Is partial recharacterization of Roth IRA conversion possible?

[Guest Ron Rhoades]

Taxpayer in 2000 converted part of traditional IRA account to a Roth IRA, transferring 100 shares of stock of a corporation, having value at time of conversion of $50 per share. In other words taxpayer undertook a conversion to a Roth IRA in the amount of $5,000. Stock has gone up, and the Roth IRA account is workth $7,500. But client wants to recharacterize part of the conversion anyway, transferring 1/2 of the account in a trustee-to-trustee transfer back to the traditional IRA account.

Question #1: Is a partial recharacterization of a Roth IRA conversion possible?

Natalie Choate in her 1999 edition of "Life and Death Planning for Retirement Benefits" states at page 222: "Although the preamble to the proposed regulations stated that 'Any portion of all' of the contribution may be recharacterized, both the proposed and final regulations themselves speak only in terms or recharacterizing 'the contribution' (not 'any portion or all of the contribution'), and the examples given deal only with total rechacterization.

I am confused. Final Reg. Sect. 1.408A-5, at Q-1, A-1, states: "In accordance with section 408A(d)(6), except as otherwise provided in this section, if an individual makes a contribution to an IRA (the FIRST IRA) for a taxable year and then transfers the contribution (or a portion of the contribution) in a trustee-to-trustee transfer from the trustee of the FIRST IRA to the trustee of another IRA (the SECOND IRA), the individual can elect to treat the contribution as having beeen made to the SECOND IRA, instead of to the FIRST IRA, for Federal tax purposes." In my reading of the Final Regs., as stated above - "or a portion of the contribution" - implies that a partial recharacterization would be permitted.

Also, on page 4 of the instructions to form 8606, it states under "Recharacterizations", that there are three types of recharacterizations, including: "You converted an amount from a traditional ... IRA to a Roth IRA and later recharacterize part or all of it back to a traditional ... IRA."

Natalie Choate's word I usually take as gospel, but her 1999 edition may have been written before the final regs were issued or fully contemplated, and certainly before form 8606 and its instructions 8606 were amended.

Any insight you may have would be appreciated.

Question #2. If a partial recharacterization is permitted, how is it reported?

ASSUMING A PARTIAL RECHARACTERIZATION IS PERMITTED:

Final Reg. Sect. 1.408A-5 A-2© seems to state that "the net income attributable to the amount of a contribution [being recharacterized] is calculated in the manner prescribed by Sect. 1.408-4©(2)(ii) (disregarding the parenthetical clause in Sect. 1.408-4©(2)(iii)"

That section in turn states: "The amount of the 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 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."

So, returning to our example, if the taxpayer recharacterizes 1/2 of the now $7,500 account, the taxpayer would recharacterize $3,750. The amount reported on the (extended) 2000 tax return as the conversion amount would be 1/2 of the original amount converted, or $2,500 (1/2 of the original total $5,000 converted), or so it appears to me.

If this is true, then on Form 8606, line 14a, the amount originally converted would be entered as $5,000. On line 14b, the amount recharacterized (not including earnings) would be $2,500. A statement should also be attached to Form 8606 explaining the recharacterization.

Is this correct?

Thank you.

[BPickerCPA]

You are permitted to do a partial recharacterization, and I agree with your computation of how the 50% recharacterization would be computed and reported.

[JAMES PATRICK]

This recharacterization is different than most posted on this and other boards. Out of curiosity I wonder if you would share with us WHY the client would want to do this, cosidering that the gains, leftin the Roth have the potential of being tax free, but the recharacterization would not?