Recharacterization of Roth Conversion

[Bruce Steiner]

Taxpayer had a large traditional IRA, which she intended to convert to a Roth IRA over a number of years, beginning 1999 and ending the year before reaching age 70 1/2, so as not to be in the highest income tax bracket in any year.

She converted some in 1999, and some in 2000, and now finds that her income went over $100,000 in 1999. So she has to recharacterize the 1999 conversion, along with the "income" thereon.

The calculation would be simple if she had not yet done the conversion for 2000 (into the same account). But it's made more complicated by the fact that she already did the conversion for 2000.

The regulations appear to say that she simply has to write to the IRA custodian (in this case, a large brokerage firm) to have them recharacterize the 1999 contribution plus the "income" thereon. This would leave it up to the IRA custodian to do the calculation.

What is the best way to handle this?

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Bruce Steiner, attorney

(212) 986-6000 (NY office)

(201) 862-1080 (NJ office)

also admitted in FL

[John G]

I have had some exposure to this problem. Be prepared for a real mess. Yes, the custodians of brokerages have had some exposure to these Roth "divorces". But expect misunderstandings about the circumstances, dates, and procedures. Don't assume that each staffer at your custodian execute the procedures in the same way, so if more than one person handles the problem your risk of a screw-up increases. Don't assume that they use the correct prices for shares on the proper dates.

My suggestion is that you bypass the local staff and talk directly to the upper levels of the IRA department that is more familiar with these issues. It is my understanding is that the big firms have proceedures in place for how to do this, you may get to provide some input, but that is probably at the custodians discretion. Do check their results. I have some experience with a pricing problem where Bear Stearns was off about 35%.

Sounds like you need better income forecasts. Some of the wild cards include mutual fund distributions, state tax returns (often overlooked!), bonuses (probably not an issue for a retiree) and K1s from S corps. Unfortunately, these sources of income can hit you in late December or in the case of partnerships or K1s even after you have begun the next year. You may want to consider shifting some income earning assets to tax free municiple accounts to give you more breathing room.