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The August issue of Ed Slott's IRA Advisor Newsletter discusses one of the few second chances in the tax code.

A Roth recharacterization.

The provision allows you to undo (to reverse) a Roth conversion as if it never happened and no tax is owed.

You have to admit that is a good deal considering the rigid, unforgiving tax code in many areas.

The August issue of Ed Slott's IRA Advisor Newsletter talks about traps you can run into with the Roth recharacterization and how to avoid them.




Inside Ed Slott's IRA Advisor Newsletter

Roth Recharacterization Traps and How to Avoid Them

  • Failing to recharacterize an ineligible 2009 conversion
  • Not understanding MAGI for 2009 Roth conversions
  • Unnecessary 2010 Roth recharacterizations
  • Losing out on the 2-year income split
  • The amount recharacterized is NOT the amount transferred back to the IRA
  • You can't recharacterize money that was used to pay taxes
  • Advisor action plan

IRS Denies Late Recharacterization Request

PLR 201024071 Released by IRS June 18, 2010

  • Facts of the case
  • Impact of the IRS' emphasis on the 'necessity' to recharacterize
  • IRS allows a late recharacterization
  • IRA recharacterization rules
  • Advisor action plan

IRA Beneficiaries Win Another Round on Creditor Protection

If you are not already an Ed Slott's IRA Advisor Newsletter subscriber, you can preview past issues before subscribing.


Staying with IRA Updates' August theme of recharacterizations, here is an article on the virtue of patience when it comes to the decision-making process with recharacterizations.

Some taxpayers who did Roth conversions earlier this year have seen their account values drop. As a result, they are considering doing a recharacterization of their Roth back to an IRA. But maybe they should wait a while. Why? Maybe, if they wait long enough, the Roth account will recover and not need to be recharacterized.

The better answer, however, lies in the rules for reconverting assets once they have been recharacterized. A 2010 Roth conversion that is recharacterized in 2010 cannot be reconverted until at least 2011. What if you converted in January 2010, your assets decline, so you recharacterize in August 2010? Now you cannot reconvert those funds to a Roth IRA until January 1, 2011. If the account recovers, you will have to pay income tax on the increased value when you reconvert. A 2010 conversion that is recharacterized in 2011 can be reconverted after a 30-day waiting period. In no case can you reconvert in less than 30 days.

The biggest issue, however, may be the ability to spread the taxes over 2 years, 2011 and 2012. That option is only available for a 2010 conversion. If you recharacterize a 2010 conversion in 2010 you lose that option - even on your reconversion. The reconversion will be done in 2011 and you cannot split the income on a 2011 conversion.

Everyone who timely files their tax return and pays their taxes has until October 15th of the year after the conversion to do a recharacterization. For conversions done in 2010, you have until October 17, 2011 to recharacterize. You don't have to do it now.

Take your time and evaluate all your options before making the recharacterization decision.


Private Letter Ruling 201029021

An individual we will call "Jack" maintained an IRA at Financial Institution D. He performed an online transaction which he intended to be a trustee-to-trustee transfer from his IRA to a new IRA at Financial Institution E.

However, the documents he filled out were for the establishment of a non-IRA investment account - NOT an IRA account. The new financial institution deposited the IRA funds it received into the type of investment account designated by the application. "Jack" did not realize for several years that he had completed the wrong form. He became aware of the mistake when the IRS informed him that his IRA had been distributed. "Jack" stated that the internal policies of either Financial Institution should have flagged the transaction as a non-standard transaction, and he requested a ruling that the IRS waive the 60-day rollover requirement.

However, the IRS ruled that "Jack" had not provided any evidence that indicated an error by either financial institution and denied his request.

IRA Technical Consultant Beverly DeVeny's take:

A mistake in typing an account number or selecting the wrong option can mean the end of your IRA. If you are not sure which box to select, ask for help. It didn't help that the account owner did not notice the error for "several years." PAY ATTENTION to what you are doing and follow-up.

Q: If I am over the income limit, can I contribute $5,000 to my traditional IRA and then once it is funded convert it into a Roth IRA every year after that, effectively funding a Roth IRA? If this is possible are there any rules or guidelines that I need to be aware of?

A: Yes, there are income limits that still apply to making Roth IRA contributions. If you are over the limit you can, if you have earned income, make a non-deductible IRA contribution. The maximum you can contribute in 2010 is $5,000 and if you are age 50 or older by 12/31/2010 you can add an additional $1,000 for a total of $6,000. Then you can convert an amount equal to the contribution to a Roth IRA. When doing that conversion you must consider all of your IRAs to calculate the amount that is taxable. This is known as the pro rata rule.


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