Background
Throughout 2007, my client was contributing to a Roth IRA through payroll direct deposit, in the amount of $25 from each paycheck. The client gets paid every two weeks. This would normally mean 26 paychecks. Due to some bonuses, the client actually received 29 paychecks. From each paycheck, $25 was sent by direct deposit into the Roth IRA. Each deposit was actually made during the calendar year 2007, and each deposit was accurately treated as a contribution for 2007. Total contributions to the Roth IRA, therefore, came to $725.
I advised my client to recharacterize all of the contributions to a Traditional IRA, and to make an additional contribution of $1300 to the Traditional IRA. By doing so, my client lowered his AGI to an amount that will license the Retirement Savings Contribution Credit at the 50% level. (The filing status is HoH.) This reduced the client's tax liability to zero, and also had the effect of increasing his EIC.
The IRA itself is with an online broker, and most of the money in the account is invested in exchange-traded funds. But the direct deposit contributions throughout 2007 had simply been accumulating in the money market component of the account. The account is an extremely flexible, self-directed program. Contributions are not automatically invested in any particular product. They simply sit there until the client takes action.
I helped the client fill out a form provided by the broker to request the recharacterization, and we attached a simple schedule identifying the date and the amount of each direct deposit contribution.
The Question
The broker only transferred $677.41 from the Roth IRA to the Traditional IRA.
The recharacterization request form was sent to the broker by mail, using a postage stamp, if anyone remembers what that is [LMAO]. And somehow, neither one of us actually kept a copy of the document. I had saved an electronic copy of the schedule of contributions, but we didn’t have a copy of the broker’s form. So I thought maybe one of us had made a clerical error of some sort with respect to the amount of the recharacterization. But it seemed like they had recharacterized $675, plus the earnings associated with that amount. So I suspected that perhaps the first two $25 contributions, at the beginning of 2007, had been used to make a fund purchase (along with other money that had been contributed around the end of 2006), and that these contributions could not be recharacterized as cash. Perhaps the broker needed an explicit request to recharacterize the assets that had been purchased with those contributions. Or maybe it would simply be easier for my client to send a check for another $50. Either way, something had to be done, because we had already filed the client’s return, reporting a Traditional IRA contribution of $2025 (client’s direct contribution of $1300, plus the payroll contributions of $725 that were to be recharacterized).
My client sent an e-mail to the broker’s customer service group, asking for an explanation as to why only $677.41 had been transferred from the Roth to the Traditional account.
Here’s the response from the broker:
So the amount was adjusted to reflect losses rather than earnings.
It seems like they did this correctly. The intent is to literally turn back the clock, or use a time machine, to make things the way they would be if the client had contributed $725 to the Traditional IRA instead of the Roth.
What’s bothering me is that it looks like the broker is somehow averaging “overall losses” throughout the year, and attributing a certain portion of the losses to those contributions on a proportional basis. I assumed that since we explicitly instructed the broker to recharacterize money that was sitting in the account as cash, that the broker would recharacterize that money, rather than recharacterizing a certain percentage of the account. In fact, the broker did not transfer any securities from the Roth to the Traditional. The broker only transferred cash.
Was this recharacterization done correctly?
This is more of an intellectual exercise. I think we’re going to do nothing at this point. If it is ever questioned by the IRS, we can simply concede the issue and allow the tax return to be adjusted to reflect a Traditional IRA contribution of $1977.41 instead of $2025. The consequences of that adjustment would be minimal.
But I’d like to understand this a bit better…
I guess the real answer will come when the broker issues Form 5498, which is what is used to document the amount of my client’s 2007 contributions. If the broker is doing this properly, Form 5498 will show total contributions for 2007 of $2025.
Any thoughts on this? If it's really wrong, I suppose we should try to get it corrected before April 15.
Throughout 2007, my client was contributing to a Roth IRA through payroll direct deposit, in the amount of $25 from each paycheck. The client gets paid every two weeks. This would normally mean 26 paychecks. Due to some bonuses, the client actually received 29 paychecks. From each paycheck, $25 was sent by direct deposit into the Roth IRA. Each deposit was actually made during the calendar year 2007, and each deposit was accurately treated as a contribution for 2007. Total contributions to the Roth IRA, therefore, came to $725.
I advised my client to recharacterize all of the contributions to a Traditional IRA, and to make an additional contribution of $1300 to the Traditional IRA. By doing so, my client lowered his AGI to an amount that will license the Retirement Savings Contribution Credit at the 50% level. (The filing status is HoH.) This reduced the client's tax liability to zero, and also had the effect of increasing his EIC.
The IRA itself is with an online broker, and most of the money in the account is invested in exchange-traded funds. But the direct deposit contributions throughout 2007 had simply been accumulating in the money market component of the account. The account is an extremely flexible, self-directed program. Contributions are not automatically invested in any particular product. They simply sit there until the client takes action.
I helped the client fill out a form provided by the broker to request the recharacterization, and we attached a simple schedule identifying the date and the amount of each direct deposit contribution.
The Question
The broker only transferred $677.41 from the Roth IRA to the Traditional IRA.
The recharacterization request form was sent to the broker by mail, using a postage stamp, if anyone remembers what that is [LMAO]. And somehow, neither one of us actually kept a copy of the document. I had saved an electronic copy of the schedule of contributions, but we didn’t have a copy of the broker’s form. So I thought maybe one of us had made a clerical error of some sort with respect to the amount of the recharacterization. But it seemed like they had recharacterized $675, plus the earnings associated with that amount. So I suspected that perhaps the first two $25 contributions, at the beginning of 2007, had been used to make a fund purchase (along with other money that had been contributed around the end of 2006), and that these contributions could not be recharacterized as cash. Perhaps the broker needed an explicit request to recharacterize the assets that had been purchased with those contributions. Or maybe it would simply be easier for my client to send a check for another $50. Either way, something had to be done, because we had already filed the client’s return, reporting a Traditional IRA contribution of $2025 (client’s direct contribution of $1300, plus the payroll contributions of $725 that were to be recharacterized).
My client sent an e-mail to the broker’s customer service group, asking for an explanation as to why only $677.41 had been transferred from the Roth to the Traditional account.
Here’s the response from the broker:
Due to overall losses in the account the portion of the losses attributed to $725 in contributions was $47.59 therefore we only recharacterized $677.41. We calculate earnings or losses at the time we process the recharacterization so there is nothing further that needs to be removed from the account for this transaction. If you need further assistance, please reply to this email. You also have the option to call Customer Service between 8:00am and 9:00pm (ET), Monday through Friday. Our toll-free number is 1.800.xxx.xxxx. When you call, please mention reference number xxxxxxx.
It seems like they did this correctly. The intent is to literally turn back the clock, or use a time machine, to make things the way they would be if the client had contributed $725 to the Traditional IRA instead of the Roth.
What’s bothering me is that it looks like the broker is somehow averaging “overall losses” throughout the year, and attributing a certain portion of the losses to those contributions on a proportional basis. I assumed that since we explicitly instructed the broker to recharacterize money that was sitting in the account as cash, that the broker would recharacterize that money, rather than recharacterizing a certain percentage of the account. In fact, the broker did not transfer any securities from the Roth to the Traditional. The broker only transferred cash.
Was this recharacterization done correctly?
This is more of an intellectual exercise. I think we’re going to do nothing at this point. If it is ever questioned by the IRS, we can simply concede the issue and allow the tax return to be adjusted to reflect a Traditional IRA contribution of $1977.41 instead of $2025. The consequences of that adjustment would be minimal.
But I’d like to understand this a bit better…
I guess the real answer will come when the broker issues Form 5498, which is what is used to document the amount of my client’s 2007 contributions. If the broker is doing this properly, Form 5498 will show total contributions for 2007 of $2025.
Any thoughts on this? If it's really wrong, I suppose we should try to get it corrected before April 15.
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