ROTH IRA transferred by mistake into a traditional IRA (indirect rollover)

[runbullrun]

We had a call from a brother of a client a few days ago. Here is the situation:

His fiance took a full distribution of a ROTH IRA from Broker 1. The money was deposited into her PERSONAL account (took possession - they should have done trustee to trustee but did not). 

She then wired the money to Broker 2 to open an account, which unfortunately was set up as a Traditional IRA. The error in setting up the wrong type of IRA was the taxpayers error. The client realized their error at some point (this was all done in the last month). Now they want to put the money back into a ROTH, but Broker 2 is saying it needs to be done as either:

1. Roth conversion (taxable)

     2. Take the traditional IRA and move the assets into a non-retirement account (taxable)

Has anyone encountered this? Is there any way for Broker 2 to re-code the account without causing a taxable event?

Help is much appreciated! 

Gregg

[IRonMaN]

Sounds like she now has a traditional IRA with basis to keep track of.

[TaxGuyBill]

Tell the broker to "remove excess contributions" of the total Traditional IRA amount.  That should undo the contribution to the Traditional IRA.

Do an indirect rollover by depositing money into a new Roth account.

[qbteachmt]

Taking possession isn't an issue, as long as the person still is within the 60-day window?

"for Broker 2 to re-code the account"

No.

I agree that it should all be treated as Basis and conversion to Roth. Yes, the 1099-R(s) will be issued as early distributions, but as long as you have the due diligence to show what transpired and they are in the 60-day window, it should withstand scrutiny as a Rollover of Basis, a nontaxable conversion. What you want to do is check for withholding, of course. That will need to be added back.

First 1099-R: complete distribution of Roth IRA, exception applies to early distribution, since it was "rolled" the same as if it was put into an employer plan account, as far as the Roth IRA disbursement agent knows.

Second 1099-R: Conversion of Basis (might have some taxable earnings while they've need trying to deal with this mess) to Roth. It should be done Direct, to avoid withholding.

[qbteachmt]

"That should undo the contribution to the Traditional IRA."

It wasn't contribution, though. It would be coded as rollover. It wasn't new money for the year.

[TaxGuyBill]

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@qbteachmt wrote:

"That should undo the contribution to the Traditional IRA."

It wasn't contribution, though. It would be coded as rollover. It wasn't new money for the year.

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It is not allowable to roll over a Roth to a Traditional, so it is a failed rollover that is treated as a new contribution, regardless of what check-boxes the broker put into his computer.

[qbteachmt]

I was thinking that as long as this is within the 60-day window, it would be moot. As a failed or invalid rollover, asking for corrective action on the excess risks they will keep $7k, though, since that is the contribution limit for the year. That's one thing to be aware of.

The reason it needs to be direct is that there has already been a "1 in 12 month" (she touched the funds in between).