Case of the Week: Recharacterization Deadline

The ERISA consultants at the Retirement Learning Center Resource regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and executive compensation arrangements.

A recent call with an advisor in New Jersey is representative of a common inquiry involving a recharacterization. The advisor asked:

“Is it too late to recharacterize a Roth conversion for 2016?”

Highlights of Recommendations

A 2016 conversion to a Roth IRA, generally, can be undone (“recharacterized”) as late as Oct. 16, 2017 [IRC Sec. 408A(d)(6)].  However, if your client completed a conversion of 401(k) assets to a designated Roth account within the 401(k) plan (rather than to an external Roth IRA), he or she would not be able to recharacterize the in-plan conversion, regardless of when the conversion occurred [IRS Notice 2010-84, Q&A 6.]

The IRS will allow taxpayers to recharacterize an unwanted Roth IRA conversion for any reason without tax or penalty as long as it is done by the deadline, which is generally October 15 of the year following the year of conversion. (If the time for completing the rechacterization falls on a Saturday, Sunday or legal holiday, the deadline becomes the next businesses day. Oct. 15, 2017, is a Sunday, so the deadline becomes the 16th [IRC Sec. 7503].)

The recharacterization timeframe is connected to when your client filed his or her tax return. For a conversion to a Roth IRA completed in 2016, if your client filed his or her 2016 tax return on time (i.e., by April 17, 2017) he or she could recharacterize the unwanted conversion without tax or penalty at any time up to Oct. 16, 2017. Of course, he or she would have to properly amend the 2016 tax return to reflect the recharacterization.

For a conversion completed in 2017, if your client files his or her 2017 tax return on time (i.e., by April 16, 2018), the individual would have until Oct. 15, 2018, to recharacterize the unwanted conversion without tax or penalty.

To accomplish a recharacterization, your client would need to transfer the converted amount, along with any gains or losses, back to a traditional IRA within the prescribed IRS timeframe. Even in the case of a qualified-plan-to-Roth IRA conversion, the rechacterization must go to a traditional IRA; it cannot go back to the original qualified plan [Treasury Regulation 1.408A-4, Q&A 3 and IRS Notice 2008-30, Q&A 5].

Following a recharacterization, your client has the option to “reconvert” a similar amount to a Roth IRA after satisfying the required waiting period for a “reconversion.” The required waiting period ends on the date that is the later of:

  • 30 days after the recharacterization; or
  • January 1 of the year following the conversion.

Example: Thom converted a portion of his 401(k) plan assets in 2016 to a Roth IRA. He filed his 2016 tax return timely on April 17, 2017.  Thom elects to recharacterize his 2016 Roth IRA conversion to a traditional IRA by Oct. 16, 2017, and amends his 2016 tax return. The soonest Thom could reconvert a similar amount would be Nov. 15, 2017.

As a rule of thumb, if a client converts and recharacterizes in the same year, he or she must wait until the following year to reconvert.

Conclusion

The IRS’ Roth IRA conversion/recharacterization/reconversion rules give taxpayers a great deal of flexibility if the proper process steps are completed within the set deadlines. Clients who are contemplating any of the three actions should carefully discuss them with their tax advisors.

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“Case of the Week” is the winner of an APEX Award for Publication Excellence for 2017.

Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation.

©2017, Retirement Learning Center, LLC. Used with permission.

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