1099-R Code 2, Backdoor Roth

[Ayhn]

The client's prior employer closed her IRA account and sent a check of $672 to her for indirect rollover. The 1099-R shows total distribution of $840 with $168 federal tax withholding and code-2 early distribution with exception. She deposited the check and another $168 out-of-pocket contribution to her new IRA account AFTER 60 days. In her situation, the $840 distribution is taxable right? How much is subject to 10% penalty--$840 or $672? ProConnect didn't automatically show any penalty or Form 5329 with code 2, do I need to override and make 10% penalty and Form 5329 show?

The client later converted $840 IRA contribution ($672 indirect rollover plus $168 out-of-pocket contribution) to Roth IRA (backdoor Roth, her income is above threshold and IRA contribution are nondeductible). It looks like $168 is nontaxable because it's after-tax money contributed, and $672 is taxable to convert to Roth IRA? (She had a Form 5498 for traditional IRA showing contribution of $168, and a Form 5498 for Roth conversion showing amount $840)

Thank you!!!

[George4Tacks]

Employer closed the IRA?  That does not sound correct. Withholding would indicate something different. Who was the check from?

[qbteachmt]

Employers do not control IRA accounts. IRA = Individual Retirement Arrangement.

Employers control retirement accounts, under a retirement plan. Even if that is a SIMPLE IRA plan, the employee still keeps and controls the SIMPLE IRA account. So, look at the 1099-R to see if the "type of account" box is checkmarked.

"$840 or $672?"

You are confusing gross and net. The gross is the full amount. The net is what they got in hand.

There are different rollover windows depending on the plan type or account, the reason this was disbursed, the age of your taxpayer, etc. Right now, it didn't meet the typical 60-day rollover, so everything else about this is moot. Other than, your taxpayer would only be able to make that $840 deposit as a current/tax year contribution, not a rollover, and only as long as there is at least $840 in earnings, and barring other restrictions. In other words, it needs to be a qualified new contribution or it should be removed as a corrective distribution.

Also, get a copy of the Form 5498, and/or account statement to see exactly what this is: type of account, what they identified the deposit as, etc.

Remember: 1099-R is for money Out. The issuer doesn't necessarily know what happened next, what applies, and you have code 2, which implies there is some sort of exception to the early distribution penalty.

Until you know more details, nothing here makes sense.

[qbteachmt]

Oh, let's address this "conversion/contribution:"

It's also a mess.

"converted $840 IRA contribution ($672 indirect rollover plus $168 out-of-pocket contribution)"

If what you first described is true, the rollover of the net amount + a make up of the withholding would all be Rollover. Or, it is all Contribution. It can't be a split, because it is all from the same action.

"to Roth IRA"

Coming from a Trad IRA, it's never segregated like you just described it. Once it is in the Trad, it might be Basis and pre-taxed, but your taxpayer should have not had basis from the Gross event already described.

"(backdoor Roth"

It's not backdoor. Backdoor is when your taxpayer contributed nondeductible to a Trad IRA and has no other IRA, SIMPLE IRA or SEP IRA funds, and immediately converts to Roth, thereby avoiding any risk that there is taxable income in that "direct transfer to a different tax treatment."

Your taxpayer either had pre-tax or post-tax funds to start with. You already stated you thought the funds are split, and a backdoor can't be split.

"her income is above threshold"

Thresholds only apply for new contributions. What you started with is either Rollover, Conversion, or both. These never have a threshold. There are restrictions for frequency in some cases.

"and IRA contribution are nondeductible)."

Technically, you didn't have any contributions.

"It looks like $168 is nontaxable because it's after-tax money contributed"

No; she made up the missing amount that was withheld. It would be from any money she has on hand, but it was replacing whatever the original account held. It still is considered part of the Gross Distribution.

"and $672 is taxable to convert to Roth IRA?"

See, a Backdoor would not be taxable. And that's what you do not have, in this example.

"(She had a Form 5498 for traditional IRA showing contribution of $168"

It shouldn't be contribution if it is part of rollover. Contribution would also have a "for XXXX" year identified to it. But both rollovers and conversions are simply "funds already in these accounts, being moved or changed as to type of account."

"and a Form 5498 for Roth conversion showing amount $840)"

Yeah, nothing how it's been stated, is right. If that Form 5498 is correct, then:

Your taxpayer still made a bad rollover and everything should be undone.

[sjrcpa]

OP explained it better here:

https://accountants.intuit.com/community/proconnect-tax-discussions/discussion/questions-about-form-...

[qbteachmt]

I had some time to put some resources together that might give a more correct perspective:

Not IRA but employer plan...

From: https://www.fidelity.com/learning-center/smart-money/what-happens-to-your-401k-when-you-leave-a-job

"If your 401(k) or 403(b) balance has less than $1,000 vested in it when you leave, your former employer can cash out your account or roll it into an individual retirement account (IRA)."

60 days from when the funds were received to make the rollover...

From: https://www.investopedia.com/articles/personal-finance/112315/what-happens-401k-after-you-leave-your...

"For indirect rollovers, you have 60 days to deposit the money into another 401(k) plan or IRA. If you fail to do so, the money will be taxable and you will likely face an additional 10% early withdrawal penalty."

The 20% withholding in specific cases, and making up the difference...

From: https://www.employeefiduciary.com/blog/401k-distribution-rules-frequently-asked-questions

"You can also rollover a distribution paid directly to you within 60 days. These “indirect” rollovers are rare because rollover-eligible distributions paid directly to you are subject to mandatory 20% Federal income tax withholding. That means you’ll need to use personal funds to roll over your full distribution."

All of these are applicable if it turns out this was an employer plan account 401(k) 403(b) 457, etc.

The Roth conversion is simple: if the Trad IRA rollover was not allowed, then the Roth activities are not allowed and should be undone (as should the Trad IRA). If the Trad IRA rollover is allowed, it is a rollover of those employer funds. Basis will not change and retains what it was when it was with the employer.

If the taxpayer had no basis in these funds (if all employer amounts were pre-taxed and any earnings or match were also never taxed), and if there were only these funds, or only never-taxed funds, in Trad, SIMPLE and SEP IRA, and if there were no earnings while is was sitting in the Trad IRA, then Conversion to Roth is Taxable, the same as any conversion.

There is no backdoor anywhere here.

There is no new contribution anywhere here.

All of this can be proven by the documentation.

[qbteachmt]

Okay, so now we know it was employer 457 account.

Read here for the exceptions, and there also is a link to the 60-day waiver, which your taxpayer might benefit from:

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-exceptions-to-tax-o...

Please read everything here, including the new part I've added, and then update here if you still have questions.

The first thing to determine is if/when the 60-days expired. Everything else is moot, if there is no legit rollover.

And please stop applying the word "backdoor" to anything here. That's an entirely different process. You seem to treat these activities as synonyms, but they are not. Let me help:

"backdoor Roth, her income is above threshold and IRA contribution are nondeductible)"

The Trad IRA would be made as nondeductible if you are taking advantage of the Backdoor provision. That's because the person can't contribute to a Roth based on income thresholds, but your taxpayer is not making a contribution. This entire scenario is not Contribution. It's not New Money. That's also why income levels have nothing to do with your taxpayer's scenario. All of this is misleading for the issue: backdoor, nondeductible, contribution, and income levels. Those are for an entirely different situation.

Your taxpayer has funds from an employer, and you are trying to determine if they were handled properly for distribution, rollover and conversion. These three words: distribution, rollover, conversion.