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I plugged in our tax info into TaxCut and am facing a warning (and higher taxes than initially anticipated) related to a Rollover to Roth conversion this year, where 403b assets from my wife's previous employer were moved into a Rollover IRA and I estimated we'd be safe in moving these same Rollover assets into her Roth IRA account (through Firstrade). Upon doing a "Final Check" for our federal return, it states "It appears that your spouse may have made an erroneous conversion because your MAGI exceeds $100K. ..... If our MAGI >$100K, this is an erroneous conversion and your spouse must recharacterize it."

I've a few questions from this, as I contend the $100K statement:
1) What constitutes MAGI? I found "Adjusted gross income ("AGI") represents your total income reduced by certain deductions known as "adjustments," but before you take your itemized deduction or standard deduction, and before you take the deduction for personal exemptions."

So would this mean our collective income from Box #2 from our W-2s? Would this not include the IRA distributions (of $8.5K)?
2) If it turns out our MAGI does exceed that limit, then in performing the recharacterization of a certain portion of that $8.5K to get us beneath the $100K limit, would we be subject to any fees or penalties?


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1) What constitutes MAGI? I found "Adjusted gross income ("AGI") represents your total income reduced by certain deductions known as "adjustments," but before you take your itemized deduction or standard deduction, and before you take the deduction for personal exemptions."

Right. AGI is the starting point. The Modification (hence MAGI - Modified AGI) for this purpose is removing the income related to the conversion. An example might help. Let's give you $80k in W-2 income, $5k in interest, and $25k from converting a traditional IRA to a Roth. Your AGI will be $110k. Your MAGI is $110k less $25k or $85k. That is low enough for the Roth conversion to be allowable.

--Peter
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1) What constitutes MAGI? I found "Adjusted gross income ("AGI") represents your total income reduced by certain deductions known as "adjustments," but before you take your itemized deduction or standard deduction, and before you take the deduction for personal exemptions."

So would this mean our collective income from Box #2 from our W-2s? Would this not include the IRA distributions (of $8.5K)?


Start by doing the Roth MAGI calculation in Pub 590. This will tell you whether you have a tax problem or a TaxCut problem.

2) If it turns out our MAGI does exceed that limit, then in performing the recharacterization of a certain portion of that $8.5K to get us beneath the $100K limit, would we be subject to any fees or penalties?

When you do the MAGI calculation you'll see that the Roth conversion income isn't part of MAGI. Thus, if you recharacterize you won't change MAGI.

Let's identify the problem before we worry about fixing it. Do the MAGI calculation and get back to us.

Phil
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Thanks for the reference Phil. I've referred to Pub 590 http://www.irs.gov/pub/irs-pdf/p590.pdf (page 56 of 104) to calculate my MAGI for Roth Purposes
Steps are as follows (just to make sure I'm doing this properly)
1) Enter AGI on line 22/form 1040A (which I've referred to ... the applicable "income" items for me are "7 wages, 8a taxable interest, 9a ordinary dividends, and 11a IRA distributions". I've got my calculated income now. My AGI on 1040A (line 22) subtracts my student loan interest adjustment from my calculated income. So now I've got my AGI.
2) Then enter income from conversion of an IRA to a Roth IRA or a min required distribution ... I enter the $8.5K that was rolled over into the Roth IRA earlier this year
3) Subtract line 2 from 1 (I do that)
4 skip (no traditional IRA deduction)
5 Enter student loan interest deduction ... I do that
Skip 6 through 11
12) Add amounts in lines 3 through 11 ... I do that
13) Enter $160K if married filing jointly ... I do that
14) Is amount on line 12 > amount in line 13 --> No ... meaning amount in line 12 is my MAGI for Roth IRA purposes


SO .... drats .... looks like I am dealing with what's called a "Failed Conversion" per page 59 of 104 in Pub 590. It states basically (fit for my situation)...

"If when I converted amounts from a traditional IRA into a Roth IRA, I expected to have MAGI of $100K or less, but my expectations did not come true, I have made a failed conversion.
RESULTS of a failed conversion - If the converted amount (contribution) is not recharacterized (explained in chpt 1), the contribuion will be treated as a regular contribution to the Roth IRA and subject to the following tax consequences.
- a 6% excise tax per year will apply to any excess contribution not withdrawn from the Roth
- distributions from the traditional IRA must be included in my gross income
- 10% additional tax on early distributions may apply to any distribution

HOW to Avoid - I must move the amount converted (including all earnings from the date of conversion) into a traditional IRA by the due date (including extensions) for my tax return for the year during which I made the conversion to the Roth IRA. I do not have to include this distribution (withdrawal) in income."

So ... based on these details from Pub 590, is it true I should contact my broker (Firstrade) where this rollover conversion occurred, and ask them to move this original amount converted ($8535), by April 15th, from the Roth IRA account, where it currently sits back into the traditional IRA account (or rollover IRA account?). In addition, I believe I'd have to move any gains/losses these holdings have experienced since the original conversion back in August 2006 (about $1625, or 16% appreciation across 8 stocks and 1 fund) I just calculated on 8 stocks). Or can I move only just enough that gets us under the $100K MAGI limit, and leave the rest in the Roth? Does this constitute a "recharacterization"?

eurobask
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So ... based on these details from Pub 590, is it true I should contact my broker (Firstrade) where this rollover conversion occurred, and ask them to move this original amount converted ($8535), by April 15th, from the Roth IRA account, where it currently sits back into the traditional IRA account (or rollover IRA account?). In addition, I believe I'd have to move any gains/losses these holdings have experienced since the original conversion back in August 2006 (about $1625, or 16% appreciation across 8 stocks and 1 fund) I just calculated on 8 stocks). Or can I move only just enough that gets us under the $100K MAGI limit, and leave the rest in the Roth? Does this constitute a "recharacterization"?<?i>

Remember that Roth MAGI doesn't include any of the conversion income, so undoing the conversion isn't going to change MAGI. IOW, no, you cannot partially undo it.

Tell your Roth custodian that you have to "recharacterize" (term of art) the conversion. It's not clear whether there's anything other than the conversion in that account, but if there is the custodian will compute the amount that needs to go back to the traditional.

Phil
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