Recharacterize R/O from Traditional to Roth
In 2010 a client rolled over funds from a 403B with significant basis into a traditional IRA. When I sat with him to complete his tax return, the 1099-R for the transfer showed the basis (most of the funds) and I asked him why he did not roll it into a Roth instead.
Since the rollover occurred in 2010 and the recharacterization deadline has not yet passed, is he permitted to recharacterize a R/O contribution to a TIRA to a Roth? I know we generally think of recharacterizations as referring to undoing a Roth conversion rather than “correcting” a rollover, but Pub 590 and Form 8606 seem to imply that this is also permitted – though they do not clearly say so. BTW – the broker (Pershing) says this is not permitted by the IRS. They say that you can only recharacterize a “contribution” or a Roth conversion, not a R/O. However, Pub 590 seems to refer to a R/O as just another type of contribution.
Permalink Submitted by Alan Spross on Wed, 2011-03-16 21:44
Pershing is correct. The Pub 590 reference is not very easy to understand even when you read it. See p 29 “effect of previous tax free transfers”. And here is the IRS Reg from 1.408A-5 Q 4:
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Q–4. Can an amount contributed to an IRA in a tax-free transfer be recharacterized under A–1 of this section?
A–4. No. If an amount is contributed to the FIRST IRA in a tax-free transfer, the amount cannot be recharacterized as a contribution to the SECOND IRA under A–1 of this section. However, if an amount is erroneously rolled over or transferred from a traditional IRA to a SIMPLE IRA, the contribution can subsequently be recharacterized as a contribution to another traditional IRA.
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So this was an expensive error. All he can do now is to file the 8606 when it is next due to add his basis to his TIRA on line 2. Then he can convert but it will be subject to the pro rate rules and it will also not be a 2010 conversion, so the taxable portion cannot be deferred for two years.