Sometimes things don’t go exactly as planned—and multiple errors cascade to create an issue. That was the case for the taxpayer who requested PLR 201617019.
In this case the taxpayer wished to deposit after tax funds into a new traditional IRA. The taxpayer already had an existing traditional IRA, but he did not want the funds going into that IRA since he planned to convert the funds in the new IRA to a Roth IRA.
While the ruling doesn’t mention the reason, presumably the taxpayer’s adjusted gross income for the year was above the level that would allow him to make a Roth IRA contribution. However, since the law does not limit Roth conversions based on income levels, a taxpayer can make a nondeductible contribution to a traditional IRA and then roll those funds into a Roth IRA as a roundabout way to place funds into a Roth.
While a letter ruling doesn’t give us numbers, let’s use a $5,000 contribution that was to eventually make its way to a Roth IRA and a $100,000 existing traditional IRA that was remain as a traditional IRA. Thus the transaction can be diagramed as follows:
Unfortunately, the IRA custodian misunderstood the taxpayer’s instructions. First, the institution deposited the contribution into the existing traditional IRA and, upon being told to convert what was supposed to be the new IRA to a Roth, converted the existing IRA to a Roth. Thus the actual transaction diagram looks like this:
Needless to say, the second transaction generates a much larger amount to be included in the taxpayer’s income—instead of $5,000 being converted to a Roth, $105,000 ended up being converted.
All, however, was not yet lost. The taxpayer could still have recharacterized the transactions through the due date of his return, including extensions, under IRC §408A(d)(6) and Reg. §1.408A-5, Q&A 1, by doing a trustee to trustee transfer to get the funds back into the proper account.
But the errors continued. The taxpayer received a Form 1099R with Code “2” indicating an exception applied to the early distribution excise tax, for the entire amount of the conversion ($105,000 in our example). The ruling indicates the taxpayer believed this meant that the rollover had been completed properly. While it doesn’t explicitly say so, the relief paragraph suggests that the taxpayer showed this 1099R to his preparer who came to the same conclusion. Thus no election was made to recharacterize the transaction.
Not surprisingly the IRS had a different (and correct) reading of the Form 1099R, eventually contacting the taxpayer looking to collect additional tax. The taxpayer at that point filed for the private letter ruling, requesting an extension of time to recharacterize the transaction.
The National Office granted that request, concluding:
The information and documentation submitted in this case are consistent with Taxpayer A’s assertion that he did not intend to convert Traditional IRA B into a Roth IRA and that given the Form 1099-R he received from Financial Institution D, he was unaware that Amount 1 had been rolled over into Roth IRA C. Taxpayer A also relied on his professional tax preparer to prepare his return for the 20xx year. His tax professional did not advise him that Amount 1 was a taxable distribution and he failed to inform Taxpayer A of the election that could have been made under section 408A(d)(6) of the Code and section 1.408A-5 of the l.T. Regulations. Thus, Taxpayer A was unaware of the necessity of making the election. Taxpayer A’s failure to recharacterize Amount 1 in Roth IRA C on or before the date prescribed by law, including extensions, for filing Taxpayer A’s 20xx Return, was caused by Taxpayer A’s reasonable reliance on a qualified tax professional, who failed to advise Taxpayer A to make the election. Under the set of circumstances in this case, Taxpayer A satisfies the requirements of section 301.9100-3(b)(1 )(iii) and (v) of the Regulations.
Accordingly, we rule that, pursuant to section 301.9100-3 of the regulations, Taxpayer A is granted a period not to exceed 60 days from the date of this letter to recharacterize Amount1 plus earnings from Roth IRA C back to Traditional IRA A.