IRS Rules & Calculations for IRA Recharacterization

by Jane Meggitt

Individual retirement accounts (IRAs) come in several varieties. When an IRA contributor makes a contribution into one IRA type and then changes it into another type, the Internal Revenue Service defines it as a recharacterization. To avoid penalties, IRA account holders must follow IRS rules and calculations for recharacterization.

Types of IRAs

Contributors to both traditional and Roth IRAs may save up to $5,000 per year if under age 50 and $6,000 if over 50 if receiving those amounts in wage or salary compensation, as of 2011. Contributions to traditional IRAs are made with pre-tax dollars, and may be deducted from federal income taxes if the employee does not have a retirement plan at work. Monies from traditional IRAs cannot be withdrawn without penalty until the account holder reaches the age of 59 1/2, and mandatory withdrawals begin at age 70 1/2. Withdrawals on a traditional IRA are subject to tax, typically at a lower rate than when the account holder was employed. Contributions to Roth IRAs are made with taxable income. There is no mandatory withdrawal age and withdrawals are tax-free. Simplified Employee Pensions allow employers to make deductible contributions to a SEP or SIMPLE IRA, which has the same rules as the traditional IRA regarding deductions and withdrawals.


When recharacterizing, you might change the contribution made to a traditional IRA to a Roth IRA. A contributor may also realize he earned too much during the year to qualify for a Roth IRA and then switches to the traditional IRA. It's possible the taxpayer did not make as much money as expected and wants to switch from the Roth to the traditional IRA so the contribution is deductible. Under recharacterization, regulations allow a transaction reversal. Roth IRA contributions may be recharacterized into a SIMPLE or SEP IRA. If a traditional IRA is mistakenly transferred or rolled over to a SIMPLE IRA, the amount may be recharacterized later as a contribution to another traditional IRA account. If you mistakenly roll over or transfer an amount from a traditional IRA to a SIMPLE IRA, you can later recharacterize the amount as a contribution to another traditional IRA. However, employer contributions to a SIMPLE or SEP IRA cannot be recharacterized to traditional or Roth IRAs.


Under IRS rules for recharacterizing contributions, you must have the contribution transferred from the IRA in which it was first made to the second IRA using a trustee-to-trustee transfer. Transfers made by the tax return due date, including any extensions, during the year qualifying for the contribution can be treated as made to the second IRA instead of the initial IRA. When calculating recharacterization, you must include in the transfer net income allotted to the contribution. In cases of a net income loss, the transferred net income could be a negative amount. The recharacterization must be reported on the income tax return for the year in which it was made. The contribution to the second IRA must be treated as being made on the date it was made to the original IRA. While traditional IRAs do not have income limits for qualification, Roth accounts do, so take that into account when calculating recharacterization. For 2011, a single head of household may earn up to $107,000 for a full contribution and a partial contribution if making up to $122,000. Married couples filing jointly may earn up to $169,000 for a full contribution and $179,000 for a partial contribution. For 2011, SEP account holders may contribute up to 25 percent of income, with a maximum of $49,000.

Excess Contributions

If you contributed more money to an IRA than law permits, certain recharacterization is allowed. Only actual contributions may be recharacterized. If applying the excess contributions for previous years as the current year's contribution, recharacterization is permitted only if recharacterization falls within the time limits for the tax year in which the applied contributions were made. For example, if you contributed $1,000 more for the prior year than allowed, you could recharacterize the amount for the current year by the general April 15 tax due date. However, if you already made your contribution limit for the current year by April 15, you could not recharacterize and would face IRS penalties.

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