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New Tax Law Changes Roth IRA Conversion Strategy

Probable Repeal of Roth IRA Recharacterizations at Year-End

The Senate and House of Representatives have both passed versions of the new tax reform law that eliminates the availability of Roth IRA recharacterizations after December 31, 2017.

 

Benefits of Recharacterization

Recharacterization gives taxpayers a "do-over" opportunity. One use is when a Traditional IRA that is converted to a Roth IRA afterward declines in value – forcing the IRA owner to pay income tax on a converted amount that now exceeds the value of the IRA. Recharacterizing reverses the transaction to eliminate the excess tax.

Typically, we don't know exactly what our total taxable income will be until the end of the year. Because of this, a common strategy is to convert more than you think you will need to “fill the [tax] bracket” or up to whatever the target amount is. If that amount is overshot, we would do a partial recharacterization to bring your taxable income to exactly where it needs to be. Recharacterization can also be done if the taxpayer simply changes their mind and doesn't want to pay the tax.

According to Ed Slott, “It is like betting on the horse after the race is over!”

Until now, the law has allowed recharacterizations to be made as late as October 15 of the following year.

 

The New “Do It or Lose It” Date Could Change to December 31st

The Final version of the Senate and House bills eliminate this extra time to recharacterize a Roth conversion. Under both versions of the law, it seems that December 31, 2017, may be "the do it or lose it date" for recharacterizations of conversions made in 2017.

If this provision is interpreted in this way this would eliminate the strategy mentioned above for conversions done in 2017. This could pose a problem for those that planned to take advantage of recharacterizing after the New Year.

It seems to me however that there may be room for interpretation here. The following is the excerpt from the final bill regarding the removal of the Roth recharacterization provision:

The House bill repeals the special rule that allows IRA contributions to one type of IRA

(either traditional or Roth) to be recharacterized as a contribution to the other type of IRA. Thus,

for example, under the provision, a conversion contribution establishing a Roth IRA during a

taxable year can no longer be recharacterized as a contribution to a traditional IRA (thereby

unwinding the conversion).276

Effective date.−The provision is effective for taxable years beginning after December 31,

2017.

This still seems unclear to me whether it applies to conversions that were already done in 2017. It references the conversion “during the taxable year” that can no longer be recharacterized and the provision is effective for “taxable years beginning after December 31, 2017” which to me means that you can no longer recharacterize Roth conversions done in the taxable year after this date which is 12/31/2017. So then a conversion done in 2018 cannot be recharacterized which is very clear, however, a conversion done in 2017 occurs in the taxable year before the provision ends, so then wouldn’t it stand to reason that a 2017 conversion can still be recharacterized up to the deadline in 2018 as it normally would have in the past? Furthermore, it seems unreasonable that this bill could be signed into law just days before the end of year closes giving effectively no practical time to unwind any conversion before the end of the year to which it is supposedly to apply. For many custodians, we have already passed the cutoff date for guarantee that such transactions can be completed before year end which just doesn’t seem fair or reasonable. But then again when is congress fair or reasonable?

The full bill can be found by going to http://docs.house.gov/billsthisweek/20171218/CRPT-115HRPT-%20466.pdf.

 

The Unknown May Cost You

In my sole opinion, It is possible that this provision will be effective ONLY for Roth conversions done in 2018 and beyond. However, that is a risk and it may be some time before we receive any clarification

If you have done a Roth conversion in the year 2017, you need to address this with your financial adviser immediately to know whether you should reconsider doing a full or partial recharacterization before year-end assuming it is even possible. If you are confident that there is no reason you'd need or want to recharacterize then there is no action necessary

 

Contact us ASAP!

The end of the year is very busy. It is critical that you contact us as soon as possible so that we can ensure we have enough time to review your conversion thoroughly. Click here to contact the office nearest you.

Please also keep in mind that all requests to recharacterize a Roth conversion will need to be submitted to the IRA custodian enough in advance to ensure it is accepted and completed before the end of the year and effectively this time may already have passed.

No More Roth IRA Recharacterizations After 2017

Beginning in 2018, it is clear that all Roth conversions will be irrevocable so if you plan to do any Roth conversions, it will require more careful review and possible change in strategy

At Portnoff Financial, we thoroughly review and carefully evaluate your financial situation to make sure a Roth conversion makes sense for you and to be ready and able to pay the expected tax bill. With that being said, when it comes time to discuss future Roth conversions, know you are in good hands.

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