In Greek mythology, Epimetheus was a Titan who lacked forethought, and had instead the gift, or curse, of hindsight and afterthought. In tax law, “recharacterization” plays a similar role. When you change your mind after converting a traditional IRA to a Roth IRA, you can elect to recharacterize the conversion and put yourself back into your original position. Why would you want to? One reason is because you have to pay federal income tax on the amount you originally converted. So if, for example, the assets you converted declined in value, you’d be paying tax on money you no longer have, and in hindsight, the decision to convert no longer seems sound. If you recharacterize by the due date of your tax return for the year you made the original conversion, the tax bill goes away.
What happens if you miss the recharacterization deadline? The taxpayer in Private Letter Ruling 2016-35013, petitioned the IRS for relief in exactly that situation.
The taxpayer converted her traditional IRA to a Roth in December 2012. In early 2013, the assets in her new Roth had declined in value due to fraud, and the taxpayer filled out the forms for her financial institution to recharacterize the converted amount. She submitted the paperwork on April 13, 2013. The taxpayer filed her 2012 federal income tax return on time, and did not report the Roth conversion.
In December 2013, the financial institution notified the taxpayer the recharacterization could not be processed until she filled out an application for a traditional IRA and paid a fee. The taxpayer did both and resubmitted her request for recharacterization. In June 2014, the financial institution re-opened the traditional IRA and completed the recharacterization.
In August 2014, the IRS sent the taxpayer a notice saying the original conversion should have been included in income on the taxpayer’s 2012 tax return.
After receiving the notice, the taxpayer requested a private letter ruling requesting relief in the form of an extension of time to make the recharacterization. She argued that the fraud was out of her control, as was the financial institution’s initial rejection of her recharacterization request.
Sections 301.9100-1, 301.9100-2, and 301.9100-3 of the federal income tax regulations provide guidance concerning requests for relief submitted to the IRS on or after December 31, 1997. Here are the relevant regulations.
Section 301.9100-1(c) provides that the IRS may grant a reasonable extension of the time fixed by a regulation, a revenue ruling, a revenue procedure, a notice, or an announcement published in the Internal Revenue Bulletin for the making of an election or application for relief in respect of tax under, among others, Subtitle A of the internal revenue code.
Section 301.9100-2 lists certain elections for which automatic extensions of time to file are granted. The relief requested in this case is not referenced in section 301.9100-2.
Section 301.9100-3 generally provides guidance with respect to the granting of relief with respect to those elections not referenced in section 301.9100-2. This section provides that applications for relief will be granted when the taxpayer provides sufficient evidence to establish that (1) the taxpayer acted reasonably and in good faith, and (2) granting relief would not prejudice the interests of the government.
Section 301.9100-3(b)(1) provides that a taxpayer will be deemed to have acted reasonably and in good faith if the taxpayer (i) requests relief under section 301.9100-1 before the failure to make a timely election is discovered by the IRS; (ii) failed to make the election because of intervening events beyond the taxpayer’s control; (iii) failed to make the election because, after exercising reasonable diligence, the taxpayer was unaware of the necessity for the election; (iv) reasonably relied upon the written advice of the IRS; or (v) reasonably relied on a qualified tax professional, including a tax professional employed by the taxpayer, and the tax professional failed to make, or advise the taxpayer to make, the election.
Section 301.9100-3(b)(3) provides that for purposes of paragraph (b), a taxpayer is deemed to have not acted reasonably and in good faith if the taxpayer uses hindsight in requesting relief. If specific facts have changed since the due date for making the election that make the election advantageous to a taxpayer, the IRS will not ordinarily grant relief. In such a case, the IRS will grant relief only when the taxpayer provides strong proof that the taxpayer’s decision to seek relief did not involve hindsight.
Section 301.9100-3(c)(1 )(ii) provides that ordinarily the interests of the government will be treated as prejudiced and that ordinarily the IRS will not grant relief when tax years that would have been affected by the election had it been timely made are closed by the statute of limitations before the taxpayer’s receipt of a ruling granting relief under this section.
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The extension relief should not be granted.
The information and documentation submitted in this case do not support the taxpayer’s assertion that she satisfies the criteria in section 301.9100-3(b)(1) of the regulations.
The taxpayer requested relief after the IRS discovered that her Roth IRA had not been recharacterized back into a traditional IRA, and she was aware of the necessity of the election in February 2013, which gave her time in which to make a timely election to recharacterize. The taxpayer has not established that there were any intervening events beyond her control, and there was no reliance on a qualified tax professional or on the written advice of the IRS.
Section 301.9100-3(b)(3) of the federal income tax regulations provides that if the facts have changed since the due date for making the election that make the election advantageous to the taxpayer, the IRS will grant relief only when the taxpayer provides strong proof that the request for relief is not based on hindsight. Strong proof was not submitted in this case.
Accordingly, we are unable to grant an extension of time in which to recharacterize the Roth IRA pursuant to section 301.9100-3 of the regulations.