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Recharacterizing

big-cedar-tree-tiny-girl-by-woodleywonderworksFor IRA contributions, the concept is simple:  a certain amount may be contributed to the account each year, dependent upon the type of IRA and your MAGI (this is all covered here if you need a refresher).  But what if you find out that you are ineligible to contribute to a Roth IRA due to the MAGI limitation?  How about if you made contributions to a Trad IRA and, upon filing your taxes found out it would be in your best interest to put those funds in your Roth instead?  Enter the Recharacterization.

Recharacterization of IRA Contributions

This is a relatively simple process, but, as with most things, the Code makes it seem like rocket science.  Essentially, if you make a contribution to one type of IRA and then decide that you’d rather have it in the other type of IRA, you can affect this recharacterization by:

  • notifying both trustees (the original IRA and the second IRA) of the transfer
  • requesting a trustee-to-trustee transfer
  • include in the transfer any net income attributable to the contributions being recharacterized
  • report the recharacterization on your tax return for the year (Form 8606)
  • treat the contribution to the second IRA as if made on the date of the contribution to the first IRA (in other words, as if you had done it the right way the first time)
  • if the first IRA was a Traditional IRA, you are not allowed a deduction for that contribution for the tax year (obviously, since it wasn’t left there)
  • All of this has to happen before the due date of your tax return, plus 6 months – for most calendar-year taxpayers this is October 15. (see Footnote below  for additional info)

Wrinkles

Now, if you thought that was way too many steps to get something really simple accomplished, look at the following examples of additional confusion to add to the mix:

Conversion by Rollover from Traditional IRA to a Roth IRA… if you’re converting funds from your TIRA to the RIRA and the transfer occurs within two tax years (but still within the allowed 60 days)  you would treat the activity as having been completed before the end of the first tax year if you needed to later recharacterize the conversion.

Rollovers… if you’ve already made a tax-free transfer of the funds, in general those funds are not eligible to be recharacterized.

Recharacterizing Excess Contributions… since excess contributions must be removed prior to filing that tax return for the applicable tax year, any recharacterization of those amounts would have to be accomplished strictly by the due date of the return – no extra 6 months in this case.

Recharacterizing SEP or SIMPLE funds… if you’ve converted funds from a SEP-IRA or a SIMPLE IRA to a Roth IRA and wish to recharacterize those funds, they must go back to the type of IRA that they came from, either a SEP or a SIMPLE, but not a Traditional IRA.  But these can be new accounts if the old account was closed.

Mistaken Rollover to SEP or SIMPLE… if you mistakenly made a rollover transfer of Traditional IRA funds to a SEP or SIMPLE, you can recharacterize those amounts back into a Traditional IRA.

Employer Contributions… it is not allowed to recharacterize employer contributions to a SEP or SIMPLE plan as contributions to another type of plan.

NOT a Rollover… when considering the “once a year” restriction on rollover transfers, recharacterization is not counted as a rollover, so roll away!

No Reconversions (within limits)… if you converted from a TIRA to a RIRA and the recharacterized the conversion, you can not then re-convert those funds to the RIRA again in the same tax year, or within 30 days of the recharacterization (if after the end of the tax year).

Decedent… the election to recharacterize can be made on behalf of a deceased IRA owner by the executor, administrator, or other person responsible for the decedent’s final tax return.

So as you can see, there are lots of ways to complicate the process, but in general the act of recharacterization is pretty simple, as long as you follow the rules and pay attention to the dates.

Footnote: In this one case, the IRS allows additional time for completing the recharacterization activity even if you have not completed it by the prescribed dates.  There are some specific things that have to be accomplished in order to receive this extra time:

  • your return must have been filed on time
  • you must have done the following within 6 months of your filing date:
    • notify the trustees of the intent to recharacterize
    • provide trustees with all necessary information
    • request the transfer

Once complete, you must amend the return, write “Filed pursuant to section 301.9100-2” on the return, and refile with the recharacterization noted.  File the return at the same address as your original return.

Photo bywoodleywonderworks

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  1. […] IRA.  If this is done by mistake, you can recharacterize those funds back into a Trad IRA (see this article for more information on […]