Roth IRA Recharacterizations

American taxpayers in general (and our clients in particular) have been encouraged to defer tax as long as possible. Since Roth IRAs have the same investment risk as other vehicles, those who chose to convert, and pay tax on, some or all of a traditional IRA are at risk of the value declining by the time tax on the conversion is due, owing tax on values that were higher than now.

To avoid this potential regret, Congress created an escape clause which is known as “recharacterization”. Taxpayers can choose to recharacterize, basically undoing the Roth IRA conversion, until mid-October of the year following the conversion (the final deadline to file returns).

2010 was the first opportunity for many of our clients to convert some or all of their traditional IRAs to a Roth IRA. Many did. With the Roth IRA, taxpayers never have to pay tax on qualified distributions and there are no minimum required distributions beginning at age 70-1/2. But when initially “converting” a traditional IRA to Roth, tax must then be paid on the amount being converted.

If a return is filed before the final deadline and it did not include the recharacterization, an amended return is required to recharacterize and the amended return must still be filed by the final deadline (typically October 15th, but October 17th in 2011).

There is very special tax treatment for Roth conversions in 2010 which allows taxpayers to spread the recognition of the income into the two succeeding years (50% each in 2011 and 2012), but this deferral of tax into two installments does not extend the recharacterization period. The deadline is still October 17, 2011.

In view of the substantial market advances throughout 2010 and 2011 thus far, it seems unlikely that a recharacterization will be attractive, but in the event of a significant decline in values later this year, we’ll be on alert to help you consider taking advantage of this second look before you actually do file your 2010 tax return.

Kacy Gott, CFP®
Chief Planning Officer, Principal

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