Tax Reform and the Recharacterization Rule

Posted by Lee Reams Sr. on

The Tax Cuts & Jobs Act repeals the special rule that allows a traditional IRA to Roth IRA conversion to be later unwound. Thus, for example, under the provision, a conversion contribution to a Roth IRA during a taxable year can no longer be recharacterized as a contribution to a traditional IRA (thereby unwinding the conversion). The provision is effective for taxable years beginning after December 31, 2017 (IRC Sec. 408A(d)(6)(B)(iii) as amended by TCJA Sec. 13611(a).

However, recharacterization 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 (Conference Report). Thus, if an individual makes a Roth IRA contribution, it can be converted to a traditional IRA contribution or vice versa, provided the conversion is accomplished before the unextended (the IRA contribution must be made by the unextended due date) due date for the return.    

Note: This rule applies for conversions from a traditional IRA, SEP or SIMPLE to a Roth IRA. The new law also prohibits recharacterizing amounts rolled over to a Roth IRA from other retirement plans, such as 401(k) or 403(b) plans (IRS FAQ).

Special Rule for Conversions Made in 2017 – A Roth IRA conversion made in 2017 may be recharacterized as a contribution to a traditional IRA if the recharacterization is made by October 15, 2018. A Roth IRA conversion made on or after January 1, 2018, cannot be recharacterized (IRS FAQ).

Commentary: This change can be a problem for individuals whose retirement funds are invested in a stock fund, for example, if the fund declines in value after the conversion and the converted amount can no longer be recharacterized to avoid the tax on the declined value.