traditional IRA.  You enter it as a Roth contribution switch it to a Traditional IRA as I said.   You do NOT include any earnings,  The earnings were not a contribution.

[impuesto88]

That's what I did earlier, can I take a pause here (stop at step 8.7.) to make sure I'm on the right track so far? Thanks.

On Deductions & Credits, the Traditional IRA and Roth IRA interview

1. I checked only Roth IRA box
2. Tell Us the Value of All Your Traditional IRA Accounts on Dec 31 2020
   1. Not sure why it is asking about Trad IRA although it is a Roth interview
   2. I entered 0 (because the conversion happened in Nov 2020)
3. Did you make Roth IRA Contributions?
   1. YES
4. Is This a Repayment of a Retirement Distribution?
   1. NO
5. Enter Your Roth IRA Contributions
   1. 6000
6. Tell Us How Much You Transferred (recharacterization)
   1. 7000
7. Roth IRA Explanation Statement
   1. Date of the Original Contribution: 10/01/2020
   2. Date of the Recharacterization: 11/15/2020
   3. The Amount Recharacterized: 6000
   4. The Amount Transferred (Recharacterization plus earnings or losses): 7000
   5. Reason for the Recharacterization: excess contribution
8. Let Us Track Your Roth IRA Basis
   1. Would you like us to track your Roth IRA basis?
      1. YES
   2. Withdraw from Your Roth IRA Before 2020?
      1. NO
   3. Enter Prior Year Roth IRA Contributions
      1. 115000 (sum of 2018 and 2019)
   4. Any Roth IRA Conversions Before 2020?
      1. NO
   5. Enter Excess Contributions for prior years 
      1. So does prior years include 2020?
         1. I assumed no and entered 0
   6. Income Too High To Deduct an IRA Contribution
      1. continue
   7. You Currently Have a Penalty
      1. It is asking me to enter the amount of excess contribution I want to withdrawn before May 17

[impuesto88]

Btw I think I understand the difference between contribution and amount tranferred (including earning), that's why I mentioned them in my original post.

My broker did a recharacterization in Nov 2020 on the entire 6000 contribution (number expected in line 1 of 8606), and transferred 6000+1000 = 7000 (number in 1099-R) into my brand new traditional IRA account

[macuser_22 · Accepted solution]

Your step #6 should be $6,000 not $7,000.  As I said the earnings are NOT a contribution.    Only enter the amount of the contribution ($6,000).

(I said that before).

[impuesto88]

There we go, now the number on 8606 looks good.

Thanks macuser_22.👍

Hope this thread would be helpful to others as well.

[impuesto88]

One more question on 1099-R then, does the 7000 in 1099-R (the one with distribution code 2 in particular, see green below) go into anywhere in 8606 at all?

I assume not based on your answer "There is no tax or penalty on the before-tax earnings since the earning were simply switched into the recharacterized account."  But now I'm seeing the 8606 generated by turbotax has 7000 in line 16, and 1000 (taxable amount) in line 18.

【 As the result of the above steps, I received 2 1099-R forms

1. the one for Roth IRA account has distribution code N, box 2a = 0,  box 1 = 7000
2. the one for trad IRA has distribution code 2, box 1=box 2a=$7000, and the IRA/SEP/SIMPLE box checked  】

[macuser_22]

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@impuesto88 wrote:

One more question on 1099-R then, does the 7000 in 1099-R (the one with distribution code 2 in particular, see green below) go into anywhere in 8606 at all?

I assume not based on your answer "There is no tax or penalty on the before-tax earnings since the earning were simply switched into the recharacterized account."  But now I'm seeing the 8606 generated by turbotax has 7000 in line 16, and 1000 (taxable amount) in line 18.

【 As the result of the above steps, I received 2 1099-R forms

1. the one for Roth IRA account has distribution code N, box 2a = 0,  box 1 = 7000
2. the one for trad IRA has distribution code 2, box 1=box 2a=$7000, and the IRA/SEP/SIMPLE box checked  】

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That is correct.   The earnings are taxable.