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Leslie Bonacum
Neil Allen

You’ll Have To Make Up Your Mind On Roth Conversions, CCH Says

(Riverwoods, ILL., October 22, 1998) -- How indecisive can you be in choosing between a traditional IRA and converting to a new Roth IRA? Starting soon, you will have less opportunity to reduce your taxes by shuffling funds back and forth between the two types of retirement savings vehicles, according to CCH INCORPORATED, a leading provider of tax law information.

CCH analyst Nicholas Kaster, J.D., LL.M., said that the IRS has issued an interim rule to prevent a potential abuse of the ability to convert a traditional IRA into a Roth account. "This is an area of confusion that goes back to the establishment of Roth IRAs in 1997 tax legislation," Kaster noted.

The original Roth provisions allowed holders of traditional IRAs to convert funds to the new Roth IRA accounts. But this option was only open to taxpayers with gross incomes of less than $100,000. What would happen when someone made a conversion thinking they would qualify for favorable treatment, and then received a bonus or other windfall that put them over the $100,000 limit?

Congress addressed that possibility this year, in a "technical correction" contained in the IRS Restructuring and Reform Act of 1998. A provision written into that law allowed taxpayers to "recharacterize" a Roth contribution back into a traditional IRA.

But what happens if someone converts from a traditional IRA into a Roth and then recharacterizes back to traditional, and then decides that he or she really wants to be in a Roth after all. Does the law permit "reconversions"? And, is there any limit on the back-and-forth shuffling between traditional and Roth accounts?

This is more than a theoretical possibility. Suppose your traditional IRA held 1,000 shares of XYZ stock, worth $80 a share in June, when you converted it to a Roth IRA. Under the rules governing conversions, you would add $20,000 to your ordinary income for each of the next 4 years when you figured your tax. (Under another 1998 technical correction, you could also pay tax on the entire $80,000 this tax year.)

But suppose that by August, a share of XYZ has declined to $50. If you could only "undo" the conversion and then do it over again -- and until now, there wasn’t anything to prevent you from doing just that -- your tax would be based on an extra $12,500 this year, rather than $20,000.

That’s the situation the IRS has addressed in interim rules released today and effective for transactions in 1998 and 1999. While leaving transactions before November 1, 1998 untouched, the IRS is limiting "reconversions" to one a year for 1998 and 1999 after that date.

"The Service is basically drawing a curtain over any reconversions made before November 1, 1998. You may have shoveled money in and out of a Roth IRA dozens of times up until that date, and the last reconversion will still be treated as valid as long as you meet the income requirements," Kaster said.

Looking forward, after November 1, 1998, you are allowed one reconversion in 1998 and one reconversion in 1999.

What will happen if someone makes more than one reconversion? They won’t be punished, exactly, but they won’t reap any benefit either, Kaster says. "Basically, the IRS will roll back the clock to the last valid reconversion, and that will be the transaction that determines the tax consequences."

Kaster notes that while taxpayers can rely on the notice for the time being, the IRS may come up with different rules at some time in the future -- although they’ve promised that any new rules won’t be retroactive.


CCH INCORPORATED, headquartered in Riverwoods, Ill., was founded in 1913 and has served four generations of business professionals and their clients. The company produces more than 700 electronic and print products for the tax, legal, securities, human resources, health care and small business markets. CCH is a wholly owned subsidiary of Wolters Kluwer U.S.

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