Recharacterization is a process by which a contribution to a Roth or traditional IRA, or a conversion from a non-Roth IRA to a Roth IRA, can be reversed or "undone."
There are three possible recharacterization situations. There are detailed examples of recharacterizations here.
First, a regular, annual contribution to a traditional IRA can be recharacterized as a Roth IRA. The recharacterization must be for the same year the contribution was made. Any amount in the traditional IRA that is not a direct result of a regular contribution for the same year cannot be recharacterized (they are converted).
Second, a regular, annual contribution to a Roth IRA can be recharacterized as a traditional IRA contribution. The recharacterization must be for the same year the contribution was made. Any amount in the Roth IRA that is not a direct result of a regular contribution for the same year cannot be recharacterized as a contribution (they are recharacterizations of a conversion).
Third, an amount that was converted from a non-Roth IRA to a Roth IRA can be recharacterized as a non-Roth IRA from which it was converted. The recharacterization must be the direct result of a conversion. Any amounts in the Roth IRA that are not a direct result of a conversion (i.e. they are regular contributions) cannot be recharacterized as a conversion (they are a recharacterization of a contribution).
The recharacterization is effected by doing a trustee-to-trustee transfer of the funds in one IRA to a different type of IRA. The transfer must be a trustee-to-trustee transfer and must be done on or before the due date (with extensions) of the tax return. The transfer must include any earnings or losses on the original contributed or converted amount.
In a recharacterization, there is an amount recharacterized and an amount transferred. It is important to understand the difference. The amount recharacterized represents the original amount contributed or converted and does not include any earnings or losses incurred after the original contribution or conversion. The amount transferred is the amount recharacterized plus any earnings or minus any losses incurred after the original contribution or conversion. Refer to these examples.
The intent of recharacterization was to permit a taxpayer to reverse a contribution to a Roth IRA back to a traditional IRA. If the taxpayer converted a traditional IRA to a Roth IRA and then determined that the conversion was not advantageous, he or she could recharacterize the converted amount back to a traditional IRA. In such a case, the original conversion is essentially a rollover from the original traditional IRA to the resulting traditional IRA (although it is not considered a rollover for the "one rollover per year" rule.) The conversion to the Roth IRA is considered to have never happened.
Regular, annual contributions (not converted contributions) to a Roth IRA may also be recharacterized. A taxpayer might contribute $4,000 to a Roth IRA and then discover that the contribution is limited due to modified AGI. He or she can then recharacterize any or all of the $4,000 to a traditional IRA. In this case, the recharacterized amount is considered to have been made to the traditional IRA and the contribution to the Roth IRA is considered to have never been made.
Annual contributions to a traditional IRA may also be recharacterized. A taxpayer might contribute $4,000 to a traditional IRA and then discover that the contribution is non deductible. He or she can then recharacterize any or all of the $4,000 to a Roth IRA. In this case, the recharacterized amount is considered to have been made to the Roth IRA and the contribution to the traditional IRA is considered to have never been made.
A person can do a recharacterization even if the entire contribution was allowed.
If the original contribution or converted amount has experienced net losses at the time of the recharacterization, the transfer of the remaining amount will generally constitute a transfer of the original amount. For example, a $4,000 contribution to a new Roth IRA made in March is only worth $3,400 in August. The $3,400 (the entire amount of the account) is transferred in a trustee-to-trustee transfer to a traditional IRA. This is the recharacterization of the entire $4,000 originally contributed although only $3,400 was transferred.
For each recharacterization transaction, a 2013 Form 1099-R will be issued showing the amount transferred in box 1 and code "N" or code "R" in box 7. Code "N" is for a contribution or conversion that was made for 2013 and was recharacterized in 2013. Code "R" is for a contribution or conversion that was made for 2012 and was recharacterized in 2013. These Forms 1099-R are reported on the tax return for the years to which the recharacterization applies, not in the year the recharacterization actually took place. Form 1099-R with a code "N" is reported on a 2013 tax return. Form 1099-R with a code "R" need not be reported on a 2012 or 2013 tax return, although the recharacterization itself must be reported.
Most recharacterizations will occur in 2014 for contributions or conversions done in 2013. As a result, the recharacterizations will be reported on a 2014 Form 1099-R with a code "R" and may not be received until January of 2015. The recharacterization needs to be reported on the 2013 tax return, but the Form 1099-R with code "R" does not need to be reported separately on the 2013 or 2014 tax return.
