Florida Estate Planning: Roth IRA Recharacterization Granted

In Private Letter Ruling 200921036 the National Office of the Internal Revenue Service concluded that a taxpayer would be granted an extension of time to recharacterize a Roth IRA back into a regular IRA.

FACTS:

"Adam" owned IRA X, a traditional IRA maintained by Custodian M. On September 2 of Year 1, Custodian M, at Adam's request, transferred Amount A from IRA X to IRA Y, a Roth IRA, as a Roth IRA conversion. IRA Y is also maintained by Custodian M.

At the time of the conversion, Adam believed that his modified adjusted gross income ("MAGI") for Year 1 would not exceed the $100,000 MAGI limit for conversions under section 408A(c)(3)(B) of the Code. However, in December of Year 1, several of Adam's mutual fund investments issued substantial capital gain distributions. Due to these unforeseen distributions, Adam's MAGI exceeded the allowable annual statutory limit, and he became ineligible for the conversion.

Upon learning of his ineligibility to convert IRA X to Roth IRA Y, Adam immediately instructed Custodian M to recharacterize his Roth IRA back to a traditional IRA. He did not report the conversion on his individual income tax return for Year 1 and he never made any further contributions or withdrawals from IRA Y.

In Year 2, while consolidating his investment and retirement accounts, Adam discovered that Custodian M had not recharacterized Roth IRA Y as a traditional IRA as he had instructed.

Until that time, Adam was unaware that Custodian M had not made the conversion he had requested.

Adam's request for relief under section 301.9100 of the Treasury Regulations (the "Regulations") was filed shortly after discovering that Roth IRA Y had not been recharacterized as a traditional IRA, and prior to the Internal Revenue Service (the "Service") discovering that Adam had not timely elected to recharacterize Roth IRA Y to a traditional IRA. The statute of limitations on Adam's federal income tax return for Year 1 closed.

Adam requested a ruling pursuant to section 301.9100-3 of the Regulations, that the Service grant him a period of 60 days from the date of issuance of the ruling to make the election under section 1.408A-5 of the Regulations to recharacterize Amount A as a contribution back to a traditional IRA. Adam also requested that the ruling be applied retroactively to Year 1 so that no excise tax under section 4973 of the Code will apply.

IRS ANALYSIS

The IRS noted that section 408A(d)(6) of the Code and section 1.408A-5 of the Regulations provide that, except as otherwise provided by the Secretary, a taxpayer may elect to recharacterize an IRA contribution made to one type of IRA as having been made to another type of IRA by making a trustee-to-trustee transfer of the IRA contribution, plus earnings, to the other type of IRA.

In a recharacterization, the IRA contribution is treated as having been made to the transferee IRA and not the transferor IRA. Under section 408A(d)(6) of the Code and section 1.408A-5 of the Regulations, this recharacterization election generally must occur on or before the date prescribed by law, including extensions, for filing the taxpayer's Federal Income Tax Return for the year of contribution.

The IRS further noted that Section 408A(c)(3) of the Code and section 1.408A-4, Q&A-2 of the Regulations provide, in relevant part, that an individual with adjusted gross income in excess of $100,000 for a taxable year is not permitted to make a qualified rollover contribution to a Roth IRA from an individual retirement plan other than a Roth IRA during that taxable year.

Additionally, the IRS noted that Section 4973(a) of the Code imposes a 6 percent excise tax on excess contributions to an IRA including a Roth IRA.

Section 4973(f) of the Code defines excess contributions with respect to a Roth IRA as the sum of:

1) the excess (if any) of the amount contributed for the taxable year to the Roth IRA over the amount allowable as a contribution under section 408A(c)(2) and (c)(3), and
2) the amount of excess contributions determined for the preceding taxable year reduced by the sum of any distributions out of the account for the taxable year plus the excess (if any) of the maximum amount allowable as a contribution under section 408A(c)(2) and (c)(3) for the taxable year over the amount contributed by the individual to all individual retirement plans for the taxable year.

The IRS also noted that Sections 301.9100-1, 301.9100-2, and 301.9100-3 of the Regulations, in general, provide guidance concerning requests for relief submitted to the Service on or after December 31, 1997. Section 301.9100-1 (c) provides that the Commissioner of Internal Revenue, in his discretion, may grant a reasonable extension of the time fixed by a regulation, a revenue ruling, a revenue procedure, a notice, or an announcement published in the Internal Revenue Bulletin for the making of an election or application for relief in respect of tax under, among others, Subtitle A of the Code.

Section 301.9100-2 of the Regulations lists certain elections for which automatic extensions of time to file are granted. Section 301.9100-3 generally provides guidance with respect to the granting of relief with respect to those elections not referenced in section 301.9100-2. The relief requested in this case is not referenced in section 301.9100-2.

Section 301.9100-3 of the Regulations provides that applications for relief that fall within section 301.9100-3 will be granted when the taxpayer provides sufficient evidence (including affidavits described in section 301.9100-3(e)(2)) to establish that (1) the taxpayer acted reasonably and in good faith, and (2) granting relief would not prejudice the interests of the Government.

Section 301.9100-3(b)(1) of the Regulations provides that a taxpayer will be deemed to have acted reasonably and in good faith:

1) if its request for section 301.9100-1 relief is filed before the failure to make a timely election is discovered by the Service;
2) if the taxpayer inadvertently failed to make the election because of intervening events beyond the taxpayer's control;
3) if the taxpayer failed to make the election because, after exercising reasonable diligence, the taxpayer was unaware of the necessity for the election;
4) the taxpayer reasonably relied upon the written advice of the Service; or
5) the taxpayer reasonably relied on a qualified tax professional, including a tax professional employed by the taxpayer, and the tax professional failed to make, or advise the taxpayer to make, the election.

Section 301.9100-3(c)(1)(ii) of the Regulations provides that ordinarily the interests of the Government will be treated as prejudiced and that ordinarily the Service will not grant relief when tax years that would have been affected by the election had it been timely made are closed by the statute of limitations before the taxpayer's receipt of a ruling granting relief under this section.

In this case, the IRS found that the information presented and documentation submitted by Adam is consistent with his assertion that his failure to elect to recharacterize the Roth IRA on or before the date prescribed by law, including extensions, for filing his Federal Income Tax Return for the year of contribution, was caused by his reasonable reliance on Custodian M to recharacterize Roth IRA Y as a traditional IRA, and Custodian M's failure to recharacterize IRA Y as instructed by Adam.

Further, Adam filed this request for section 301.9100 relief shortly after discovering that Custodian M did not make the conversion, and before the Service discovered his failure to make a timely election to recharacterize the failed conversion.

Thus, based on the information and the representations submitted, Adam acted reasonably and in good faith with respect to requesting an extension of time to recharacterize Amount A as a contribution to a traditional IRA. Specifically, we conclude that Adam has met the requirements of clauses (i) and (v) of section 301.9100- 3(b)(1) of the Regulations.

Additionally, section 301.9100-3(c)(1)(ii) of the Regulations contemplates that the interests of the government might not be prejudiced where closed years are involved if the amount of tax the taxpayer would pay if relief were granted to make a late election would be the same as if the election were timely made.

In this case, granting relief will not result in Adam having a lower tax liability in the aggregate for all taxable years affected by the election than he would have had if the election had been timely made, nor will any closed years be affected, as Adam has filed his return as if the election had been timely made. Therefore, the interests of the government will not be prejudiced by granting the request for relief.

Accordingly, Adam is granted an extension of time not to exceed 60 days as measured from the date of this letter ruling to recharacterize Amount A, held in Roth IRA Y, plus earnings attributable thereto, as a contribution to a traditional IRA.

In addition, the IRS found that because the election to recharacterize Roth IRA Y, if made within 60 days of the date of this ruling letter, will be treated as if timely made in Year 1, Amount A will not be considered an excess contribution within the meaning of section 4973(f) of the Code for purposes of the excise tax described in section 4973 of the Code.

COMMENT:

Although one should never depend upon so-called "9100 Relief," this Ruling does provide some insight as to when 9100 Relief can be granted. It is also a good reminder of the power of the recharacterization provisions and Regulations.

Although in this instance the recharacterization provisions applied where the taxpayer's MAGI exceeded $100,000, there is nothing in the Regulations to prevent a recharacterization if the Roth IRA falls in value after the conversion or if the taxpayer's financial circumstances change significantly. Further, a taxpayer may want to consider a recharacterization if they become involved in a lawsuit and the taxpayer's regular IRA provides stronger asset protection than their Roth IRA.

As a planning point, in light of today's increasingly litigious society, prior to executing a Roth conversion, the prudent taxpayer will check with an asset protection attorney to ensure that the asset protection in the Roth IRA is adequate.