The IRS has clarified how a provision in the Tax Cuts and Jobs Act that no longer will allow the recharacterization of rollovers from traditional IRAs to a Roth IRA as being made to a regular IRA. TCJA repeals the ability to recharacterize a Roth IRA conversion as a transfer to a traditional IRA for taxable years after December 31, 2017. [IRC §408A(d)(6)(B)(iii)]
Under prior law a taxpayer could enter into the transaction described in the example below:
The taxpayer converted $100,000 of his regular IRA to a Roth IRA on January 12, 2016. By October 14, 2017 the value of that converted Roth IRA had dropped to $70,000.
The taxpayer could elect to recharacterize that transfer to a Roth IRA as a transfer to a traditional IRA so long as the taxpayer did so before the extended due date of the 2016 return, thus avoiding paying tax on the $100,000.
Instead, the taxpayer would then convert the account to a Roth IRA in October of 2017, now paying tax on only the $70,000 value, reducing the amount that tax was paid on to convert the traditional IRA to a Roth by $30,000.
Congress in TCJA decided that this practice needed to stop. Note that Roth IRA contributions are still able to be recharacterized to traditional IRA contributions under these rules—only the rollover contributions are affected by this change.
There was initially some confusion regarding whether a 2017 rollover to a Roth IRA could be recharacterized back to regular IRA since the provision applied to tax years beginning after December 31, 2017. The language could be interpreted as barring any recharacterizations once a taxpayer’s 2018 tax year began, even if the conversion took place prior to that year. Alternatively, the provision could be read to only apply to original conversions that took place in 2018.
The IRS, in a posting on their webpage, decided to interpret this provision the second page. Per the page:
How does the effective date apply to a Roth IRA conversion made in 2017?
A Roth IRA conversion made in 2017 may be recharacterized as a contribution to a traditional IRA if the recharacterization is made by October 15, 2018. A Roth IRA conversion made on or after January 1, 2018, cannot be recharacterized. For details, see “Recharacterizations” in Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs).