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I had too much tax taken out on the Roth rollover. Now what?

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marathon don
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I had too much tax taken out on the Roth rollover. Now what?  Reply with quote  

I recently rolled my traditional IRA to a Roth but blundered slightly. I had too much federal and state tax withheld. About 8k worth for federal according to Turbo tax

I called the firm who holds the IRA's and initially they said I could just submit an addendum to the internal transfer and have less tax withheld. I find out today that is not the case according to IRS rules. In addition, the person I spoke with said that all of the tax withheld counts as a distribution and I will pay a 10% penalty for the tax going to the Feds and the tax refund of 8K TTax says I am going to get. I have never read that anywhere. If it were true I would think TTax would have alerted me to that.

I see some options.

1. Perform a Recharacterization of the conversion back into a non Roth IRA then do another conversion into a Roth with the proper amount of tax withheld. However the rep at the brokerage says the taxes I paid for the conversion into the Roth will not be subject to recharacterization and only the net amount in the Roth will. This is not what I interpret from what I have read. Am I mistaken or is this guy at the brokerage correct? What he said made no sense to me at all. But I could be wrong.


The other option I see is to take the 8K refund and risk an audit. But if I do that I’m wondering if there will be a penalty on the refund as a distribution?

I would much rather have it in the Roth than take the cash. I can’t see the feds leaving a loophole allowing people to take out more cash than taxes due, get a refund and walk with no penalty.

Any help is appreciated.
MD
Post Wed Dec 17, 2008 2:50 am
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marathon don
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I meant converted.  Reply with quote  

Thanks Jim. Smile
Post Wed Dec 17, 2008 3:24 am
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coaster
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Boy, this is a head scratcher, and I'll say one thing for sure -- if you recharacterize it back and then reconvert you're asking for one hell of a paperwork nightmare, aren't you? Shocked

You didn't take constructive receipt of any of the funds -- i.e. it was an internal transfer. Roths weren't around yet when I was in the biz and I never bothered learning the ins and outs of them because my IRAs are traditional, so don't take anything I say as the word from the top, but I don't think you pay penalties if you don't take constructive receipt. And as far as what the investment company says, they might be right, if it's done within a certain time period. I know with a 401(k) rollover you have 45, or is it 60? days to reinvest before getting walloped. So I'd think if the same applies to a conversion, if you get that over-withholding "refunded" and reinvested within that window, then it's as if it was never withheld at all.

That sounds logical, but the IRS isn't logical. And there's one thing I CAN say for sure: don't assume that the IRS is giving you the correct advice. I'd add to that: if you're sure you got all the right numbers plugged into the right spots in Turbo Tax, then I'll take TTax over what an IRS 800-number person tells me any day.

Jim, Jim .... calling Jim!! I'll bet he knows the answers. Very Happy

~Tim~
Post Wed Dec 17, 2008 4:55 am
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marathon don
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Another point of confusion  Reply with quote  

While researching this further I came across this.

No: tax-free rollovers. If you made a tax-free rollover to a traditional IRA, you can't transform that event into a conversion to a Roth IRA. It doesn't matter whether the rollover came from an employer plan or another IRA. You can't change a tax-free rollover into a Roth IRA conversion.

Does this mean if I rolled my former employers 401k plans into a traditional IRA I can't convert it a Roth?

A month ago I had two separate traditional IRAs that were each solely funded by 401k rollovers years ago. I then rolled one into the other and converted to a Roth from there a few days ago. Now I'm wondering if I have a basis by combining the two traditional IRAs before the conversion.

I thought I did my due diligence but maybe not. This is becoming less fun each day.

MD
Post Wed Dec 17, 2008 1:50 pm
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BlankenshipFP
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Just to clarify the facts:

You did a conversion from a trad to a Roth, using the trad funds to pay tax on the conversion. Any funds that did not "make the trip" into the Roth will be considered a distribution from the trad, and if this is prior to age 59 1/2, subject to 10% penalty. Furthermore, you indicate that you calculated the required tax on the conversion and your calculations indicate that you had too much withheld, which means you will have a larger than necessary amount subject to penalty.

Primary concern here should be the amount of money subject to the 10% penalty - the tax withheld can be part of a refund or applied to estimated tax for 2009. I don't think you need to be overly concerned about an audit just because you got a large refund.

If you can't make a change to the amount withheld (via the brokerage), can you make up the difference with a cash deposit into the Roth IRA? In other words, put cash into the account to offset the amount that was withheld? I think as long as 60 days has not passed you should be able to do this.

If I've got your facts down wrong, give me some more clarity and I'll take another stab at it...

Jim Blankenship, CFP®, EA
Blankenship Financial Planning, Ltd.
www.BlankenshipFinancial.com
Standard IRS Circular 230 Notice Applies
Post Wed Dec 17, 2008 2:32 pm
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coaster
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Just a note about a 401(k) rollover to an IRA, because this is the way mine happened: the IRA is classified as a "rollover IRA". But as soon as you add new funds to it then it becomes a "traditional IRA." Without researching it I don't know off the top what the difference is, but T Rowe Price definitely classsifies them differently, and it was my impression that was due to IRS rules. Something about comingling funds. I apologize for not having time to research it right now. Maybe later today...... Wink

~Tim~
Post Wed Dec 17, 2008 3:21 pm
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BlankenshipFP
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I have never understood that nomenclature either. It's possible that the custodian changes the "type" of account to help them keep track of the "once per 12 months" rollover rule - in practice this applies to the sending and receiving accounts, so once you've rolled over one IRA, many custodians will not allow you to roll over another into the same receiver for 12 months.

Jim Blankenship, CFP®, EA
Blankenship Financial Planning, Ltd.
www.BlankenshipFinancial.com
Standard IRS Circular 230 Notice Applies
Post Wed Dec 17, 2008 3:46 pm
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marathon don
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Thanks for taking the time to answer the questions to my dilemma.

“You did a conversion from a trad to a Roth, using the trad funds to pay tax on the conversion.”

I think this is true. I combined two rollover IRAs (does that make it a traditional?) and converted the whole amount minus the tax. I had a flat 33% for federal and 5% for state withheld. Looking at this below I don’t even know if what I did was allowable. Plus, these IRAs were from employer plans with employer contributions.

No: tax-free rollovers. If you made a tax-free rollover to a traditional IRA, you can't transform that event into a conversion to a Roth IRA. It doesn't matter whether the rollover came from an employer plan or another IRA. You can't change a tax-free rollover into a Roth IRA conversion.


“Any funds that did not "make the trip" into the Roth will be considered a distribution from the trad, and if this is prior to age 59 1/2, subject to 10% penalty.”

Does that include the tax withheld? The tax withheld is considered a distribution? Btw, I am under 59 ½.

“Furthermore, you indicate that you calculated the required tax on the conversion and your calculations indicate that you had too much withheld, which means you will have a larger than necessary amount subject to penalty.”

Yes the 8K refund that I want in the Roth. Which is why I’m thinking a Recharacterization might be the way to go.
However I am told by the brokerage the tax already withheld at the conversion will not be subject Recharacterization and is sent to IRS anyway.

The only amount I will see returned to the Trad will be the net amount in the Roth. According to everything I have read a Recharacterization n is to erase the entire event.

So the question is: is a full Recharacterization even possible since tax was withheld?


What a headache.
Post Wed Dec 17, 2008 10:42 pm
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coaster
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I interpret the taxes as a distribution, too. And I don't see why tax withheld but not yet sent to the IRS by the investment company couldn't be returned or reversed if it's done within the appropriate time window, if that applies here. But that's just opinion and guesswork, and that's why I've been thinking about your situation, Don. You've got two threads running on a couple different aspects of your situation, and it's become apparent it's quite a complicated situation, and I'm guessing involves fairly substantial amounts of money. There's a limit as to how much and how specific we can get with advice without doing the appropriate financial analysis; something that I'm not longer qualified to do, and something that's difficult to do online anyway. I really think you'd be best served by paying for a local professional's advice before you make any moves that could further complicate your situation. I'm confident that Jim is current and knowledgeable and provides accurate information, but without actually seeing the numbers and doing a face-to-face there may be relevant information that he's not aware of, because you yourself aren't aware it's relevant.

So, for whatever free advice is worth on an internet forum these days, that's mine: go see and pay for the service of a professional you can discuss this face-to-face. Smile

~Tim~
Post Thu Dec 18, 2008 1:01 am
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marathon don
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I do appreciate and value all of the input received thus far.

Yes you're right. It is complicated so today I have talked to 2 CPAs. Not sure which I am going to go see yet.

I'll be talking to the IRA dept Manager tomorrow to see why it is so friggin difficult to change the amount of tax I want withheld. Even the CPA says it can be done easily if they haven't paid the taxes yet.

Thanks again!
Post Thu Dec 18, 2008 2:13 am
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coaster
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Merry Christmas and best wishes to ya!! Mr. Green

~Tim~
Post Thu Dec 18, 2008 4:58 am
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BlankenshipFP
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First of all: coaster, thanks. You pulled the trigger on the "you should seek local help" at just the right time. This was getting pretty hairy.

don - yes, the taxes withheld are a distribution. There is nothing that requires you to withhold taxes, you could have waited and made an estimated payment in January from current income/cash sources if you wished.

Best of luck with your new-found CPA buddies!

Jim Blankenship, CFP®, EA
Blankenship Financial Planning, Ltd.
www.BlankenshipFinancial.com
Standard IRS Circular 230 Notice Applies
Post Thu Dec 18, 2008 2:36 pm
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marathon don
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Thanks Tim and Jim.

The nice manager lady at TD didn't call like she said she would. Maybe she got side tracked or maybe perhaps they just don't want my accounts anymore. And that can be arranged.

Merry Christmas to you guys and of course everyone else here.
MD
Post Fri Dec 19, 2008 1:47 am
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