by Barry C. Picker, CPA/PFS, CFP
© 1999, Barry C. Picker
The following copyrighted article is available exclusively on the Roth IRA Web Site:
On February 3, 1999, the Internal Revenue Service issued final regulations under Section 408A, Roth IRAs. For the most part, the final regulations follow the proposed regulations, with certain clarifications. There is, however, a major change with regard to reconversions, effective in 2000. The IRS also did not change their position with regard to conversions in the year a taxpayer attains age 70½.
In the case of Roth conversions in 2000 or later, the final regulations state that following a recharacterization, a taxpayer may not then convert those funds into a Roth IRA until the later of the beginning of the tax year after the tax year of the conversion, or the end of thirty days after the recharacterization. So if a conversion is made in 2000, any recharacterization cannot then be reconverted to a Roth until the beginning of 2001, or thirty one days after the recharacterization, whichever is later. There are two major changes between the application of the final regulations rules, and the rules in effect for 1998 and 1999 as a result of Notice 98-50. One change is that a failed conversion will count as a conversion for purposes of this rule. In Notice 98-50, a failed conversion does not count. This means that if an individual converts an IRA to a Roth in 2000 and then has to recharacterize it in the beginning of 2001 due to having an income in excess of $100K, the individual must wait until at least the 31st day after the recharacterization, before again converting those funds into a Roth IRA. The second, and probably the more important change, is that any reconversion made during the prohibited period, that is, prior to the later of the beginning of the year after the original conversion or the end of the thirty day period after the recharacterization, will be treated as a failed conversion, rather than as an excess conversion, which is the treatment under Notice 98-50. That means that the conversion will be treated as invalid, and therefore subject to premature distribution and excess contribution penalties, if it is not recharacterized. However, just to keep things interesting, if a reconversion is a failed conversion only because it was made within the prohibited period, that is not counted for purposes of computing a new prohibited period. For example, a taxpayer converts a traditional IRA to a Roth IRA in June, 2000 and then recharacterizes it back to a traditional IRA in September, 2000. The taxpayer then reconverts the account back to a Roth in December, 2000. This reconversion must be recharacterized since it is made in the prohibited period, but once it is recharacterized, the taxpayer can do a conversion in 2001, even if it’s before the end of the thirty day period after the recharacterization of the December conversion.
Other items clarified in the final regulations and the background information are as follows--
-A Roth IRA may be established for a minor, subject to the minor having earned income for the year of the contribution.
-A change in filing status during the four year income spread of a 1998 conversion, will not affect the spread. Thus a taxpayer getting divorced or married, will just continue to include the required income on his return for each tax year, under whatever filing status is used for that year.
-If an IRA from which substantially equal periodic payments (SEPP) are being taken is converted to a Roth IRA, the SEPP must continue to be taken from the Roth. In the case of a 1998 Roth conversion on which the income is being spread over four years, the SEPP distributions from the Roth will be subject to the income acceleration rules. However, the distributions will not be subject to the 10% early withdrawal penalty.
-If an individual who has converted an IRA to a Roth IRA dies, the executor or personal representative is authorized to recharacterize that conversion back to a traditional IRA. This is also true if the personal representative wishes to recharacterize an annual IRA contribution.
-A conversion of a SEP IRA, a SIMPLE IRA, or a conduit IRA, can be recharacterized back into a SEP, SIMPLE or conduit IRA.
-The final regulations clarify that the computation of net income, required for the recharacterization of a commingled IRA, or for a partial recharacterization, includes net losses. The original proposed regulations technically did not, although it was clear from the beginning that this was an oversight and the losses were allowed.
-A beneficiary of a Roth IRA cannot aggregate the inherited Roth IRA with other Roth IRAs maintained by the beneficiary, unless it is aggregated with another Roth IRA inherited from the same decedent. The only exception is that a spouse who elects to treat the inherited Roth as her own, can aggregate the account with her other Roth IRAs.
-An initial contribution to a Roth IRA starts the five year clock running for purposes of determining when qualified tax free distributions may be taken, even if the entire Roth IRA is emptied via a distribution. This contribution will not start the five year period if it is revoked within seven days, recharacterized, or is an excess contribution that is removed. Therefore if a taxpayer contributes $2K attributed to 1998 to a Roth IRA in March, 1999, and withdraws the money the next day, the five years will still be up in 2003 even though there are no funds in the Roth IRA.
All in all, other than the changes in the reconversion rules, nothing earth-shattering. The final regulations should cover most of it, until the next law changes.
Link to text of Final Roth IRA Regulations
The Author:
Barry C. Picker is a Certified Public Accountant with the Personal Financial Specialist
designation, and is a Certified Financial Planner licensee. He runs his own accounting and
financial planning firm located in Brooklyn, NY, and is also a member of the NYS Society
of CPAs Estate Planning Committee. He has taught seminars and written articles on tax
topics, and has been quoted in various publications. In addition, he is part of a panel
that answers tax questions on America Online at keyword:TaxLogic. He can be reached at
(718) 934-4300, or via E-Mail at BPickerCPA@cs.com.