PLR 1239015: IRS denies late recharacterization after Roth IRA funds left the accounts

Plain-English summary

A married couple converted traditional IRA funds to Roth IRAs in 2009 even though their modified adjusted gross income exceeded the applicable conversion limit. They did not learn of the problem until after the deadline to recharacterize the conversions, and they later transferred the Roth IRA balances to non-IRA accounts. The IRS denied their request for more time because a recharacterization required the amounts to remain in the Roth IRAs, so the taxpayers could not complete the required trustee-to-trustee transfer. The ruling did not express an opinion on other possible tax treatment.

Ruling snapshot

• Question: May taxpayers recharacterize failed Roth IRA conversions after the deadline when the converted funds have been moved to non-IRA accounts?
• Outcome: Denied
• Key authorities: IRC §§ 408 and 408A; Treas. Reg. §§ 1.408A-4, 1.408A-5, and 301.9100-1 through 301.9100-3

Full text (IRS public release)

201239015

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND GOVERNMENT ENTITIES DIVISION

JUL 03 2012

Uniform Issue List: 9100.00-00

TEPRA

Legend:

Taxpayer A =
Taxpayer B =
IRA C =

Roth IRA D =

Financial Institution E

IRA F :

Financial Institution G

Roth IRA H =

Account I =

Account J =

Amount 1 =
Amount 2 =
Amount 3 =

Amount 4 =

Amount 5 =

201239015

Dear

This letter is in response to a request for a letter ruling dated July 15, 2011, from
your authorized representative, in which you request relief under section 301.9100-
3 of the Procedure and Administration Regulations (“P&A Regulations”).

The following facts and representations have been submitted under penalty of perjury
in support of the ruling requested:

Taxpayer A is married to Taxpayer B. Taxpayer A maintained IRA C, an individual
retirement account (“IRA”) under section 408(a) of the Internal Revenue Code (the
“Code”), with Financial Institution E. Taxpayer A also maintained Roth IRA D, an IRA
under section 408A of the Code, with Financial Institution E. Taxpayer B maintained
IRA F, an individual retirement account under section 408(a) of the Code, with
Financial Institution G. Taxpayer B also maintained Roth IRA H, an IRA under section
408A of the Code, with Financial Institution E.

On December 21, 2009, Taxpayer A transferred Amount 1 from IRA C to Roth IRA D.
On December 31, 2009, Taxpayer B transferred Amount 2 from IRA F to Roth IRA H.
At this time, Taxpayers A and B believed that they had successfully converted their
traditional IRAs to Roth IRAs unaware they were ineligible to do so for the 2009 tax
year because Taxpayers A and B had adjusted gross income (“AGI”) of Amount 5.
For this tax year, the AGI limit under section 408A(c)(3)(B) of the Code for converting
a traditional IRA to a Roth IRA was $100,000, with AGI as modified under section
408A(c)(3)(C). Since the modified AGI of Taxpayers A and B exceeded the limit for
conversions during the 2009 tax year, the conversions were improper. The 2009 joint
Form 1040 tax return for Taxpayers A and B was timely filed on October 15, 2010,
with a valid extension. The 2009 tax year is not a closed year under the statute of
limitations.

Taxpayers A and B also were not aware that a conversion to a Roth IRA could be
recharacterized back to a traditional IRA by making an election to do so on or before
the due date of the return (plus extensions) for the tax year in question. The tax
preparer for Taxpayers A and B was not made aware of the conversions until October
18, 2010. Soon after the discovery of the improper conversions, the tax preparer
informed Taxpayers A and B that their income (Amount 5) exceeded the limit for
converting funds in traditional IRAs to Roth IRAs. The financial advisor for
Taxpayers A and B contacted Financial Institution E and requested that Amounts 1
and 2 be transferred back to traditional IRAs. He was informed that this could not
be done because the request was after the October 15, 2010 deadline for making
this transfer (recharacterization). On December 22, 2010, Taxpayer A requested
that Financial Institution E transfer the entire account balance in Roth IRA D
(Amount 3) to a non-IRA investment account (Account I). On December 23, 2010,
Taxpayer B also requested that Financial Institution E transfer the entire account
balance in Roth IRA H (Amount 4) to a similar non-IRA investment account
(Account J).

201239015

At the time the request for a private letter ruling was filed, the Internal Revenue Service
(the “Service”) had not discovered the need for Taxpayers A and B to recharacterize the
Roth IRA conversions which were made in 2009.

Based on the foregoing facts and representations, you have requested that,
pursuant to section 301.9100-3 of the P&A Regulations, Taxpayers A and B
each be granted an additional period of time to recharacterize their failed
Roth IRA conversions to traditional IRAs.

With respect to your request for relief under section 301.9100-3 of the P&A
Regulations, Code section 408A(d)(6) and section 1.408A-5 of the federal Income
Tax Regulations (the “I.T. 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)
and section 1.408A-5, 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 contributions.

Section 1.408A-5, Q&A-6 of the I.T. Regulations describes how a taxpayer makes
the election to recharacterize the IRA contribution. To recharacterize an amount
that has been converted from a traditional IRA to a Roth IRA: (1) the taxpayer must
notify the Roth IRA trustee of the taxpayer's intent to recharacterize the amount,
(2) the taxpayer must provide the trustee (and the transferee trustee, if different
from the transferor trustee) with specified information that is sufficient to effect the
recharacterization, and (3) the trustee must make the transfer.

Code section 408A(c)(3) provided, with respect to the 2009 tax year, that an
individual with modified AGI 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.

Section 1.408A-4, Q&A-2, of the I.T. Regulations provides, in summary, that an
individual with modified AGI in excess of $100,000 for a taxable year is not
permitted to convert an amount to a Roth IRA during that taxable year. Section
1.408A-4, Q&A-2, further provides, in summary, that an individual and his or her
spouse must file a joint federal income tax return to convert a traditional IRA to a
Roth IRA, and that the modified AGI subject to the $100,000 limit for a taxable year
is the modified AGI derived from the joint return using the couple’s combined
income.

Sections 301.9100-1, 301.9100-2, and 301.9100-3 of the P&A 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

201239015

Commissioner of Internal Revenue, in his discretion, may grant a reasonable
extension of the time fixed by a regulation, revenue ruling, revenue procedure,
notice, or 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 P&A 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 P&A 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)) 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 P&A Regulations provides that a taxpayer will be
deemed to have acted reasonably and in good faith (i) if the taxpayer's request for
section 301.9100-1 relief is filed before the failure to make a timely election is
discovered by the Service; (ii) if the taxpayer failed to make the election because of
intervening events beyond the taxpayer’s control; (iii) if the taxpayer failed to make
the election because, after exercising reasonable diligence, the taxpayer was
unaware of the necessity for the election; (iv) the taxpayer reasonably relied upon
the written advice of the Service; or (v) 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)(i) of the P&A Regulations provides that the interests of
the Government are prejudiced if granting relief would result in a taxpayer having a
lower tax liability in the aggregate for all taxable years affected by the election than
the taxpayer would have had if the election had been made timely.

Section 301.9100-3(c)(1)(ii) of the P&A 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 Taxpayer A and B’s request for a ruling dated July 15, 2011, the authorized
representative states that it is the position of the Taxpayers that the grant of the
extension requested will not prejudice the interests of the Government because
it results in the Taxpayers having the same tax liability that would have resulted
if the election to recharacterize Roth IRA D and Roth IRA H to traditional IRAs
had been made timely.

201239015

In this case, the modified adjusted gross income of Taxpayers A and B exceeded
the $100,000 limit under section 408A(c)(3)(B) of the Code for tax year 2009. Thus
Taxpayers A and B were ineligible to convert Amount 1 from traditional IRA C to
Roth IRA D and Amount 2 from traditional IRA F to Roth IRA H in 2009.

Taxpayers A and B were unaware they were ineligible to convert traditional IRAs
to Roth IRAs until their tax preparer informed them after October 18, 2010, that their
income (Amount 5) exceeded the limit for converting funds in traditional IRAs to Roth
IRAs. Upon being informed of this, Taxpayers A and B transferred Amount 3 from
Roth IRA D and Amount 4 from Roth IRA H to non-IRA Account I and non-IRA
Account J, respectively.

With respect to Taxpayers’ request for relief, we conclude that, based on the
information submitted and the representations contained herein, we cannot grant
the relief that the Taxpayers requested. In this case, relief under sections
301.9100-1 and 301.9100-3 of the P&A Regulations is conditioned on Taxpayers A
and B otherwise being able to elect to recharacterize their failed Roth IRA
conversions in a manner that complies with the requirements of Code section
408A(d)(6) and section 1.408A-5 of the I.T. Regulations. This means that the
amounts to be recharacterized must still be held by the Roth IRAs. However,
Taxpayers A and B have transferred Amounts 3 and 4 from Roth IRA D and Roth
IRA H, respectively, to non-IRA accounts. As a result, Taxpayers A and B cannot
elect to recharacterize the failed conversion amounts, and the Taxpayers are not
eligible for relief under sections 301.9100-1 and 301.9100-3 of the P&A
Regulations. Therefore, Taxpayers A and B are not authorized to transfer Amount
3 in Account I and Amount 4 in Account J to traditional IRAs.

No opinion is expressed as to the tax treatment of the transaction described herein
under the provisions of any other section of either the Code or regulations which
may be applicable thereto.

This ruling is based on the assumption that all the traditional IRAs and Roth IRAs
described above meet the requirements of Code sections 408 and 408A,
respectively, at all relevant times.

This letter is directed only to the taxpayers who requested it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent.

201239015

A copy of this letter ruling has been sent to your authorized representative pursuant to
a power of attorney on file in this office. If you wish to inquire about this ruling, please
contact (I.D. # , ,at( )

Sincerely yours,

Carlton A. Watkins

Manager
Employee Plans Technical Group 1

Enclosures:
Deleted Copy of this Letter
Notice 437

CC: