Two Roth Conversion Tax Scenarios: Communication is Key

Good communication with your tax preparer is essential to make sure that your tax return is prepared correctly. This is important whether you meet with your tax preparer in person or, as many people do, whether you mail in/drop off your pertinent tax information to have your return prepared.

Even if you’ve kept track of all your records perfectly, have every receipt and tax form that’s needed and are well organized, without proper communication, there could easily be errors on your return through no one’s fault in particular.

Consider the following two scenarios:

In the first scenario, you’re 65 years old and have an IRA that consists entirely of pre-tax money. To help pay for some of your bills, you decide to take a distribution of $20,000.

In a second scenario, you’re the same age, 65, and you have the same IRA consisting entirely of pre-tax money, except this time, you convert $20,000 to a Roth IRA.

When tax time comes around, you will want to properly report either of these transactions to make sure you avoid any problems with the IRS, right? Of course you do, but here’s the problem, in both of the scenarios above, you’ll receive an IRS Form 1099-R showing a distribution of $20,000. Furthermore, both 1099-R forms will show a Code 7 in Box 7 to indicate a “Normal distribution.” In every way, shape and form, the two 1099-R forms will be identical.

So how then, will your tax preparer know that you made a Roth conversion? Well, you have to tell them! Now you might be thinking to yourself why, if the 1099-R forms are the same, would it matter? The simple answer is that even though the 1099-R reporting from your IRA custodian to the IRS is the same in both scenarios, your reporting of the transactions on your personal income tax return is different. With the Roth IRA conversion, you have to file IRS Form 8606, whereas that form is not necessary if you simply take a distribution (that’s not converted).

So remember, it’s not just good marriage advice, but good tax advice too... communication is the key to success!

By Jeffrey Levine, IRA Technical Expert