You Have Until October 15th to Reverse Your Roth IRA Conversion

Converting your traditional IRA into a Roth IRA is a smart tax strategy – when it works. But in many cases, once converted, the account’s value plummeted. This means you’ll end up paying taxes on an account value that is nonexistent. If you converted your traditional IRA into a Roth IRA in 2012 and you’re not happy with the results, you have the option of converting it back to an IRA. The loophole is that it must be done by October 15, 2013.

When you converted your traditional IRA into a Roth IRA last year, the transaction was treated as a distribution from the traditional IRA followed by a contribution of the distributed amount to the Roth account. So the conversion triggered a 2012 federal income tax bill (and maybe a state income tax bill, too) based on the traditional IRA’s value on the conversion date. However, one tax-friendly feature of the Roth conversion option is that you have until October 15th of the following year to reverse a conversion.

Reverse IRA Conversions

To give you an idea of when it is a smart choice to reverse your conversion, let’s say you converted your traditional IRA into a Roth account in 2012, and it has plummeted in value and is now worth significantly less than on the conversion date. This is a less than ideal situation because you would have to pay income tax on the value of the account on the conversion date, even though its value has diminished considerably. Since you have until October 15, 2013 to recharacterize your account back to traditional IRA status, it will be as if the ill-fated conversion never happened, so you won’t owe any 2012 income tax on the conversion. In other words, the 2012 conversion is reversed this year with no tax harm done.

The caveat is that if your converted Roth IRA includes other contributions, it may not be possible to simply reverse the conversion. For example, if the Roth IRA has contributions for pre-2012 tax years, you will be unable to recharacterize that part of the account balance that is attributable to those pre-2012 contributions.

In terms of your filing your Tax Return, if you extended the filing deadline for your 2012 Form 1040 to October 15, 2013, and have not yet filed the return, you reflect the reversal of the 2012 Roth conversion by simply not including the income triggered by the conversion on your return.

If you’ve already filed your 2012 Form 1040, you’ll have to file an amended 2012 return to delete the conversion income and claim a refund for the related tax bill. Consult your tax adviser for full details about filing an amended return.

Contact your Anders advisor with any questions regarding the Roth IRA conversions.