Retirement Plan Recharacterization means according to Reg. Sec. 1.408A-5 that if you make a contribution to one type of IRA (Individual Retirement Account)  you may be able to treat the contribution as though it had been made to a different type of IRA. This is basically considered a correction that can be significant for a wide variety of reasons.

One common reason that I’ve seen is if you converted a traditional IRA to a Roth IRA you may want to recharacterize the Roth IRA back to a traditional IRA if the value of the assets in the Roth IRA has declined between the conversion date and the due date for the tax return reporting the conversion.

This is because the amount you would have to include in income as a result of the conversion to a Roth IRA is based on the value of the account at the time of the conversion and does not take into account the decline in value between the conversion date and the due date of the return including extensions.

However a most common issue for recharacterization purposes occurs when you receive a distribution from a traditional IRA in one tax year and roll it over into a ROTH IRA in the next tax year but still within 60 days of the distribution from the traditional IRA. In this case you treat the contribution to the ROTH IRA as though it occurred in the year of the distribution from the traditional IRA.

You recharacterize a contribution or IRA conversion in either of two ways, a trustee-to-trustee transfer or simply by re-designating the first IRA as the second IRA, rather than transferring the account balance.

If you elect to recharacterize an IRA contribution you must report the recharacterization, and you must treat the contribution as having been made to the second IRA instead of the first IRA, on your income tax return for the tax year for which the recharacterized contribution was made to the first IRA. There are 2 types of recharacterizations that I’ll address.

1. You made a contribution to a traditional IRA and later recharacterized part or all of it to a Roth IRA.

If you recharacterizes only part of the contribution and the contribution included nondeductible amounts, you must report any nondeductible portion that remains in the traditional IRA on Part I of Form 8606, Nondeductible IRAs. If you recharacterize the entire contribution you do not report the contribution on Form 8606. See IRS Form 8606 Instructions for further information.

In either case, you must attach a statement to your tax return explaining the recharacterization.

For example if you contributed $4,000 to a new traditional IRA on May 27, 2013 and on February 24, 2014, you determined according to the active participant rules that your 2013 modified adjusted gross income will limit your traditional IRA deduction to $1,000. The value of your traditional IRA by that time grew to $4,400. You decided to recharacterize $3,000 of the traditional IRA contribution as a Roth IRA contribution, and have $3,300 ($3,000 contribution plus $300 related earnings) transferred from your traditional IRA to a Roth IRA in a trustee-to-trustee transfer and subsequently deduct the $1,000 traditional IRA contribution on Form 1040.

In this case you do not have to file Form 8606, but must attach a statement to your return explaining the recharacterization.

The statement indicates that you:

(a) contributed $4,000 to a traditional IRA on May 27, 2013;

(b) recharacterized $3,000 of that contribution on February 24, 2014, by transferring $3,000 plus $300 of related earnings from the traditional IRA to a Roth IRA in a trustee-to-trustee transfer; and

(c) that all $1,000 of the remaining traditional IRA contribution is deducted on Form 1040.

You do not report the $3,300 distribution from the traditional IRA on her 2013 Form 1040 because the distribution occurred in 2014. You do not report the distribution on your 2014 Form 1040 either, because the recharacterization related to 2013 and was explained in an attachment to her 2013 return.

2. You rolled over an amount from a qualified retirement plan to a Roth IRA in 2013 and later recharacterized all or part of the amount to a traditional IRA.

If you recharacterizes only part of the amount rolled over, you must report the amount not recharacterized on Form 8606, Nondeductible IRAs. If you recharacterizes the entire amount you do not report the recharacterization on Form 8606.

In either case, you must attach a statement to your tax return explaining the recharacterization and you must include the amount of the original rollover on the line for “pensions and annuities” on Form 1040, Form 1040A, or Form 1040NR. If the recharacterization occurred during the year for which the return is being filed, you must also include the amount transferred from the Roth IRA on the line for “IRA distributions” on Form 1040, Form 1040A, or Form 1040NR.

If the recharacterization occurred in the following year, you report the amount transferred only in the attached statement, and not on his or her return for the preceding year or for the year in which the recharacterization occurred.

For example you rolled over $50,000 from your 401(k) plan to a new Roth IRA on July 20, 2013. On March 25, 2014, you decided to recharacterize the rollover. The value of the Roth IRA on that date is $49,000. You recharacterize the rollover by transferring that entire amount to a traditional IRA in a trustee-to-trustee transfer and report $50,000 as an amount received from pensions and annuities on the line for “IRA distributions” on your 2013 Form 1040. You do not include the $49,000 as an IRA distribution on line 15a because it did not occur in 2013. You also do not report that amount on his 2014 return because it does not apply to the 2014 tax year. You do not have to file Form 8606, but you must attach a statement to his 2013 Form 1040 explaining that:

(a) you made a rollover of $50,000 from a Code Sec. 401(k) plan to a Roth IRA on July 20, 2013, and

(b) you recharacterized the entire amount, which was then valued at $49,000, to a traditional IRA on March 25, 2014.

In accordance with Circular 230 Disclosure