quote:
Originally posted by John G:
BPicker, a question for you. Who makes the calculation? The custodian or the taxpayer/tax preparer? I had the impression that the custodian wants to do the math because of fiduciary responsibilities.
The partial recharacterization rules (unless they have been revised since the 1999 CFR quoted below) appear to assume the custodian will compute the income allocable to the amount being transferred; otherwise they would be impossible to comply with.
The basic rule in 1.408-5 seems to be:
(a) An individual makes the
election described in this section by
notifying, on or before the date of the
transfer, both the trustee of the FIRST
IRA and the trustee of the SECOND
IRA, that the individual has elected to
treat the contribution as having been
made to the SECOND IRA, instead of
the FIRST IRA, for Federal tax purposes.
The notification of the election
must include the following information:
the type and amount of the contribution
to the FIRST IRA that is to
be recharacterized [note - not the amount of income attributable; it would be odd to lump that in as "any additional information" below -- Condorcet];
the date on which the contribution was made to the FIRST IRA and the year for which it
was made; a direction to the trustee of
the FIRST IRA to transfer, in a trustee-
to-trustee transfer, the amount of
the contribution and net income allocable
to the contribution to the trustee
of the SECOND IRA; and the name of
the trustee of the FIRST IRA and the
trustee of the SECOND IRA and any
additional information needed to make
the transfer.
***
© If paragraph (B) of this A–2 does
not apply, then the net income attributable
to the amount of a contribution
is calculated in the manner prescribed
by §1.408–4©(2)(ii) (disregarding the
parenthetical clause in §1.408–
4©(2)(iii)).
Section 1.408 ©(2) provides:
(ii) The amount of net income attributable
to the excess contributions is an
amount which bears the same ratio to
the net income earned by the account
during the computation period as the
excess contribution bears to the sum of
the balance of the account as of the
first day of the taxable year in which
the excess contribution is made and
the total contribution made for such
taxable year. For purposes of this paragraph,
the term ‘‘computation period’’
means the period beginning on the first
day of the taxable year in which the
excess contribution is made and ending
on the date of the distribution from the
account.
(iii) For purposes of paragraph
©(2)(ii), the net income earned by the
account during the computation period
is the fair market value of the balance
of the account immediately after the
distribution increased by the amount
of distributions from the account during
the computation period, and reduced
(but not below zero) by the sum
of: (A) the fair market value of the
balance of the account as of the first
day of the taxable year in which the
excess contribution is made and (B) the
contributions to the account made during
the computation period.
***
Assuming the date of the "distribution" is the date of the recharacterization transfer, there is no way for the taxpayer to know the proper amount of earnings to transfer. IMHO, the IRS regulations suffer throughout from a fundamental defect, in that they assume the taxpayer is in control of the timing of events, rather than at the mercy of an incompetent and indifferent custodian. In practice, what does one do? If the taxpayer is forced to specify the amount, and errs on the high side, may he then simply treat a sufficient portion of the phantom "earnings" as a greater amount of recharacterized contribution? That is, if one needs to recharacterize $100 because the custodian misreported a 1998 amount on a 1999 form 1099R (just to use a random example), and one estimates $50 of earnings and therefore orders $150 transferred, but it turns out the earnings were only $40 on $100 as of the transfer date, then may (should) he treat it as a recharacterization of $107.14 and earnings of $42.86? If so, must he send some kind of revised notice to the custodian(s)? (and what does he do when the first custodian again will not report correctly to the IRS?). Is there reason to believe the IRS will live with a calculation that is accurate as of the close of business the day before the transfer instructions are mailed, or delivered, to the custodian?
Editorial comment: IMHO, Senator Roth and his pandering colleagues who created the nightmarish complexity of the IRA provisions of the Code are responsible for many billions of dollars in deadweight loss to the national economy, namely the value of resources and time expended on creating, interpreting, and trying to comply with arbitrary rules; the fees spent on setting up (and transfering from unsatisfactory custodians) millions of unnecessary additional accounts; the trees destroyed to print all the reports, etc. – all for a supposed incentive to private savings that is so inefficient it would be laughable were it not for the enormous waste of resources involved (most contributions to IRAs come from funds that would have been saved without a tax gimmick, reinvestments within an IRA may be offset by a higher marginal propensity to consume income outside the IRA, and of course the loss of revenue contributes to public dissaving).
-- Condorcet