New Tax Law: No more recharacterization by 10/15 of next year

1 Reply

I figured some on this forum would find this interesting:

https://www.financial-planning.com/news/new-tax-bill-no-more-roth-ira-do-overs

A quote from the article:

As a reminder, here’s how a Roth conversion cycle usually works under current tax law.

  • First, there's a Roth conversion, in which the client converts a traditional IRA into a Roth IRA and pays income tax on the amount converted.
  • If the value of the converted funds declined or there was a change in the client’s financial circumstances, however, they may have wanted to reverse the conversion. Current tax law allowed for a recharacterization, or reversal of the conversion up to October 15 of the year following the conversion. It was one of the rare second chances or do-overs allowed in the tax code.
  • Then, after a time limit, those same funds could be re-converted to the Roth. This “cycle” allowed clients to maximize the value of the Roth conversion well after the fact.

The new tax law eliminates the ability to recharacterize a Roth conversion, so going forward Roth conversions will be permanent, even though the true income for the year may not be known by year-end.

Congress seems to believe that many taxpayers were using the recharacterization to game the system, moving in and out of the Roth IRA using certain investment strategies. But I have found that the reason some clients wanted to undo their Roth conversion was usually due to a change in their circumstances like a job loss, big medical bill or other expenses they did not see coming. The recharacterization gave them the flexibility to change their mind for a limited time. Now that window has closed for good.

@Jeff Brower

There is a debate currently whether 2017 conversions can still be recharacterized in 2018, especially conversions done earlier in 2017. The law is not clear. We expect it will be clarified at some point.

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