Recharacterize a Roth Conversion

Submitted by THOMAS WNUK on Sat, 2018-02-10 16:40

An individual had a rollover IRA in 2017. The individual made no contributions to the IRA in 2017. In 2017 the individual converted 100% of the assets in the IRA to a Roth. Tax returns for 2017 have not been filed.

The question is; Is it possible to recharacterize the Roth now and reduce the tax burden for 2017?

My understanding from perusing Publication 529-A is that recharacterization would apply to contributions, but maybe not the principal amount converted.

I’ll hang up and listen.

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Permalink Submitted by Alan - IRA critic on Sat, 2018-02-10 17:21

Yes, a 2017 conversion can be recharacterized up to 10/15/2018. 2017 is the last year for which conversions can be recharacterized. However, if there are significant gains on the conversion, a recharacterization will transfer those gains back to a TIRA. For example, if a 10,000 conversion gained 20% and is now worth 12,000, and the combined federal and state marginal rate is 28%, because of the gain the 12,000 in the Roth was achieved at an effective rate of 23.3%.

Permalink Submitted by David Mertz on Sat, 2018-02-10 18:09

That should read “… and is *now* worth $12,000.”

Permalink Submitted by THOMAS WNUK on Mon, 2018-02-12 14:47

nfm

Permalink Submitted by THOMAS WNUK on Sat, 2018-02-10 18:13

Thanks Alan I thought that would be the case. Taxes on any gains would be a pittance compared to the taxes on the converted amount. Another factor to consider is that the additional income from the conversion caused the amount of taxable Social Security income to triple up to the 85% maximum which would result in an additional substantial tax bite.

Permalink Submitted by THOMAS WNUK on Mon, 2018-02-12 19:08

Does the recharacterization have to be done in 2017 to apply to 2017 tax return?

Permalink Submitted by Alan - IRA critic on Mon, 2018-02-12 23:01

It must be done by 10/15/2018 if the 2017 return is filed by 4/17 or an extension is filed. Otherwise, by 4/17.

Permalink Submitted by THOMAS WNUK on Sun, 2018-02-25 16:36

So in 2017 account owner converted $40K from a TIRA to a Roth. At the time of recharacterization, the makeup of the Roth was 300 shares of stock A, 13 shares of stock B and a small amount of cash. In mid-Feb 2018 account owner requested recharacterization 200 of the of the 300 shares of stock A back to the TIRA. Since the 1099-R and 5498 for 2017 have already been issued and won’t be amended the custodian sent two letters.One letter stated that the amount remaining in the Roth was $xx + plus a gain of $yy for a value of $zz The other stated that the amount returned to the TIRA was $aa + a gain of $bb for a value of $cc Is the amount $zz the amount that needs to go in 1040 line 15b as the taxable amount of the distribution? My accountant sent me a worksheet to go through in order to determine how much to report on line 15b and that the worksheet would need to accompany my return. Would the worksheet amount need to be the same as the $zz amount from the letter?My intuition tells me that the amounts $xx and $aa should have equalled the original $40K. Between 01/01/18 and 01/31/18 the account owner converted additional TIRA money into the Roth. I’m wondering if the custodian recharacterized conversions from both years or just from 2017. Since $xx + $aa don’t equal the original $40K I’m guessing that they did.

Permalink Submitted by Alan - IRA critic on Sun, 2018-02-25 18:41

The taxable amount of the conversion is $xx. That is reported on Form 8606, and if there was basis in the TIRA, then Form 8606 will apply that basis in Part I and Part II will show the taxable amount of the conversion. $xs goes on line 15a of Form 1040 and 15b would be the same or less if TIRA basis reduced the taxable amount.
Since the partial recharacterization occurred in 2018, the 2017 return will NOT show any of the amounts on line 15. However, the 2017 return requires an explanatory statement indicating the amount and date of the conversion, the amount of that conversion that was recharacterized ($aa) and what the recharacterized portion was worth when transferred back to the TIRA ($cc). This is what the IRS requests in the 8606 Inst.
The worksheet should not go with the return. The IRS wants the brief explanatory statement instead.
You are correct that xx plus aa should equal 40k. Since they don’t add up, something is wrong. A review of the Feb, 2018 account statements should identify what was done. This should be done before completing the explanatory statement, although if the 2018 conversion was recharacterized as well, that will not be reported on the 2017 return. The eventual 1099R issued in Jan, 2019 to report the recharacterization of the 2017 conversion will be coded R to indicate that a 2017 conversion was recharacterized. If the 2018 conversion was recharacterized as well, that will be reported on a separate 1099R coded N.
It will be interesting to see if the Feb statements differ from the letter.The letter should have clarified the date of the conversion being partially recharacterized. Note that if more than one conversion was recharacterized, the calculations must be separate as well as the 1099R forms if the conversions were done in different years.

Permalink Submitted by THOMAS WNUK on Sun, 2018-02-25 19:54

There was no date of recharacterization in either letter. How are the gains treated for tax purposes?

Permalink Submitted by Alan - IRA critic on Sun, 2018-02-25 22:15

The account statements for Feb should still be revealing. The gains on the conversion portion that is retained stay in the Roth and the gains on the recharacterized portion are transferred back to the TIRA, These are NOT taxable events and Box 2a on the 1099R that reports them will therefore not show any taxable amount.

Permalink Submitted by THOMAS WNUK on Sun, 2018-02-25 22:45

Thank you. If the account holder wanted to reconvert the recharacterized amount back to the Roth could that still be done in 2018?

Permalink Submitted by Alan - IRA critic on Mon, 2018-02-26 00:16

Yes, it can be reconverted after waiting 30 days from the date of the recharacterization.

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