Reconversion

[Guest AMAN]

Is the following assertion correct?

A taxpayer can recharacterize his Roth IRA (which was the result of a conversion in 1998) to a traditional IRA by October 15, 1999 as long as he filed a timely return, even if he was not over the $100,000 limit or did not mark his return "married filed separately." (i.e. taxpayers can recharacterize by October 15, 1999 for any reason, as long as they filed a timely return)

[BPickerCPA]

Your assertion is correct.

[Guest Mary Ann]

If one recharacterizes the Roth to a traditional IRA does this mean it will be converted to a traditional IRA - and since the taxes have already been paid on it for 1998 - that the IRA will have a basis of the original converted amount that the tax has been paid on? Could one choose to have that result - Or would one have to go back and amend the 98 tax return for a refund?

Client converted to a Roth in 98. Now has decided to buy a house and withdraw the funds. He would be hit with a 10% penalty for being under 59 1/2 and also 10% penalty for withdrawing before 5 years had elapsed. So if he were to recharacterize, then withdraw from traditional IRA he at least would avoid the second 10% penalty.

I'll have to do some research but will appreciate any replies.

[Kathy]

First of all, I don't believe there are 2 10% penalties. If you withdraw ffunds from a converted Roth within 5 years of the conversion, then there is a 10% penalty applied unless one of the penalty exceptions applies. Just one 10% penalty, not two.

Secondly, the purpose of recharacterizing is to either back out of a conversion that was not allowed (income was too high or married people end up filing separately). Some people are using it if they find they can't afford the taxes on the conversion. However, if the conversion was proper and they can afford the taxes, there is no need to recharacterize.

[BPickerCPA]

[[secondly, the purpose of recharacterizing is to either back out of a conversion that was not allowed (income was too high or married people end up filing separately). Some people are using it if they find they can't afford the taxes on the conversion. However, if the conversion was proper and they can afford the taxes, there is no need to recharacterize.]]

People are permitted to recharacterize for ANY reason. They MUST recharacterize if the original conversion is improper, but for a reason as simple as "I changed my mind", you can recharacterize.

On other issues, I agree that there is only 1 10% penalty.

[BPickerCPA]

By the way, if the withdrawal if for a qualified first time home purchase, and properly limited, then the 10% penalty is avoided even if withdrawn from the Roth. However, if the 4 year spread of income was elected, then the withdrawal will cause an acceleration.

[Guest Mary Ann]

If there is only "one" 10% penalty, then which one is it? The one for taking the funds out before 5 years have passed? - or the one for being under 59 1/2 at the time of withdrawl? The lasst seminars I attended indicated that both penalties would apply. Which one do you think does not apply?

This client is not a first time home buyer so I don't believe he has any relief in that direction.

No one spoke to the issue of what the basis in the IRA would be after reconversion. I suspect it would be best to go back and amend 1998 when the original conversion took place and apply for a refund. Then when he takes the money out in 1999 the tax won't be due until then.

Thanks for your replies.

[BPickerCPA]

[[if there is only "one" 10% penalty, then which one is it? The one for taking the funds out before 5 years have passed? - or the one for being under 59 1/2 at the time of withdrawl? The lasst seminars I attended indicated that both penalties would apply. Which one do you think does not apply?]]

There is a 10% penalty that applies to taking conversion dollars out of a roth within the first five years after the conversion. Any applicable exception applies to this penalty, including being over age 59½.

There is also a 10% penalty for taking EARNINGS out of a roth prior to attaining age 59½. Again, any applicable exception applies.

By definition, both penalties cannot apply to the same dollars, but since a withdrawal can consist in part of both types of dollars, both penalties can be applicable. For example, you convert $100K and then 3 years later when it is worth $115K, you empty the account. No exception applies. You will pay a 10% on the $100k of converted value withdrawn within 5 years, and you will pay income tax AND 10% penalty on the $15K of earnings, since you are under 59½.

I am saddened, but not surprised, that wrong info is being given in seminars. I've heard too much of this.