Roth & AGI

How does the irs know if you've reached the phase out limit on your AGI? Is this supposed to be self-policed? If you don't report Roth contributions how do they match it?

Blixet,

In late May your IRA custodian sends the IRS and the IRA owner a report of the contributions made for the previous year (2007 at this time). This is form 5498:
http://www.irs.gov/pub/irs-pdf/f5498.pdf

Now the IRS has your MAGI, and what your annual contribution amount to your IRA.

I see. What happens if you contributed the max but were actually in the early part of the phase out income wise?

If you don't remove the excess amount before your tax return is due (April 15 for most), then you'll have an excise tax of 6% for that tax year. If you still have the funds in the account, there's no benefit to removing them now, assuming that you'll be making a contribution again for this tax year - the excess contribution can be applied to the subsequent year (rather than being required to be withdrawn). The 6% excise tax still applies.

In reading here: http://www.fairmark.com/rothira/deadline.htm and it seems that I might be able to make a recharacterization even though I've filed before April 15. Is this correct?

I need to pull out my tax return to check, but I noticed my rebate check was substantially reduced and I'm sure it's because my AGI was too high. I'm really suprised my tax preparer didn't warn me since his program asks if we contributed and how much to the Roth IRA.

Yes, I believe that is correct. So what you're doing is changing the contribution year of the excess funds to the current year.

Well, we've already contributed for the current yr (08). So I think I need to have the trustee change the overage plus earnings (if any) to a traditional non-deductible IRA. I can reconvert it in 2010 to the Roth hopefully.

Trying to read the instructions on the IRS forms, I think I need to file an 8606 to report the portion now in the trad IRA, but since it's not deductible, I'm not sure if I need to file the 1040 x amended. They say report it on line 15a, but that's if it is to be deducted, I think. Maybe just the 8606 and a statement of my reasons.

Yes, to complete the re-characterization reporting, submit form 8606 - and you will need to submit an amendment (1040X) along with it, even though the recharacterized amount is not deductible and so therefore the return will not change. Write “Filed pursuant to section 301.9100-2” on the amended return.

Thank you very much. After reading the instructions for the 1040x I think I bascially just need to fill out the section on part II giving the reason for the change but don't need to fill in any of the front part lines 1-33 since nothing is changing. The 8606 should be easy.

I have to watch this for this year as well since even though the phase out limit has gone up I might get bitten again. It'll be easier to recharacterize if necessary before filing this time.

It was the large amount of cap gains and an increase in my dividends that bit me in '07. Since they mostly come in December, I will have to look closely at how much there is this year.

It turns out that the amount I could contribute to the Roth was printed on the cover sheet of my copy of my tax return, but I told the preparer we had already contributed the max and he didn't mention anything. I think I glossed over the paragraph when I looked at the return. Kind of a pain, especially since I will just reconvert it all to the Roth in '10.

Thanks again, Jim and Clyde.

Not a problem... keep in mind, the amount that you re-characterize has to include the growth attributable to the excess contribution...

And, sometimes tax preparers are overwhelmed with "stuff" during the season and don't fully hear what you are telling them. Luckily you've discovered this in time and can resolve it simply.

Not a problem... keep in mind, the amount that you re-characterize has to include the growth attributable to the excess contribution...

I talked with the rep from the trustee about that and he says they will calculate it for me, but I will double check. Fortunately, there is actually some growth in that account.

And, sometimes tax preparers are overwhelmed with "stuff" during the season and don't fully hear what you are telling them. Luckily you've discovered this in time and can resolve it simply.
He's usually very sharp. Does wear 2 hearing aids for a hearing disability but I don't think that was they reason since he did enter the info correctly. My bad for not reading thoroughly. Add another lesson.

Thanks again.

Form 8606 is a stand-alone form. It does not need to be accompanied by a 1040 of any stripe.

So, if I'm only reporting a change to a non-deductible traditional IRA, no changes to deductibilty, no income change, even though I filed before Apr 15 w/no extensions, I can get away with just the 8606 and some note of explanation? :confused: (sorry for the long, qualified question :o )

Form 8606 is a stand-alone form. It does not need to be accompanied by a 1040 of any stripe.
I learn something new every day. I have always either included it with the original filing (if extended) or an x. Thanks clyde!

How do dividends increase income? I thought dividends were taxed differently?

Or maybe I don't know the tax form well enough- maybe they are taxed lower, but still add into MAGI?

Summarizing -

A 2007 ROTH IRA contribution turns out to be in excess of the maximum contribution.
That contribution has generated some gains.

The taxpayer has until the due date of his return plus extensions to correct this problem.
There is a quirk in the rules that gives the taxpayer until October 15, 2008 to fix this problem. Even when the tax return was filed by April 15, 2008 and no extension was requested.

The taxpayer must remove the excess contribution and earnings from the ROTH IRA by October 15, 2008.
The taxpayer wishes to put this excess amount into a non-deductable TIRA for 2007.
The taxpayer must open a TIRA to receive the Non-Deductble contributions plus earnings.
The taxpayer completes form 8606 showing a non-deductable contribution (Not Earnings) to a TIRA for 2007 and sends this with an explanation to the IRS.

A 1040X would not be needed because there are no changes to be made to any of the numbers on the original 1040 filed by April 15, 2008.

In January 2009, a 1099R is sent to the IRS and the taxpayer showing the distribution from the ROTH IRA.
The distribution amount is reported on 1040 line 15a.
Line 15b will be blank.
Attach an explanation to the 1040 describing what you did.

In this scienario the 6% excise tax would not apply because the problem was corrected before the Ocober 15, 2008 deadline.
The 6% excise tax would apply if the taxpayer kept the funds in the ROTH IRA after the October 15, 2008.

Questions?
Comments?

Thanks, very clear!

The gains received by the taxpayer are put on line 15b and are taxable income.
The gains may also be an unqualified distribution from the IRA and subject to the 10% penalty.
The penalty amount (10% of the gain) is reported on 1040 line 60.If the gains are never withdrawn from the IRA, even though they shift from Roth to traditional, they are taxable and penalized? Why aren't they taxable at withdrawal instead? (not that it appears it's going to matter after the recent market decline/gains have evaporated)

Blixet,

I edited my earlier post.

The gains and contribution stay in the IRA.
You need to have a TIRA to accept the change.
There is no tax or penalty when this is completed by October 15, 2008.

I agonized over this for some time, researched, and ask others more knowledgable than I.

Thanks for keeping me honest!!
Sorry to hear of your losses....

I really appreciate your effort in helping educate me in this situation. Above and beyond! This happens to be where I hold my REIT funds. Was positive for the year until the last few days and then BAM! Got hammered. Lots of volatility in real estate this year, up or down 4-5% in a day.

Bottom line is it seems like an easy fix, but I shouldn't have let it slip by in the 1st place. This year will be close again, but I am now on the alert. I'll double check our MAGI before filing.