Can I treat a recharacterization as a conversion when filling out my taxes if I gave my IRA trustee the wrong instructions? Or do I have to unwind the whole thing?

[glossingers]

My income exceeds the limit to contribute to a Roth IRA so I was intending to do a back-door conversion. However, I botched the instructions.  Before I ask my trustee to re-characterize it back I want to know if I can simply file my taxes as if I processed it correctly as a conversion.  Does the IRS really care what's in the trustee's records as long as I'm paying taxes and filling out the proper tax forms?

[Opus 17]

You'll have to tell us more about what you actually did. 

[glossingers]

I contributed $6,000 to my traditional IRA in March 2021 then mistakenly told Fidelity to re-characterize the full contribution to my Roth IRA. Which they did including ~$200 of gains. I exceed the income limit to contribute to a Roth though. I spoke to Fidelity who said I would have to recharacterize it back to a traditional IRA. I would prefer to just report the $6,200 on my taxes as a conversion and pay the applicable taxes. 

[Opus 17]

@glossingers 

In that case, you need to report the traditional IRA contribution as a non-deductible contribution, and then report the conversion. This is commonly known as a “back door“ Roth conversion. 

However, this will only work if you have no deductible balance in any IRA.  If you have any IRA accounts(this one or any other) that contain

tax-deductible contributions, then the back door Roth won’t work the way it is supposed to.

Do you have any tax deductible IRA’s?

[glossingers]

@Opus 17 
I do have a small non-deductible balance in my traditional IRA. I also understand about the pro rata requirement. I plan to convert the rest this year so there is no balance going forward. So if I do report the recharacterization as a conversion I’ll have to complete a substitute 1099-R with the appropriate boxes (2A filled in) and codes (distribution code 2 instead of N) since Fidelity won’t be issuing one?

[Opus 17]

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@glossingers wrote:

I contributed $6,000 to my traditional IRA in March 2021 then mistakenly told Fidelity to re-characterize the full contribution to my Roth IRA. Which they did including ~$200 of gains. I exceed the income limit to contribute to a Roth though. I spoke to Fidelity who said I would have to recharacterize it back to a traditional IRA. I would prefer to just report the $6,200 on my taxes as a conversion and pay the applicable taxes. 

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You can't treat it as a conversion if you told them to recharacterize it.  And if you did a conversion now, it would be for 2022, because conversions can't be back-dated.

I believe you do need to re-re-characterize the Roth contribution as a non-deductible contribution to a traditional IRA.  I believe this can be done before April 15, 2022, and you would report a non-deductible I traditional IRA contribution on your 2021 tax return with form 8606.

Then sometime in 2022, you can convert the entire traditional IRA balance to a Roth and pay the tax on the deductible portion of the conversion, and that would be reported on your 2022 tax return.

As an alternative, you can do the transaction in two separate steps that will have the same net result.

1. Withdraw the $6200 from the Roth IRA as a "withdrawal of excess contributions."  You will also have to withdraw the earnings, if any, from that $6200.  You must do this before April 15. 

2. Make a new non-deductible contribution of $6000 to the IRA, before April 15, applied to the 2021 tax year. 

What then happens on your 2021 tax return is you only report the new $6000 non-deductible IRA contribution.  The IRA-Roth-withdrawal technically never happened, so that get's ignored by your tax return.  If you had earnings on the $6200 in the Roth, you will get a 1099-R next year and it will be taxable plus a 10% penalty for early withdrawal.  And then you can still convert the traditional IRA to a Roth in 2022 and pay the pro-rata income tax on the deductible portion.

@dmertz  Can you confirm or correct?

[dmertz]

The tax code says that the original recharacterization is irrevocable.  I interpret that to mean that re-recharacterization is not permitted.

A return of contribution would be $6,000 with the distribution being $6,000 plus the $200 of gains while in the traditional IRA plus the gains or loss on the $6,200 while in the Roth IRA.  (If my interpretation is incorrect and re-recharacterization is permissible, this same amount would be transferred to a traditional IRA.)

[Opus 17]

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@dmertz wrote:

The tax code says that the original recharacterization is irrevocable.  I interpret that to mean that re-recharacterization is not permitted.

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I thought that was also true but I could not find a link to verify.  I did find that the TCJA made Roth conversions irrevocable, but I could not confirm the same about recharacterizations.

@macuser_22 

[dmertz]

It's a bit obscure.  CFR 1.408A-5 Q&A-4 says:

Q-4. Can an amount contributed to an IRA in a tax-free transfer be recharacterized under A-1 of this section?

A-4. No. If an amount is contributed to the FIRST IRA in a tax-free transfer, the amount cannot be recharacterized as a contribution to the SECOND IRA under A-1 of this section. However, if an amount is erroneously rolled over or transferred from a traditional IRA to a SIMPLE IRA, the contribution can subsequently be recharacterized as a contribution to another traditional IRA.

In this case, the FIRST IRA is the traditional IRA that received the recharacterization contribution and the SECOND IRA is the Roth IRA.  The first recharacterization was performed as a nontaxable transfer of funds to the traditional IRA, so it would seem that those funds are not eligible to be recharacterized back to a Roth IRA.

IRS Pub 590-A says:

Election can’t be changed. After the transfer has taken place, you can’t change your election to recharacterize.

Re-recharacterizing would move the same amount back as would revoking (changing) the election, so they seem to be the same thing.

Still, I've heard of custodian's allowing it, but it's not the custodian's responsibility to enforce the law.  It's the IRA owner who must follow the law.

[Opus 17]

My alternative suggestion would still work though, yes?

[dmertz]

Nothing prohibits a return of contribution and using the funds to make a new contribution up to the $6,000 contribution limit.  The earnings distributed with the returned contribution will be subject to ordinary income tax and the 10% early-distribution penalty.

[glossingers]

@dmertz  @Opus 17 

Thank you both for the explanations and advice.  Sounds like the cleanest method is to request a return of the funds and pay any appropriate penalties and taxes.