Custodian Error on Recharacterization
In April 2008, client did a $25,000 Roth conversion via an in-kind transfer from his Traditional IRA to his Roth IRA.
In October 2008, due to the market downturn, he decided to recharacterize the conversion. At the time, the value of the converted amount was $14,000. Since the client did the conversion as an in-kind transfer and subsequently sold the shares converted in-kind, he called the custodian to ask for instructions on how to complete the recharacterization request. He completed the form exactly as instructed by the custodian.
Now, in February 2009, he receives tax documents showing that the recharacterization amount was over $33,000.
I could use a few answers and some advice.
1. Given the value of the converted securities being $14,000 at the time of the recharacterization and the amount recharacterized being $33,000; it appears the custodians mistake results in recharacterization of an excess amount of $19,000. My understanding is that this harms my client by now subjecting the excess amount of $19,000 to taxes once again when either converted in subsequent years or withdrawn from the Traditional IRA. Is that the case?
2. The custodian is saying that the IRS does not allow for correction of this mistake since it was not discovered until 2009. Does anybody know if that is true? If not, what is the best way to go about getting this error corrected.
3. If the error cannot be corrected, is it unreasonable for the client to expect the custodian to make him whole by crediting one of his taxable account with funds sufficient to pay conversion taxes on the excess amount? Afterall, the recharacterization form did not include any instructions so he called the custodian and completed the form exactly as instructed.
Your help is greatly appreciated.
Permalink Submitted by Alan Spross on Tue, 2009-02-10 17:36
1) Yes, the more dollars that migrate back to the TIRA from the Roth, the higher the balance subject to future taxes will be. However, the proper net earnings allocation for recharacterizations must include the investment experience of the entire Roth account holding the conversion, not just the experience of the converted assets. This is true whether the converted assets are sold or not. Client should have seen the amount recharacterized on his IRA statements within a month of the recharacterization without having to wait for the 1099R forms. The general accuracy of the computation can be checked using the worksheet on p 31 of Pub 590 (2007 edition).
2) This is an excuse, likely caused by not knowing how to correct it or not wanting to. But the custodian does admit the calculation is wrong? IF they admit it, they probably are just trying to avoid revising the 1099R and the 5498 forms, and some additional pressure needs to be applied. A custodian does not have to provide the calculation in the first place, but if they do it incorrectly, they have to correct their error. I wish I could refer you to a Reg that confirms this. I will see if I can find one and post back.
3) This might be an option to assess the monetary damages, but what about the future earnings of the amount in the Roth that would be tax free, and will be taxed if the extra funds stay in the TIRA. A suggestion that damages will be pursued if the firm does not correct the error could be presented at the proper time, but prior to making threats it would probably be wiser to first request a conference with a senior staffer. This situation deserves management attention. If client filled out the form correctly, it eliminates one of the arguments the custodian would be likely to apply.