ROTH RECHARACTERIZATION

[BNS]

Hopefully this will not get too confusing. My clients provided their tax information to me, including 1099Rs that reflected a trustee-to-trustee transfer of previous employer 401K contributions to IRA accounts. Then they converted these IRA's to ROTH IRA"S. The 1099's on the ROTH conversions also reflected federal & state withholding as taxpayers knew they would owe taxes on the converted money and wanted to make sure their taxes were paid. However their financial advisor had quoted them the wrong limitation for ROTH rollover ($156,000 vs $100,000) and taxpayers AGI exceeded the $100K. Pub 590 states a recharacterization can be done and all monies plus earnings can go back to Traditional IRA. Papers were signed, taxpayers got refunds and sent money back to financial institution to make up the difference, etc. all before April 15th. Thought all was fine, except the financial institution said this wasn't done within 60 days rollover and money is just sitting in an account (not IRA) Taxpayer being told may now be subject to a tax & premature distribution penalty (which he plans on collecting from them if this turns out to be true)

Would IRS grant a waiver, since all of this wasn't taxpayers fault, although he didn't call me before this was done to verify if correct. Is there actually a 60 day provision, since these transactions were all trustee-to-trustee? Did taxpayer actually receive a distribution due to the withholding?

Form 5498 isn't sent until May 31st, couldn't the total amount of characterization be reported and that is what IRS would use for matching? A mess to say the least ...thanks for any input ...

[kcjenkins]

The 60 day limitation is, I believe, only on rollovers that go through the t/p's hands. Since this was trustee to trustee, most of the money was never in the clients hands, except for the amount shown as paid into the IRS [and state?] as withheld. Your client has a good court case against the financial institution that screwed this up.

The intent of Code Section 408A(d)(6), as enacted, was to permit a taxpayer who had converted an amount held in a non-Roth IRA to a Roth IRA and later discovered that his modified AGI for the year of conversion exceeded $100,000 to correct the conversion by retransferring the converted amount to a non-Roth IRA.

The regulations interpret Code Section 408A(d)(6) liberally to provide broad relief to taxpayers who wish to change the nature of an IRA contribution (and not only to allow taxpayers to correct Roth IRA conversions for which they were ineligible). Moreover, the regulations make application of Code Section 408A(d)(6) elective by the taxpayer and permit the taxpayer to recharacterize all or any portion of an IRA contribution. Reg. Section 1.408A-5, Q&A-1(a). Thus, the regulations provide that in accordance with Code Section 408A(d)(6), except as otherwise provided, if an individual makes a contribution to an IRA (the first IRA) for a taxable year and then transfers the contribution (or portion thereof) in a trustee-to-trustee transfer from the trustee of the first IRA to the trustee of another IRA (the second IRA), the individual can elect to treat the contribution as having been made to the second IRA, instead of to the first IRA, for federal tax purposes.

The regulations provide examples that illustrate the application of the recharacterization rules described above. These examples are set forth in Reg. Section 1.408A-5, Q&A-10.

[BNS]

The 60 day limitation is, I believe, only on rollovers that go through the t/p's hands. Since this was trustee to trustee, most of the money was never in the clients hands, except for the amount shown as paid into the IRS [and state?] as withheld. Your client has a good court case against the financial institution that screwed this up.

The intent of Code Section 408A(d)(6), as enacted, was to permit a taxpayer who had converted an amount held in a non-Roth IRA to a Roth IRA and later discovered that his modified AGI for the year of conversion exceeded $100,000 to correct the conversion by retransferring the converted amount to a non-Roth IRA.

The regulations interpret Code Section 408A(d)(6) liberally to provide broad relief to taxpayers who wish to change the nature of an IRA contribution (and not only to allow taxpayers to correct Roth IRA conversions for which they were ineligible). Moreover, the regulations make application of Code Section 408A(d)(6) elective by the taxpayer and permit the taxpayer to recharacterize all or any portion of an IRA contribution. Reg. Section 1.408A-5, Q&A-1(a). Thus, the regulations provide that in accordance with Code Section 408A(d)(6), except as otherwise provided, if an individual makes a contribution to an IRA (the first IRA) for a taxable year and then transfers the contribution (or portion thereof) in a trustee-to-trustee transfer from the trustee of the first IRA to the trustee of another IRA (the second IRA), the individual can elect to treat the contribution as having been made to the second IRA, instead of to the first IRA, for federal tax purposes.

The regulations provide examples that illustrate the application of the recharacterization rules described above. These examples are set forth in Reg. Section 1.408A-5, Q&A-10.

Thank you KC ...I felt the 60 day didn't really apply, except the view that the withholding was indirectly given to them. This may not have been a wise decision either, although I can understand their thinking that they would be prepaying some of their tax liability. They still would have owed lots more even with the withholding. I only wish they had asked me before the conversion what the total tax implication would be, as obviously the financial advisor didn't tell them anything and they really didn't have the cash to come up with the additional taxes that would have been due even if there AGI was less than $100K ...If income ok in other years, or wait until 2010, perhaps smaller increments would be better. The total amounts between the spouses was about $104K. The financial institution is claiming the withholdings are a premature distribution since not rolled back within 60 days. The "ROTH" did get recharacterized back to Traditional IRA account, less the withholdings. Since taxpayer returned the withhoolding money before April 15th, couldn't institution report the full amount as recharacterization on Form 5498 and if necessary request a waiver of 60 day due to total screw-up. They may be looking into this, also not sure if it would be a 2007 or 2008 early distribution. Would say 2007 since it did occur in that year, although discovery was 2008. Taxpayer is actually a young attorney, however his firm deals more with insurance related cases, but I'm sure can find connections to press the issue. He has already said he will insist that firm pay the 10% penalty if that turns out to be the case, then will move his account to somewhere else. Lives in Oregon, it does not appear they have a penalty like California. I will also forward the code sections. thanks again for your input, like I said, a real mess.