Tax planning for Roth IRAs.

• Author: Bauman, Christine Czekai

Tax year 1998 was the first year a Roth IRA could be established. Approximately $21 billion poured into mutual funds via Roth IRAs at that time. However, taxpayers have made numerous errors with their Roth IRA investments. For example, taxpayers with modified adjusted gross income (MAGI) in excess of $100,000 and married per: sons who lived together but filed separate returns are ineligible for conversions of traditional IRAs to Roth IRAs. In addition, married taxpayers filing jointly with MAGI in excess of $160,000, married taxpayers with MAGI under $10,000 who file separate returns, and all other taxpayers with MAGI greater than $110,000 are ineligible to make Roth IRA contributions. As of Oct. 14, 1999, the IRS estimated that approximately 20,000 taxpayers who appeared to be ineligible for 1998 Roth IRA conversions still had not made the appropriate corrections. The Service sent notification to these taxpayers.

In response to the problems taxpayers have experienced in applying Roth IRA rules and limits, the IRS has issued numerous authoritative guidance over the past year. For example, the Service extended the due date until the end of 1999 to undo 1998 Roth IRA contributions or conversions. This extension was granted in recognition of the newness of the Roth IRA and taxpayer difficulties. However, taxpayer confusion continues, as evidenced in Ann. 99-104. In that notice, the IRS states "[i]t has come to the attention of the Internal Revenue Service and Treasury that taxpayers have experienced particular difficulty in properly applying the rules governing Roth IRA conversion contributions and recharacterizations"

A "conversion" refers to the transfer of an amount from a traditional IRA to a Roth IRA (Regs. Sec. 1.408A-4, A-1). A "recharacterization" refers to an amount or contribution treated as contributed to an IRA other than the one to which it was originally contributed (Regs. Sec. 1.408A-5, A-1). For example, a recharacterization allows a taxpayer to change his Roth IRA contributions or conversions back to a traditional IRA (Sec. 408A(d) and Regs. Sec. 1.408A-5). Taxpayers may choose to recharacterize if they have made ineligible Roth IRA contributions or simply changed their minds as to the type of IRA account they prefer.

Taxpayers must now be concerned with the complexities surrounding post-1999 Roth IRA conversions, the income tax effects of current Roth IRA investments and the tax planning surrounding 1998 Roth IRA conversions.

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