Husband and wife each have traditional IRA accounts with the same fund company.
Each took premature distributions in late 2007. His due to disability with no intent to return the funds to the account.
Hers with the intent to cover short term expenses and replace within 60 days.
He wrote a check to return most of the amount of the distribution from her account and sent it to the fund company, but missed the 60 day deadline (They paid the tax and penalty on their 2007 return).
Funds were erroneously placed in his account rather than hers.
Error was just discovered.

Fund company admits error and, in fact, says that the check should have been returned to the investor since they missed the deadline. By way of correction, they have offered to remove the money from husbands account as of the date that it went in (Jan 15, 2008), and replace it in her account, as a rollover, as of the same date (Jan. 15, 2008). The issue I have with that is that the tax and penalty have already been paid and double taxation should be avoided. How is this reported to the IRS? Can or should this be considered a rollover of an “after-tax IRA”? The fund compay has offered to “recharacterize” the account as a Roth IRA, but as of the current date, not the original Jan. 15 2008 date, and I’m not sure how the IRS would look at that. While the Roth recharacterization is attractive from a future taxation standpoint, would it be better to have them simply remove the funds from the husbands account and return them to the wife, then she can place them in an individual “non-IRA” account?

Thank you!
Jeff