When it comes to taxes and finance, there is usually no going back in time. However, a notable exception may apply if you converted a traditional IRA into a Roth last year. In effect, you can undo a conversion as if it never happened.
This “recharacterization” technique has been repealed by the Tax Cuts and Jobs Act (TCJA), beginning in 2018. But the IRS has indicated that it is still available for 2017 conversions. Thus, you have until the extended deadline for filing your 2017 tax return—October 15, 2018—for a recharacterization.
Background: The annual contribution limit for traditional and Roth IRAs is the same. For 2018, the limit is $5,500 per person, or $6,500 if you are age 50 or older. (This is also the limit for any combination of traditional and Roth contributions for the year.) Although traditional IRA contributions may be partially or wholly tax-deductible, distributions are generally taxed at ordinary income tax rates.
Conversely, you can never deduct contributions to a Roth, but qualified distributions, such as those made after age 59½, are completely tax-free five years after setting up the account. Plus, you don’t have to take mandatory lifetime distributions after age 70½ as you do with a traditional IRA.
When you convert to a Roth, the value of the funds transferred to your new account is taxed just like a regular distribution from a traditional IRA. Therefore, if you convert some funds this year, the tax will be due on your 2018 return, but you are in line for future tax-free benefits (assuming no further legislative changes).
Why would you want to recharacterize a Roth conversion? Here are a few possibilities.
- The value of the funds has declined since the conversion, so you have effectively overpaid the tax liability.
- The amount of the conversion tax caught you by surprise, and you cannot afford to pay the IRS.
- You simply decide that the Roth conversion is not the best approach for your situation.
If any of these is true for a 2017 conversion, there is still an opportunity to recharacterize the Roth back into a traditional IRA by the extended tax return due date of October 15, 2018. But this deadline is fast approaching.
Note that you can convert back to a Roth, if that suits your needs, after some time has passed. The earliest date allowed for a reconversion is the later of the beginning of the tax year following the tax year of the conversion and the end of the 30-day period beginning on the day of the recharacterization.
Does a recharacterization or reconversion make sense for your situation? Consult your professional advisers to make an informed decision.
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