Indirect Conversion

Definition

A  Roth conversion, where the IRA owner takes  a distribution from the retirement account that is a non-Roth IRA and rolls-over over the amount to his/her Roth IRA within 60-days of receiving the distribution.

For an indirect conversion, the rollover should be treated as a ‘Roth conversion’ and not as a regular rollover, so that it is reported properly to the IRS and the IRA owner.

A Roth conversion is treated as ordinary income to the IRA owner. Therefore, except for amounts attributable to after-tax rollovers or nondeductible contributions, the conversion will be taxable.

Conversions are exempt from the early distribution penalty. As a result, code 2 is inputted in box 7 of 1099-R if the IRA owner is under age 59 ½ when the conversion is processed. However, for those those are done VIA indirect-conversions, the 1099-R will reflect Code 1 in Box 7-- unless an exception applies, because the custodian will (rightfully) treat the transaction as a regular distribution. To ensure that the conversion amount is exempted from the early distribution penalty, the IRA owner should file IRS Form 5329 and claim the exemption.

A Roth conversion is treated as a conversion for the year that the assets leave the non-Roth IRA. For instance, if an individual withdrawals amounts from a traditional IRA in December, and deposits the amount to a Roth IRA in January, the conversion is considered to have been done in December and taxable.

Referring Cite

IRC §408A, IRS Publication 590

Additional Helpful Information

Individuals are eligible to convert to a Roth IRA, only if they meet the following requirements:

1. The individual’s adjusted gross income for the taxable year does not exceed $100,000; or
2. The individual’s tax filing status is not ‘married filing separately’ IRC §408A(c)(3)(B)

However, these restrictions were repealed under the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) effective for tax years beginning January 1, 2010.

Roth IRA conversions are not  subject to the 10 percent early distribution penalty  that applies to distributions that occur before the IRA owner reaches age 59 ½  [IRC §408A(d)(3)(A)(ii)]

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