If you did a Roth IRA conversion in 2010, you have until October 17, 2011 to undo or recharacterize that conversion. For federal tax purposes, a recharacterization is treated as if the original conversion never occurred. Recharacterizing a Roth IRA conversion can provide you with a sizable tax savings if the amount you converted has suffered a significant drop in value due to a decline in the market. The potential tax saving comes from not having to pay taxes on the amount lost due to the decline in the market.
Here is an example of how recharacterizing can save you money on your taxes. In 2010, you converted $100,000 of your Traditional IRA to a Roth IRA. Assume the full $100,000 conversion is taxable and that your effective federal tax rate on the $100,000 is 25 percent. Due to market volatility, the value of the $100,000 is now $70,000.
If you do not recharacterize the conversion, you would owe $25,000 in taxes because you need to pay tax on the entire $100,000 that was converted. However, if you do recharacterize, the conversion will be treated as if it never occurred and you will not owe anything. Thus, saving you from having to pay tax on the $30,000 loss in your account.
Keep in mind that there are other reasons to consider recharacterizing even if the value of your converted has not declined. For example, you might consider recharacterizing if your economic circumstances have changed and you do not have the money to pay the taxes on your conversion.
For more information on whether or not it makes sense for you to recharacterize you should consult with your financial professional and review IRS Publication 590 http://www.irs.gov/publications/p590/index.html.
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