How to treat a recharacterization when the amount of the recharacterization exceeds the taxpayer's modified AGI

[mj46]

A client contributed to a traditional IRA in 2021 and recharacterized to a Roth, also in 2021.  However, in Lacerte Diagnostics, it says the taxpayer's Roth IRA contribution is disallowed due to modified AGI in excess of the threshold amount.  My question is, is the recharacterization treated the same as a Roth contribution as far as the limitations?  If he converts or recharacterizes it back to a traditional IRA, the contribution to the traditional IRA will also be disallowed due to modified AGI.  Is the diagnostic correct that the Roth contribution is disallowed?  If it is, I assume he will need to withdraw the contribution plus earnings.  

[qbteachmt]

"Recharacterize" is not even provided for, now.

Are you perhaps trying to relate a Backdoor Roth? You start with a Nondeductible Traditional IRA contribution, then Convert that to Roth. There is no Roth Contribution in this process.

[mj46]

I had no intention of reporting the Roth as a contribution until I read the diagnostics in Lacerte telling me to do that.  Something doesn't seem right about this whole transaction.  They sold a 3-family in 2021 so their income was nearly $300,000, covered by pension plans at work.  Their AGI would disqualify them from contributing to either a traditional or a Roth.  Is this ok?  Do I just ignore the diagnostic since it is not a critical diagnostic?

[qbteachmt · Accepted solution]

Let's remember that their intent was good, but they either did something wrong or got bad guidance or both, it seems.

You have a 1099-R, and it would have code(s).

Here is what it seems is going on:

They put money into a Traditional IRA. Are you treating it as nondeductible or attempting to be deductible? That matters. If they don't qualify for Deductible IRA contribution, and they don't qualify for Roth contribution, and they are using either scenario, that needs to be a correction.

If it is Nondeductible, then the move to Roth should have been conversion. Not recharacterization. The difference is that Recharacterization is trying to state, "Oops, I put into my Traditional IRA and I meant it to be Roth IRA contribution."

But, backdoor Roth is, "I intentionally put a nondeductible Tradition IRA amount and want to immediately convert that to Roth." Conversions are not restricted.

However, if they have other non-basis Trad IRA funds (I think SIMPLE, too; I'd have to read up), then the Conversion will be pro-rata and taxable. The reason backdoor Roth works is where there are no other deferred funds, so that the amount put into Trad IRA (nondeductible = basis) and immediately transferred or rolled (so earnings are avoided) = nontaxable event.

The issues are, then, did they intend to do something deductible? Did they intend to do something not taxable? Did they fail at both attempts?

The broker should be able to help straighten this out, and you have to the filing date of the return to do corrective distribution (take it all out). It also is possible to allocate contributions from one year to another, but it seems they made an ineligible contribution in both attempts?