If you were one of the many taxpayers who converted their traditional IRA to a Roth IRA in 2010, you may have recently received a notice from the IRS saying you owed additional taxes and penalties on the funds that were rolled over. Receiving a letter from the IRS can be fear-inducing but there is good news for some of the taxpayers who received the notices. Due to a glitch, a number of these notices were sent out in error, meaning you may not have reason to panic after all.
Roth IRA Conversion Rules
In 2010, the IRS made it possible for any taxpayer to convert their traditional IRA to a Roth IRA, regardless of their income. With a traditional IRA, you pay taxes on the money when you make qualified withdrawals but a Roth IRA is funded with after-tax dollars, meaning there is no additional tax on qualifying distributions. The IRS required taxpayers who converted a traditional IRA to a Roth IRA in 2010 to pay regular income taxes on the distribution amount. This had the potential to boost some taxpayers into a higher tax bracket, increasing their tax bill in the process. The IRS allowed those who converted their IRAs in 2010 to spread their additional tax liability out over the 2011 and 2012 tax years, rather than having to pay it all at once.
Detecting the Glitch
The IRS receives millions of tax returns each year and it can take months to verify the accuracy of the information in each of these returns. The IRS only became aware of a potential problem in connection with Roth conversions earlier this year, when it began reviewing 2010 tax returns for errors. Roth conversions for 2010 were required to be filed using Form 8606. Certain professional tax software programs were affected by an error which resulted in the second page of Form 8606 not being transmitted to the IRS. When the IRS began reviewing the 2010 tax returns, their computers detected the missing information and flagged the return, resulting in a notice being erroneously sent to the affected taxpayer. It’s unclear whether any of the tax software programs available for consumer use were affected by the glitch.
What to Do if You Receive an IRS Notice
If you believe you reported your Roth conversion accurately, it’s very likely that you may have received an IRS notice in error. This does not mean, however, that you can simply ignore the letter. Instead, you must respond to the notice and resubmit a copy of your completed Form 8606 to the IRS. Assuming your information can be verified as correct, this should resolve the issue. It’s expected that the vast majority of taxpayers who received notices will not bear any additional tax liability for their 2010 Roth conversion. The IRS recommends consulting a qualified tax professional if you have additional questions about the potential tax implications of a past or future Roth IRA conversion.
The prospect of being contacted by the IRS can be frightening but in many cases, the fear may be unwarranted. Reporting your information accurately and maintaining good records can provide you with some much-needed peace of mind should you happen to find a dreaded IRS notice waiting in your mailbox.