Recharacterization
Client did a roth conversion in July 2007 and did a roth conversion for 2008 several days ago. Given the magnitude of recent decline, we are now looking at reversing the 2007 conversion. Please verify the following: 1) even though client filed 2007 tax return in April, they can recharacterize 2007 conversion until October 15th 2008 as everyone automatically gets 6 month extension and 2) the 2008 conversion has no impact on reversing 2007 conversion other then the impact that it has on NIA calculation.
Thanks in advance.
Glenn
Permalink Submitted by Alan Spross on Wed, 2008-10-08 02:00
Glenn, you are correct on Q1. The automatic extension is granted with either a timely return filing or an extension filing by 4/15.
2) is also correct. The 08 conversion, if done into the same Roth account as the 07 conversion will affect the calculation of the NIA on the 07 recharacterization. That need for a calculation would be eliminated if each Roth conversion is made to a separate Roth IRA account, maintained until the recharacterization deadline passes. Client may want to consider that for future conversions. The separate account also eliminates diluting the investment results of a particular conversion.
Permalink Submitted by Glenn Wager on Wed, 2008-10-08 18:38
A qucik follow up question. The client is over 70.5 and took 2008 RMD before doing the 2008 conversion. As I understand it, if I reverse the 2007 conversion, the amount reversed is subject to RMD as if it had been in IRA on 12/31/07 even though it was in roth. Further, as I understand it, the RMD has to be completed before you can do conversion (which it was per the RMD that was calculated at the beginning of the year. If I now reverse the 2007 conversion and need to take an additional withdrawal to cover RMD on that amount for 2008, technically, would part of the 2008 conversion be disqualified since the RMD was supposed to be done before conversion (even though there was no way of knowing we would reverse 2007 until now).
I hope this makes sense.
Also a quick side note. You stated “The separate account also eliminates diluting the investment results of a particular conversion.” It seems to me that, given the NIA calculation, the dilution can work both for and against you. In the event you have a gain on the amount being recharacterized, it can be diluted by an additional converison prior to recharacterization. Do you see anything wrong with using that approach.
Glenn
Permalink Submitted by Alan Spross on Wed, 2008-10-08 23:56
You are probably thinking more in depth on this than the IRS ever would, and this issue had not even occurred to me before. Certainly, there is no IRS Reg that fully covers it, but in your example at the time of the 2008 conversion, the 2008 RMD HAD been satisfied at it existed at the time. A rollover would be outstanding when it is distributed, but a recharacterization does not factor in to the RMD until it is executed, and it does not seem logical to force the taxpayer to assume full recharacterization of conversions.
To be more pragmatic, the 1099R info the IRS receives does not have dates on it anyway. The IRS will be notified of the recharacterization or of rollovers, and of the RMD distribution, but not the dates of any of them. Therefore, I would only make sure to bring the RMD up to the correct total and not worry about the 2008 conversion. Excellent point though.
I agree on the dilution issue, it can either increase or reduce the pure earnings of the conversion at issue, and that can be a positive or negative depending on other issues and whether you are converting with a particular strategy or not. At the time of a recharacterization decision, the earnings the actually resulted from a conversion at that point in time affects the actual tax cost of the conversion. For example if there is a 20% loss, then the tax rate on the conversion at that point is iincreased by a 1.25 factor. A 20% gain reduces the tax rate by nearly 17%.