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IRS Clarifies Date of New Law on Roth Conversion

IRS website, "IRA FAQs - Recharacterization of Roth Rollovers and Conversions" (Jan. 18, 2018).

In Frequently Asked Questions (FAQs) posted to its website, IRS has clarified the effective date of a provision in the Tax Cuts and Jobs Act (TCJA) prohibiting a taxpayer from recharacterizing a Roth conversion. The FAQs provide that if a traditional IRA was converted to a Roth IRA in 2017, it may be recharacterized as a contribution to a traditional IRA until Oct. 15, 2018.

Background-prior law. Under pre-TCJA law, the Roth IRA rules allowed an individual to elect to "recharacterize" an IRA contribution-i.e., elect to treat a contribution made to one type of IRA as made to a different type of IRA in a so-called "conversion contribution"-by (a) transferring the contribution (or a portion of the contribtuion) from the first IRA to the second IRA in a trustee-to-trustee transfer, and (b) meeting specific requirements regarding the transfer. If this is done by the due date for filing a taxpayer's tax return (including extensions), the taxpayer can treat the contribution as made to the second IRA for that year (effectively ignoring the contribution to the first IRA).

Thus, under pre-TCJA law, taxpayers could decide to convert a traditional IRA into a Roth IRA and pay tax on the conversion, but later decide to reconvert the Roth IRA back to a traditional IRA. This allowed taxpayers to potentially benefit from hindsight in the event that market conditions or other factors made the initial conversion unwise.

New law. The TCJA amended such that the provision allowing taxpayers to recharacterize Roth IRA contributions and traditional IRA contributions does not apply to a conversion contribution to a Roth IRA. The TJCA also prohibits recharacterizing amounts rolled over to a Roth IRA from other retirement plans.

Thus, recharacterization can no longer be used to unwind a Roth conversion, but it is still permitted with respect to other contributions. For example, an individual may make a contribution for a year to a Roth IRA and, before the due date for the individual's income tax return for that year, recharacterize it as a contribution to a traditional IRA. In addition, an individual may still make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA-but the individual cannot later unwind the conversion through a characterization.

The change in law is effective for tax years beginning after Dec. 31, 2017.

Issue. There was some confusion among tax professionals regarding the effective date of the change. Specifically, there was some debate as to whether the pre-2018 effective date referred to the tax year when the recharacterization was made, or the tax year when the unwinding of that recharacterization occurs. Depending on which interpretation was proper, the date by which an election to unwind had to be made would be either the last day of 2017 or the date (including extensions) that a 2017 return is due.

New guidance. The FAQs clarify that a Roth IRA conversion made in 2017 may be recharacterized as a contribution to a traditional IRA if the recharacterization is made by Oct. 15, 2018. A Roth IRA conversion made on or after Jan. 1, 2018, cannot be recharacterized.