Simple Ira conversion to Roth IRA

[michele]

 Taxpayer maxes out her 401k on her salary. Makes to high of an income to add a contribution to a  roth. She gives me a 1099 simple ira code #2  and letter from investment advisor that says he did a conversion to the roth and let him know if he went over her 7000 limit. Well I did not think there was a limit to a conversion.  Makes me think he was trying to do a contribution which she clearly does not qualify for since she is over $140.000 Do they have paperwork showing a conversion did not see any coding lists for this. Is there a penalty exception for conversions. Was trying to look that up. There is really no reason for exception other than she put part into this so called conversion. then the rest she kept I would think she should be paying penalty on on the part she kept.

one of those the more they talk the more confused and different scenarios I keep seeing ugh!!!!!!!

[rbynaker]

I've practically given up on relying on taxpayer's knowledge for any of this stuff.  I literally just got off the phone with someone who made a $6K Roth contribution back in April.  The 5498 won't be ready until May and he said he could "only download transactions in csv format."  "How about a monthly statement for April 2021?"  Surprise, he could get one of those and lo and behold it shows a $6K contribution to an account identified as a Roth IRA and, bonus, a TY designation of 2021 right there on the statement.  So I have everything that I would have gotten from a 5498 all in one place and we don't have to wait until May.

Moral of the story, there are broker statements somewhere that will tell you what actually happened and when.  Follow the breadcrumbs.

Rick

[qbteachmt]

"and letter from investment advisor that says he did a conversion to the roth and let him know if he went over her 7000 limit."

That doesn't even exist. That is the Contribution Limit. There is no such thing as Conversion Limit.

You mention 401k and SIMPLE IRA as if they are synonyms. They are Different plans and accounts. Did she have an old SIMPLE IRA account that was converted to Roth, making a taxable event?

There is never a penalty for Conversions.

"she put part into this so called conversion. then the rest she kept"

So you have a Pro Rata conversion (if other accounts are pre-tax and have balances) and a Distribution (which might be subject to early penalty).

You have too many things intertwined. They are not intertwined. Take them one at a time.

[rbynaker]

I agree.  And IMO, an investment advisor that mentions a conversion and a 7000 limit in the same sentence immediately becomes an unreliable source of information.  There are plenty of financial advisors that I've worked with who really know their stuff and if they tell me something happened a certain way, I'm going to believe them.  There are also plenty who (as in this case) can't tell you the difference between a contribution, a conversion, or a rollover.  No problem, I don't need their opinion, I can look at the paper trail and reach my own conclusion.

I'm not sure yet if we're talking about a SIMPLE-IRA or just a simple IRA.  Since words matter, I would call the latter a Traditional IRA to avoid confusion but I can understand if not everyone else does it that way. 🙂

Rick

[qbteachmt]

"Do they have paperwork showing a conversion did not see any coding lists for this."

You can google:

1099-r codes

And get:

https://support.taxslayer.com/hc/en-us/articles/360015900291-What-do-the-distribution-codes-in-Box-7...

https://proconnect.intuit.com/community/form-1099/help/form-1099-r-distribution-codes/00/4750

https://www.hrblock.com/tax-center/irs/forms/reporting-form-1099-r-amounts-as-income/

https://support.taxslayerpro.com/hc/en-us/articles/360009305053-Form-1099-R-Box-7-Distribution-Codes

Those are IRS codes, so they are standardized.

[qbteachmt]

"a SIMPLE-IRA or just a simple IRA"

It's identified on the form.

Everything matters.

Nothing is simple.

[rbynaker]

---

@qbteachmt wrote:

It's identified on the form.

I haven't seen the form. 🙂

If it is a SIMPLE-IRA then you may also have to dig into the 2-year rule.  I'm not sure what that is, just know it exists and it's some sort of "holding period" thingy. 🙂  I can't think of a situation where I would recommend a SIMPLE-IRA, there's nothing simple about them.  I suppose they have their niche but in the vast majority of the cases I've seen you either go SEP-IRA for true simplicity or just bite the bullet and jump into a 401(k).

Rick

[michele]

she has a 401 k thru employer then personal investments which this 1099 personal IRA  with the exception code. My gut says this was a rushed idea that took place on 12/29/2021  as the investment advisor notes that date as  what happened. I just wanted to see if it really was a conversion. but would they have done 2 1099's one for the conversion and another for the amount she did not convert and pocketed to me that would have made since if you are not converting it all then there should be more than one 1099 but sometimes logic does not win out.

thx

[jeffmcpa2010]

Ask if she did a "Back Door" Roth - Make a non-deductable IRA contribution and the investment advisor immediately does a Roth Conversion for the non-deductable IRA contribution.

Since no deduction, there is no tax on the conversion and you don't have to worry about income limits, as there are none relating to Non-Deductable IRA contributions.

If that is what they were trying, you will need to do more looking to see how to enter it. I know they exist, but have never had to enter one.

[michele]

Yes i have handled back door conversions what has thrown me is the fact that  the 1099 was showing more than what they were calling a conversion. Plus he stated in his letter to me he sold some stocks at a loss to minimize her tax burden from doing this conversion. I have to talk to him and get the full story and why it was coded as an exception to penalty and she is not old enough to have the penalty waived. I can see all kind of ideas he may have had. You make the contribution to the ira then convert to roth but he ends up taking and addition 4,000 on top of what he is calling a conversion so he has to me created more of a tax situation for her. she should be paying the penalty on the 4000 that was not converted plus tax. and I really have not been given the basis in her ira to figure it all.  This mess is why I like to say  Talk to us before you do anything and let us figure it for you.

[BobKamman]

A wise investment adviser, though.  "I'm going to tell my client to send some dough to Washington right now because otherwise she'll have it to invest, and in today's market we know how that will turn out."

"Besides, by paying tax to New York this year, she doesn't lose the opportunity when she moves to Florida."

[qbteachmt]

"I can't think of a situation where I would recommend a SIMPLE-IRA, there's nothing simple about them."

They are great for small companies, and especially I like to allow employees to chose their own account brokerage under the plan. That's why.

2 year rule:

https://www.investopedia.com/ask/answers/05/simplerollover.asp

"Employees must wait two years from the time they open a SIMPLE IRA account before transferring those funds into another retirement plan. If you withdraw money from a SIMPLE IRA during the two-year waiting period, you may be subject to a 25% early-distribution penalty."

Notice that is open the account, not leave the job. Similar to why you are encouraged to open a Roth, even just to let it sit, because that starts the exclusion period clock ticking.

"then personal investments which this 1099 personal IRA"

So this conversion was made from a Traditional IRA...

"but would they have done 2 1099's one for the conversion and another for the amount she did not convert"

Not necessarily. For instance, if the entire amount was transferred (direct) and not fully deposited into a Roth at the other end (the other part went to new Trad IRA, to withholding or to disbursement to your client's personal account), the issuing agent would still only send one 1099-R. They don't know where the money went after they sent it; they only report on the 1099-R that they Distributed it per the owner's direction(s). That's why there is a code for "early, no known exception." Because they might not Know. That doesn't mean there is no exception.

"Ask if she did a "Back Door" Roth - Make a non-deductable IRA contribution and the investment advisor immediately does a Roth Conversion for the non-deductable IRA contribution.

Since no deduction, there is no tax on the conversion"

Unfortunately, that won't be true for this person, unless their Trad had no earnings all this time and no basis, either. What you are describing is Basis, or Post-tax:

"The pro-rata rule is used to determine the after-tax amount of a Roth conversion when the taxpayer has both pre-tax and after-tax balances in their IRA(s). Company sponsored plans like 401(k)s and 403(b)s are not used in the pro-rata calculation, unless rolled over to an IRA in the year of conversion"

Putting a nondeductible contribution into a Traditional IRA as a step towards "back door" Roth is fine, but otherwise, is no different than any other Conversion, and follows the conversion rule for ordering, for tax determination. What makes it "backdoor" is immediacy and not other pre-tax holding(s) to compute pro-rata against. No Earnings on it or in the account(s), when converting, is what makes a Non-Taxable conversion. Otherwise, it's pro-rata.

"the fact that the 1099 was showing more than what they were calling a conversion."

That just means your clients don't really understand any of this, and I have seen lots of brokers getting it wrong. You are looking at Distribution. That can be sent as withholding, transfers, conversion and even in her pocket. All of the above.

"Plus he stated in his letter to me he sold some stocks at a loss to minimize her tax burden from doing this conversion."

OMG; she needs to go to someone else. Conversions are by $$. There is no Gain or Loss netting against anything. All he did is convert holdings to cash, locking in that investment's reduction, within that account. Sheesh.

"I have to talk to him and get the full story and why it was coded as an exception to penalty and she is not old enough to have the penalty waived."

There is no penalty for Conversion, but there is for any withholding, unless they make it up in the rollover/conversion; and the amount she kept is subject to penalty. You would need to follow the money, to know the amount withheld and the amount she kept, because that is the Early Distribution, then.

And it's all subject to income tax, as described.

"I can see all kind of ideas he may have had. You make the contribution to the ira then convert to roth"

He already did that wrong unless the Full Trad IRA (and related account(s)) never had any earnings.

"but he ends up taking and addition 4,000 on top of what he is calling a conversion so he has to me created more of a tax situation for her. she should be paying the penalty on the 4000 that was not converted plus tax."

Yes; plus withholding, if you see that.

"and I really have not been given the basis in her ira to figure it all."

At least you know enough to take that into consideration. Help her know how much he cost her and what an idiot he is, for his supposed profession.

[jeffmcpa2010]

"They are great for small companies, and especially I like to allow employees to chose their own account brokerage under the plan. That's why."

Much easier than a SEP as the business owner (Schedule C or F) knows exactly how much he can contribute throughout the year (so long as there is profit to cover).

I had a simple ever since I started congress allowed them with 1996's Small Business Job Protection Act. Best thing I ever did for my retirement.

[qbteachmt]

For an S Corp with fewer than 100 employees, I prefer a SIMPLE IRA 5304 (not 5305). It won't provide the higher limit found under 401(k), though. Too many people do not understand that Roth 401(k) is subject to RMD. I hear some bad guidance on the radio from good people (Dave Ramsey often gets these wrong), but at the least, the conversation has been started.

I feel bad for clients like this taxpayer.

[jeffmcpa2010]

Everything I see says all you have to do to avoid the RMD on Roth401(k) is roll it to a Roth IRA, prior to reaching RMD age.

[qbteachmt]

"avoid the RMD on Roth401(k) is roll it to a Roth IRA,"

Sort of. That's why I noted opening a Roth and making one contribution, then letting it just sit idle, a great tool. There are a lot of qualifying terms, especially varying 5-year terms.

I like to use consumer-based articles.

https://www.schwab.com/resource-center/insights/content/can-you-rollover-roth-401k-to-roth-ira