IRA Recharacterization

[equinecpa]

I just reviewed a 2008 return for a new client. They made a traditional IRA contribution of $4000 in 2008. They deducted it on their tax return but received no benefit from it as after tax credits they had no taxable income.

I suggested they recharacterize it to a ROTH IRA since then the money won't be taxable when it comes out. The recharacterization will be timely filed by 10/15/09. Is there any other tax consequence to this transaction? Their broker said it would cost them more in taxes to recharacterize than leave it. I disagree but thought I'd ask in case perhaps I'm missing something?

I understand I'll have to amend the 2008 return (take out the IRA contribution) but other than that is there any other consequence of this recharacterization?

[mrbill]

I have done Recharacterizations, and it makes sense if you can stay within the 15% federal tax bracket.

[equinecpa]

I think it makes sense but my questions is would there be any tax consequences to this transaction in 2008/2009 (other than the line item coming off page 1 of their 1040?

[newbie]

I don't see any other tax consequence to this transaction. Perhaps their broker meant there would administration fees of some sort that in his opinion would cost them more to recharacterize than leave it.

[OtisMozzetti]

an alternative: perhaps don't deduct the contribution

I just reviewed a 2008 return for a new client. They made a traditional IRA contribution of $4000 in 2008. They deducted it on their tax return but received no benefit from it as after tax credits they had no taxable income.

I suggested they recharacterize it to a ROTH IRA since then the money won't be taxable when it comes out. The recharacterization will be timely filed by 10/15/09.
...
Their broker said it would cost them more in taxes to recharacterize than leave it. I disagree but thought I'd ask in case perhaps I'm missing something?
...

I would want to check whether the amendment filing to change the amount deducted would be timely, but an alternative to recharacterizing into a Roth contribution would be simply to not deduct all (or some portion) of the amount contributed to the traditional IRA. File form 8606 to claim basis arising from the portion of the contribution not deducted.

That alternative might be almost as desirable as having a Roth IRA, and all or part of the traditional IRA could be converted into Roth in some later tax year.