Fraud-hidden Roth IRA loss supports late recharacterization

Plain-English summary

An IRA owner converted a traditional IRA to a Roth IRA and then invested part of the Roth account through an adviser in commodity-pool investments. The investment manager allegedly issued false statements that concealed significant losses, and the CFTC later sought an asset freeze while the investment company entered voluntary liquidation. The taxpayer did not learn that the Roth assets had sharply declined, or might be worthless, until after the recharacterization deadline. The assets had never left the Roth IRA, and the IRS had not independently discovered the missed election. Although the limitations period was closed, the IRS found that the taxpayer acted reasonably and that relief would not reduce aggregate tax liability, so it granted 60 days to recharacterize the Roth conversion as a traditional IRA contribution.

Ruling snapshot

• Question: Could the taxpayer receive extra time to undo a Roth conversion after alleged investment fraud concealed the account's losses?
• Outcome: Approved, with up to 60 days to complete the recharacterization
• Key authorities: IRC § 408A(d)(6); Treas. Reg. §§ 1.408A-5 and 301.9100-3

Full text (IRS public release)

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

NOV 10 2014

201506015

TAX EXEMPT AND
GOVERNMENT ENTITIES

U.I.L. 9100.00-00, 408A.00-00 SE:T:EP:RA:T3

Legend:

Taxpayer A

Company F

Financial Advisor E =

Company D

Investment H

Individual G

Year 1

Amount B

Amount C

IRA X

Roth IRA Y

Date 1

Date 2

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Dear

This is in response to your letter dated December 11, 2012, submitted on your behalf,
by your authorized representative, in which you request a ruling under section 408A of
the Internal Revenue Code (Code) and under section 301.9100-3 of the Procedure and
Administration Regulations (Regulations).

The following facts and representations have been submitted in support of your request.

Taxpayer A represents that he was the title holder of IRA X. On December 30, 2010,
Taxpayer A converted IRA X to Roth IRA Y. The amount of the conversion was Amount
B. On January 12, 2011, following the advice of Financial Advisor E, Taxpayer A
invested Amount C from Roth IRA Y in Company F. Financial Advisor E worked closely
with the individual who oversaw the investment program of Company F. Company F
had assets under management with Company D. Individual G is the principal of
Company D. Company D serves as the umbrella company for Individual G’s investment
management business and the manager and managing company of commodity pools
known as Investment H. Individual G served as the senior advisor for Investment H.

On Date 1, the U.S. Commodity Futures Trading Commission (CFTC) filed an
emergency action in the U.S. District Court for the Northern District of Illinois to freeze
the assets under the control of Individual G and Company D. The CFTC’s complaint
alleges that the defendants operated a series of commodity pools called Investment H
and that the defendants made fraudulent misrepresentations and omissions in
connection with significant losses sustained by Investment H through periodic account
statements. On Date 2, Company F issued a “Critical Information Update” that
announced that Company F was placed in voluntary liquidation.

Taxpayer A did not discover that there were problems with his investments until after
the deadline for making a timely recharacterization, as prescribed in section 408A(d)(6)
of the Code. Taxpayer A then was advised by his accountant to request a ruling for an
extension of time to recharacterize the contribution to Roth IRA Y as a contribution to a
traditional IRA. The assets have never left Roth IRA Y. Because of the fraud outlined
in the CFTC complaint it is believed that Roth IRA Y is worth significantly less than has
been reported to Taxpayer A in annual statements, if not entirely worthless.

The Internal Revenue Service (Service) has not independently discovered Taxpayer A’s
failure to make a timely recharacterization.

Based on the above facts and representations, you request a ruling that, pursuant to
section 301.9100-3 of the Regulations, Taxpayer A be granted a period not to exceed
60 days from the date of this letter ruling to recharacterize the contribution to Roth IRA
Y as a contribution to a traditional IRA.

With respect to your ruling request, section 408A(d)(6) of the Code and section 1.408A-
5 of the Federal Income Tax Regulations (I.T. Regulations) provide that, except as

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otherwise provided by the Secretary, a taxpayer may elect to recharacterize an IRA
contribution made to one type of IRA as having originally 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. This recharacterization
election generally must occur on or before the date prescribed by law, including
extensions, for filing the taxpayer's Federal income tax returns 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.

Sections 301.9100-1, 301.9100-2, and 301.9100-3 of the Regulations 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: (i) if its 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 inadvertently 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

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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 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 timely made.

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 the present case, because Company D was providing false statements regarding the
value of the investments to Company F, Taxpayer A was not aware of the fact that the
value of the assets rolled over into the Roth IRA had declined until after the deadline for
making a timely recharacterization had passed. Therefore, he was unaware of the
necessity of making the election. Upon realizing the need to make the election,
Taxpayer A, in a timely manner, submitted this request for relief under section
301.9100-3.

Under the set of circumstances described above, Taxpayer A satisfies the requirements
of section 301.9100-3(b)(1) of the Regulations, clauses (i) and (iii). In addition, although
the statute of limitations is closed, since the request was filed timely and granting relief
will not result in Taxpayer A having a lower tax liability in the aggregate for all taxable
years affected by the election than Taxpayer A would have had if the election had been
timely made, we find that under section 301.9100-3(c)(1) of the Regulations, granting
relief will not prejudice the interests of the Government.

Accordingly, Taxpayer A is granted a period not to exceed 60 days from the date of this
letter ruling to recharacterize the contribution to Roth IRA Y as a contribution to a
traditional IRA.

This letter assumes that the above IRAs qualify under either Code section 408 or Code
section 408A at all relevant times.

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

A copy of this letter has been sent to your authorized representative in accordance with
your authorization on file in this office.

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If you wish to inquire about this ruling, please contact , I.D. # ,

at( )
Sincerely yours,
UE Abe >

Laura B. Warshawsky, Manager
Employee Plans Technical Group 3

Enclosures:
Deleted copy of letter ruling
Notice of Intention to Disclose

cc: