Roth IRA recharacterizations, 1099-R, and Form 8606

Question

I've accidentally landed myself in a super confusing situation with Roth IRA recharacterizations and would appreciate any pointers.

One simplifying factor is that there are only 2 accounts total across all of this: A single traditional IRA and a single Roth, all at the same broker. There are 2 recharacterizations, but nothing was left in the traditional IRA after either.

Here what happened:

• In late 2020 I opened a traditional IRA for the first time, and deposited $5,500 in it.
• A week later I accidentally deposited $550 in it that was intended for a taxable account, and quickly withdrew it.
• In December 2020 I realized I was probably over the income limits for the traditional IRA, so I filed a form w/ my broker to recharacterize everything remaining into a new Roth. Unfortunately that wasn't processed until Jan 2021. This left the traditional IRA balance at $0.
• In April 2021 I filed my taxes w/ TurboTax, it seemed to go fine. I remember entering an explanation for why I withdrew the accidental $550.
• In October 2021 I deposited $6000 cash in the traditional IRA and quickly recharacterized it, also in October, to the Roth. My traditional balance again went to $0.

So in 2021 I recharacterized twice, in Jan and Oct.

But now I am filing my 2021 taxes and have a lot of confusion:

• I received a single 1099-R from my broker covering both transactions. It has a gross distribution and taxable amount both equal to exactly the sum of the two recharacterizations. This is surprising because other than about $100 of gains while stock was still in the traditional IRA, this was all post-tax money. The 1099-R also has the following entries and is otherwise blank:
• Boxes are checked for taxable amount not determined and total distribution
• The IRA/SEP/SIMPLE box is checked
• The distribution code is 2 (Early distribution, exception applies (under age 59½).).
• State/Payer's State Number is MA
• When I enter the 1099-R into TurboTax my taxes due go up significantly as if it is all taxable.
• I started digging deeper and saw that form 8606 for my 2020 tax return unexpectedly has only $550 for nondeductible contributions leading to $550 for "This is your total basis in traditional IRAs for 2020 and earlier years". It's blank other than that. Shouldn't it have been $5,500 since I didn't recharacterize by Dec 31 2020? It seems like somehow the way I answered questions in TurboTax led to my accidental contribution being listed here but not the main contribution, although I don't actually know if it's wrong.

I'm not sure if it matters because I moved everything to the Roth, but I don't want to hurt my Roth distributions when I retire.

So I guess my questions are:

• Does any of this seem wrong to you? What is going on here? How big a hole did I dig myself?
• How would you proceed in TurboTax or otherwise?

Answer 1

Recharacterising your $5500 2020 contribution

The recharacterisation deadline is the tax filing deadline [1], as opposed to the end of the year of the contribution.

So you had until 17 May 2021 (2020's tax filing deadline) to recharacterise your $5500 2020 contribution, which you did in Jan 2021. (The reason that the recharacterisation deadline is later than the end of the year is precisely to account for the situation you are in: that you won't know for sure your income is low enough for a Traditional IRA deduction until 31 Dec 2020.) Therefore, your $5500 2020 contribution was successfully and timely recharacterised as a Roth contribution.

Because your contribution occurred in 2020 and the recharacterisation occurred in 2021 (the next year), you should have reported $0 on line 4a "IRA distributions" of Form 1040 and $0 on line 4b "Taxable amount" of Form 1040, and attached a statement explaining the dates of contribution and recharacterisation. You shouldn't have owed any income tax. If this isn't the case, you should amend your 2020 return. (Form 8606 instructions, Recharacterisations heading.)

Withdrawing your $550 2020 contribution

In addition, your deadline to withdraw contributions is also the tax filing deadline; so you also had until 17 May 2021 to withdraw your $550 2020 excess contribution. Withdrawn contributions are treated as though you never made the contribution in the first place (Form 8606 instructions, Return of IRA Contributions heading). Therefore, you should not have reported $550 anywhere on 2020 Form 8606.

You should file an amended 2020 tax return with an updated Form 8606 showing a nondeductible IRA basis of $0, attaching an explanation that you contributed and withdrew within the tax filing deadline.

Assuming your 2020 income exceeded $6000 and you're not yet old enough to make catch-up contributions, your IRA contribution limit is $6000. You exceeded this limit by $50; thus, you owe income tax, plus a 10% additional tax, on the related earnings on those $50. You said you withdrew this amount very fast, so the related earnings are likely to be a very small amount. If they are significant, you would report the related earnings on those $50 on Form 1040, line 4b (IRA distributions, taxable amount); and you would also include the related earnings on those $50 on Form 5329, line 1 (early distributions includible in income). Form 5329 has a line for Traditional IRA overcontributions, line 15, but you would leave that line blank because you had withdrawn your $50 overcontribution timely.

Recharacterising your $6000 2021 contribution

For 2021, you had until 18 April 2022 (2021's tax filing deadline) to recharacterise your $6000 2021 contribution, which you did timely in Oct 2021.

Because your contribution occurred in 2021 and the recharacterisation also occurred in 2021 (the same year), you should report $6000 on line 4a "IRA distributions" of Form 1040 but $0 on line 4b "Taxable amount" of Form 1040, and attach a statement explaining the dates of contribution and recharacterisation. Again, you won't owe any income tax.

On net, you should regard yourself as never having made any traditional IRA contributions at all, only Roth contributions.

You can pretty much ignore the "taxable amount" box on your 1099-R. (Why is it not important? See the instructions for Form 1099-R, box 2a Taxable Amount. Paraphrasing: "Generally, you [the IRA trustee] are not required to compute the taxable amount of a traditional IRA or designate whether any part of a distribution is a return of basis attributable to nondeductible contributions. Therefore, report the total amount distributed from a traditional IRA in box 2a. This will be the same amount reported in box 1. Check the 'Taxable amount not determined' box in box 2b.")

(Sorry, I don't know how to make TurboTax fill in the forms this way.)

[1] Technically, the recharacterisation deadline is the tax filing deadline plus six months; but you'd have to file timely, then file an amended return annotated as "Filed pursuant to section 301.9100-2".