Roth Recharacterizations – No; Switching Contributions – Yes

Take-Away: While a recharacterization of a Roth IRA, back to a traditional IRA is no longer possible, an IRA owner is still able, within a narrow time frame, to change the nature of their contribution from traditional to Roth, or just the opposite.

Background: From prior missives we know that an individual can no longer recharacterize or convert their Roth IRA to a traditional IRA relying on hindsight. That opportunity was eliminated in the 2017 Tax Act. Now, once a Roth IRA conversion is completed, it is permanent. That said, IRA contributions can still be converted, or switched.

Switching Contributions is Still Permitted: However, it is still possible for an individual to reverse a Roth IRA contribution if it is done for the same tax year. That means a Roth IRA contribution, if timely made, can be converted, or switched,  to a traditional IRA. Similarly, an individual’s contributions to a traditional IRA, if timely made, can be converted, or switched,  to a Roth IRA, if their income limit permits a Roth IRA contribution. The individual’s contribution to either IRA must be made by the individual’s tax filing due date; no extensions apply to this IRA contribution deadline date. Yet if an individual wants to convert their contribution from one type of IRA to the other [traditional to Roth; Roth to traditional], that individual will have an extension of time in which to make the switch. The switch must be completed by the individual’s tax-filing due date, plus extensions, which is usually six months if the tax return is filed by the due date.

Switch Deadline: The switch in IRA contributions must be completed by the individual’s tax-filing due date, plus extensions. When the individual files his/her tax return by the tax-filing due date, he/she receives an automatic six-month extension to switch his/her IRA contribution. This sets to switch deadline to sometime in mid-October.

Reasons for a Switch: Some of the reasons why an individual may want to switch the nature of their IRA contribution include: (i) the individual’s annual compensation was too high, e.g., $153,000, to permit a contribution to a Roth IRA, which must be ‘undone’; (ii) their compensation was too high to permit a full Roth IRA contribution, but a partial Roth contribution is still permissible, e.g., the individual’s compensation was more than $138,000 but less than $153,000;  (iii) the individual’s income was less than $138,000, which allows a full traditional IRA contribution to be switched to a Roth IRA contribution; and (iv) if their income level permits, their switch can take place simply because the individual prefers one type of IRA contribution over the other.

Net Income Attributable: If the individual plans to switch the nature of their IRA contribution before mid-October (6 months after their tax return due date) the net income attributable (NIA) must be included when the switch occurs. Note, too, that NIA can be both earnings and losses on the contribution before the switch occurs.

Example: Tina made a traditional IRA contribution of $6,500 in May, 2023. In March, 2024, Tina would like to switch her IRA contribution and make it a Roth IRA contribution. Since Tina’s earned income for 2023 was $128,000, Tina is eligible to make a Roth IRA contribution for 2023. Before the IRA switch, which must be made before October 15, 2024, Tina’s initial $6,500 contribution enjoyed earnings of $400 (NIA.) The entire $6,900 [Tina’s $6,500 contribution + $400 NIA] held in Tina’s traditional IRA must be recharacterized or switched to Tina’s Roth IRA as her 2023 Roth contribution. Note, too, that Tina could engage in a partial switch of some of her initial traditional IRA contribution to a Roth IRA contribution for 2023.

Implementing the Switch: The IRA custodian will have been notified of the switch. Most IRA custodians have forms that are used to implement the recharacterization-switch of the contribution. Usually, the switch is done in-kind to avoid liquidating securities held in the IRA. Then the IRA owner must notify his/her tax return preparing about the switch, if it occurs after the tax-filing due date, to file an amended tax return, e.g., if originally reported as a traditional IRA contribution, the individual’s tax return will have to be amended to remove the tax deduction associated with the contribution to a traditional IRA.

Conclusion: Recharacterizing a Roth IRA as a traditional IRA is no longer possible. But it is still possible to change an IRA contribution from traditional to Roth, or just the opposite, by making a switch in the contributions no later than the October deadline. This ability to change the nature of the IRA contribution is a big help if an individual contributes to a Roth IRA and then later discovers that he/she was ineligible to make that Roth contribution, exposing themselves to an excise tax for an excess IRA contribution