Last opportunity to recharacterize 1998 Roth IRA conversions.

• Author: Johnson, Linda

Taxpayers who convert a traditional individual retirement account (IRA) to a Roth IRA normally have until the extended due date of their tax returns to recharacterize the Roth IRA back to a traditional IRA. The IRS realizes the difficulty taxpayers have had applying the Roth conversion and recharacterization rules and the severe tax consequences of a failed Roth conversion. Consequently, the Service has announced that taxpayers who filed timely 1998 tax returns have until Dec. 31,1999 to recharacterize their 1998 Roth IRA conversions. This extension provides relief not only for taxpayers who have yet to correct a failed 1998 Roth conversion, but also presents an interesting planning opportunity for taxpayers who made valid Roth conversions in 1998.

Converting a Traditional IRA to a Roth IRA

Beginning in 1998, eligible taxpayers could convert amounts from a traditional IRA to a Roth IRA. Previously untaxed amounts from the traditional IRA usually are taxed in the conversion year; however, a special rule allows the income from 1998 conversions to be spread over four years. Although all previously untaxed amounts are subject to income tax, the income from a valid Roth IRA conversion is not subject to the 10% penalty that applies to early IRA distributions.

Sec. 408A(d)(6) allows taxpayers to recharacterize ("reverse") a Roth conversion. To recharacterize a Roth IRA, the taxpayer makes a trustee-to-trustee transfer of the Roth IRA amounts (including any earnings) to a "new" traditional IRA and elects to treat the amounts originally contributed to the Roth IRA as having been instead contributed to the "new" traditional IRA. In effect, the recharacterization negates the Roth conversion and replaces it with a transfer of funds between two traditional IRAs. However, this transfer does not count toward the Sec. 408(d)(3)(B) once-per-year rollover limit. In making a proper recharacterization election, a taxpayer also must follow the procedures outlined in Regs. Sec. 1.408A-5, Q&A-6, which states that taxpayers have until the extended due date of their tax return to recharacterize a Roth IRA. Thus, taxpayers who converted to Roth IRAs in 1998 normally would have until Oct. 15, 1999 (at the latest) to recharacterize their Roth IRAs to traditional IRAs. In Ann. 99-104, the IRS extended this deadline until the end of the year for taxpayers who timely filed tax returns for 1998. This extension provides relief for taxpayers who have yet to correct their...