Retirement Plan Recharacterization – Part III

Lessons I’ve Learned

The following are some important lessons I’ve learned in defending (and preparing) tax returns for people who engaged this concept of recharacterization:

1. Generally, both the election to recharacterize and the transfer must take place on or before the due date for filing the tax return for the year for which the contribution or conversion was made to the first IRA.

2. To add even more salt to the water special procedures are available that allow someone who has already filed a timely tax return to recharacterize contributions for up to six months after his or her tax return’s due date exclusive of extensions.

3. If you elect to recharacterize an IRA contribution or Roth IRA conversion amount you must report the recharacterization, and must treat the contribution or conversion 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

4. To recharacterize a contribution, you generally must have the contribution transferred from the first IRA to the second IRA in a trustee-to-trustee transfer. Generally, the transfer to the second IRA must be made by the due date of your tax return for the year during which the contribution to the first IRA was made.

5. Recharacterizations made with the same trustee can be made by re-designating the first IRA as the second IRA, rather than transferring the account balance.

6. After the transfer has taken place, the election to recharacterize is irrevocable. When you recharacterizes a contribution you must:

(a) include in the transfer any net income allocable to the contribution

(b) report the recharacterization on your tax return for the year during which the contribution was made; and

(c) treat the contribution as having been made to the second IRA on the date that it was actually made to the first IRA.

7. You must also notify both the trustee of the first IRA and the trustee of the second IRA that you elected to treat the contribution as having been made to the second IRA rather than the first by the date of the transfer.

Only one notification is required if both IRAs are maintained by the same trustee and include:

(a) the type and amount of the contribution to the first IRA that is to be recharacterized;

(b) the date on which the contribution was made to the first IRA and the year for which it was made;

(c) a direction to the trustee of the first IRA to transfer in a trustee-to-trustee transfer the amount of the contribution and any net income (or loss) allocable to the contribution to the trustee of the second IRA;

(d) the name of the trustee of the first IRA and the name of the trustee of the second IRA; and

(e) any additional information needed to make the transfer.

8. The election to recharacterize can be made on behalf of a deceased IRA owner by the executor, administrator, or other person responsible for filing the decedent’s final income tax return.

9. Generally, any amount that has been moved from one IRA to another in a tax-free transfer, such as a rollover, cannot be recharacterized. However, a taxpayer who mistakenly rolls over or transfers an amount from a traditional IRA to a SIMPLE IRA can later recharacterize that amount as a contribution to another traditional IRA.

10. If you receive a distribution from traditional IRA and contribute the entire amount to a different traditional IRA in a rollover contribution you cannot elect to recharacterize the contribution by transferring the contribution amount, plus net income, to a Roth IRA, because an amount contributed to an IRA in a tax-free transfer cannot be recharacterized. However, you can convert (other than by recharacterization) the amount in the second traditional IRA to a Roth IRA at any time, provided it satisfies the requirements for a qualified rollover contribution.

11. Employer contributions including elective deferrals under a SEP or SIMPLE plan cannot be recharacterized as contributions to another IRA. However, an amount converted from a SEP IRA or SIMPLE IRA to a Roth IRA can be recharacterized to a SEP IRA or SIMPLE IRA, including the original SEP IRA or SIMPLE IRA.

12. You cannot deduct any loss that occurred while the funds were in the first IRA. Also, no deduction is allowed for a contribution to a traditional IRA if the amount is later recharacterized.

13. The recharacterization of a contribution is never treated as a rollover for purposes of the one-year waiting period even if the contribution would have been treated as a rollover contribution by the second IRA if it had been made directly to the second IRA rather than as a result of a recharacterization of a contribution to the first IRA.

14. Timing of recharacterization. Generally, both the election to recharacterize and the transfer must take place on or before the due date (including extensions) for filing the tax return for the year for which the contribution to be recharacterized was made. If you miss the election deadline you can still elect to recharacterize a contribution if:

(1) your tax return was timely filed for the year the election should have been made; and

(2) you take appropriate corrective action within six months from the due date of the return, not including extensions consisting of: notifying the trustee of the taxpayer’s intent to recharacterize; providing the trustee with all necessary information; and having the trustee transfer the contribution.

After taking the necessary corrective action, you must amend your tax return to show the recharacterization. In addition to reporting the recharacterization, you must write on the amended return, “Filed pursuant to section 301.9100-2

Excess contributions actually made for a prior year and deemed to be current-year contributions for purposes of the Code Sec. 4973 excise tax on excess contributions may be recharacterized only if recharacterization would still be timely with respect to the tax year for which the contributions were actually made. This rule applies to any excess contribution, whether made to a traditional or a Roth IRA.

For more information see IRS Publication 590 – Individual Retirement Arrangements.

In accordance with Circular 230 Disclosure

Enrolled with the United States Treasury Department to practice before the IRS, governed by rules stipulated in United States Treasury Circular 230. As a Federally Authorized Tax Practitioner and a tax appeals specialist my Enrolled Agent License #85353 is issued by the United States Treasury. With this license I work for U.S. taxpayers everywhere to resolve tax matters and de-escalate stress about taxes or tax disputes for individuals and corporations with federal and state issues.

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