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rated:
I mean, what prevents anyone from taking regular  401k rollover check from old employer, and depositing it to say Fidelity Roth IRA, claiming it's an after-tax money.

How would Fidelity know? There's nothing on the check that describes the source of funds.
(Not that it's a good idea, but I just want to understand the system)
 

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rated:
Fidelity does not need to go out of their way to confirm what type of money it is (though they may have procedures to make an effort to do so).  The IRS will get the info directly.

The IRS has forms on both sides of the transaction (1099-R / 5498) which are filled out by the financial institution on each side (sending/receiving), indicating the tax status of the dollars.  The 401k administrator will report it on the 1099-R directly to the IRS if it is pre-tax money. 

rated:
Foobar33 said:   I mean, what prevents anyone from taking regular  401k rollover check from old employer, and depositing it to say Fidelity Roth IRA, claiming it's an after-tax money.

How would Fidelity know? There's nothing on the check that describes the source of funds.
(Not that it's a good idea, but I just want to understand the system)

Lets say you roll over $10,000 from a Traditional 401k to your IRA at Fidelity (as an example).

Many 401k providers (at least ones I've worked with) won't do a direct trustee to trustee transfer.  They'll mail you a check made out to the name of the trustee.  So, your 401k provider will mail you a check made out to "Fidelity Management Trust Company FBO Foobar33" (FBO = For Benefit of).

You will take that check to Fidelity (or deposit it on their app).  When you deposit it, it doesn't matter if you deposit it into your Traditional or Roth IRA at that point.  Fidelity won't care.

Come January the following year, you'll get a 1099-R from your 401k provider telling you and the IRS that they gave you a check for $10,000 to go into your Traditional IRA.  You'll also get a Form 5498 from Fidelity telling you and the IRS that you deposited $10,000 from a direct rollover into account X of type Traditional or Roth.

If you deposit the traditional IRA funds into a Roth IRA, the IRS will know and expect you to pay taxes on it.  Just like if you fail to deposit the funds into an IRA and get your bank to cash the check for you, the IRS will know because they won't have a matching 5498 deposit.

Usually it'll take 2-3 years for the IRS to catch up, but you'll get a letter asking for back taxes plus penalties plus interest.

rated:
Adding on to AverageGuy09's post.

https://www.irs.gov/pub/irs-pdf/i1099r.pdf 

1099-R and 5498 are filed by the custodians(s) involved. 1099-R reports distribution. 5498 reports contributions/rollovers. If the report amounts on 1099-R, 5498, and 1040 don't match up, something is going on.

In Foobar33's example, the 401k 1099-R reports distribution amount (box 1) but also taxable amount (box 2). Box 1 and Box 2 would be the same if it is all pre-tax.  Foobar33 sends the check over to a Fidelity Roth instead of Traditional IRA. Fidelity files a 5498 for a Roth IRA reporting the rollover amount (instead of a 5498 for a Traditional IRA). If Foobar33's 1040 doesn't report the "missing" taxable amount (1099-R box 2), then expect a letter from IRS asking for clarification.

If Foobar33 was doing a mega backdoor Roth (post-tax distribution), distribution and taxable amount on 1099R would differ (ideally taxable amount would be close to $0 as it indicates the distribution is 100% post-tax).  In this case, the IRS would be expecting a Roth IRA 5498 to be filed by Fidelity.  If none is file, then IRS would assume Foobar33 kept the money and if 1040 does reflect the penalty for early distribution involved, again, expect a letter from IRS asking for clarification.

rated:
In general: if you think you've found a clever way to cheat the IRS, the loophole has already been closed somehow.

rated:
seawolf21 said:   Adding on to AverageGuy09's post.

https://www.irs.gov/pub/irs-pdf/i1099r.pdf 

1099-R and 5498 are filed by the custodians(s) involved. 1099-R reports distribution. 5498 reports contributions/rollovers. If the report amounts on 1099-R, 5498, and 1040 don't match up, something is going on.

In Foobar33's example, the 401k 1099-R reports distribution amount (box 1) but also taxable amount (box 2). Box 1 and Box 2 would be the same if it is all pre-tax.  Foobar33 sends the check over to a Fidelity Roth instead of Traditional IRA. Fidelity files a 5498 for a Roth IRA reporting the rollover amount (instead of a 5498 for a Traditional IRA). If Foobar33's 1040 doesn't report the "missing" taxable amount (1099-R box 2), then expect a letter from IRS asking for clarification.

If Foobar33 was doing a mega backdoor Roth (post-tax distribution), distribution and taxable amount on 1099R would differ (ideally taxable amount would be close to $0 as it indicates the distribution is 100% post-tax).  In this case, the IRS would be expecting a Roth IRA 5498 to be filed by Fidelity.  If none is file, then IRS would assume Foobar33 kept the money and if 1040 does not reflect the penalty for early distribution involved, again, expect a letter from IRS asking for clarification.

Bottom line is, you cannot "accidentally" do this without the IRS noticing thanks to them being sent both 1099R and 5498 forms. If they see a pre-tax distribution on 1099R, they expect a 5498 form showing the expected traditional IRA rollover. If they receive a 5498 form for Roth IRA, without having received a 1099R for distribution from a Roth 401k account, it won't be hard to connect the dots.

As for how they'll treat it, who knows but the oops sorry my bad excuse does not go well usually. At best, they'll treat it like a regular IRA to Roth IRA conversion and assess you the tax associated with the conversion. At worst, they could also tack on the 10% early withdrawal penalty if they consider that you did not do the proper conversion within 60 days.

Unless Fidelity was also the trustee for the old employer 401k account, they won't know about your tax situation since they won't have received the 1099R from the 401k trustee so they won't have any basis for knowing what you're allowed to do and the associated tax consequences. They also won't know whether it was a mistake or you intentionally wanted to do the conversion.

rated:
Don't mess around with IRAs. Worst case scenario (other than any criminal liability which there may or may not be) is that the IRS doesn't notice. In 40 years, you pull money from your IRA and get audited. The IRS notices a disparity in your contributions claimed and their third party data. The IRS disqualifies your IRA and you have to pay 40 years of taxes, penalties, and interest. Your cushy retirement that you planned is now limited to what you have in other retirement accounts because the IRS just took all of your other assets.

There are some aggressive approaches you can take on your taxes. Leave IRAs out of that aggressive tax planning.

rated:
defjukie said:   In general: if you think you've found a clever way to cheat the IRS, the loophole has already been closed somehow.
  Unless you are a corporation. Because corporations are people with good accountants and offshore accounts.

rated:
Technically it is possible if your old employer's financial company is bad w/ reporting your 401k withdraw to the IRS.  I had that happen to me a long time ago, I left a company, rolled my 401k over, never got the IRS form from them, so I didn't remember to report it. But the IRS never complained. 

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