Does recharacterization allow tax deduction?
Taxpayer makes $5,000 Roth IRA contribution “for” 2010 on 4/15/2011 before completing 2010 tax return.
Taxpayer later learns that he could have made a deductible TIRA contribution for 2010 so he recharacterizes the 4/15/2011 Roth contribution to TIRA in August, 2011.
Is the $5,000 2010 tax deduction saved?
Thanks
Permalink Submitted by Peter Lingane on Mon, 2011-11-07 16:59
Yes. Think of recharacterizing as substituting a second event for the initial event. A timely recharactrerization of a contribution to a Roth IRA to a contribution to a traditional IRA is identical to having made a contribution to a traditional IRA on April 15th. It may be necessary to amend the federal and state tax returns to claim the benefit of the traditional IRA contribution.
Permalink Submitted by Anonymous (not verified) on Mon, 2011-11-07 20:03
Thanks Peter that’s the answer I was hoping for, can you provide a cite? The pesky IRS is arguing otherwise.
Permalink Submitted by Peter Lingane on Mon, 2011-11-07 21:03
I based my response on the regulations cited below. It is odd that the IRS would be challenging a 2010 return so soon after the filing deadline. Are you sure that the IRS is concerned about the income tax treatment of the recharacterized IRA? Might there have been an error in the way that the Roth IRA was recharacterized?
Reg. §1.408A-5. Recharacterized contributions.
Q-3. What is the effect of recharacterizing a contribution made to the FIRST IRA as a contribution made to the SECOND IRA?
A-3. The contribution that is being recharacterized as a contribution to the SECOND IRA is treated as having been originally contributed to the SECOND IRA on the same date and (in the case of a regular contribution) for the same taxable year that the contribution was made to the FIRST IRA. Thus, for example, no deduction would be allowed for a contribution to the FIRST IRA, and any net income transferred with the recharacterized contribution is treated as earned in the SECOND IRA, and not the FIRST IRA.
A-10. The rules in this section are illustrated by the following examples:
Example (2). In 1998, an individual makes a $2,000 regular contribution for 1998 to his traditional IRA (FIRST IRA). Prior to the due date (plus extensions) for filing the individual’s Federal income tax return for 1998, he decides that he would prefer to contribute to a Roth IRA instead. The individual instructs the trustee of the FIRST IRA to transfer in a trustee-to-trustee transfer the amount of the contribution, plus attributable net income, to the trustee of a Roth IRA (SECOND IRA). The individual notifies the trustee of the FIRST IRA and the trustee of the SECOND IRA that he is recharacterizing his $2,000 contribution for 1998 (and provides the other information described in A-6 of this section). On the individual’s Federal income tax return for 1998, he treats the $2,000 as having been contributed to the Roth IRA for 1998 and not to the traditional IRA. As a result, for Federal tax purposes, the contribution is treated as having been made to the Roth IRA for 1998 and not to the traditional IRA. The result would be the same if the conversion amount had been transferred in a tax-free transfer to another traditional IRA prior to the recharacterization.
Example (3). The facts are the same as in Example 2, except that the $2,000 regular contribution is initially made to a Roth IRA and the recharacterizing transfer is made to a traditional IRA. On the individual’s Federal income tax return for 1998, he treats the $2,000 as having been contributed to the traditional IRA for 1998 and not the Roth IRA. As a result, for Federal tax purposes, the contribution is treated as having been made to the traditional IRA for 1998 and not the Roth IRA. The result would be the same if the contribution had been transferred in a tax-free transfer to another Roth IRA prior to the recharacterization, except that the only Roth IRA trustee the individual must notify is the one actually making the recharacterization transfer.
Permalink Submitted by Anonymous (not verified) on Mon, 2011-11-07 23:10
Peter, thanks for the on-point citation. This is actually a 2009 contribution/deduction that the IRS is challenging, I changed the facts slightly in the posted example.
Permalink Submitted by Alan Spross on Mon, 2011-11-07 23:31
DId you check to be sure the 1099R and 5498 forms conform to what was intended, including the coding on the 1099R?
Also, was an explanatory statement made on the 1040X used to claim the deduction?