1 See Institute Memorandum to Pension Members No. 62-98, Pension Operations Advisory Committee No. 51-
98 and Transfer Agent Advisory Committee No. 65-98, dated October 16, 1998.
[10429]
October 28, 1998
TO: PENSION MEMBERS No. 65-98
PENSION OPERATIONS ADVISORY COMMITTEE No. 56-98
TRANSFER AGENT ADVISORY COMMITTEE No. 72-98
RE: CALIFORNIA ISSUES LEGAL RULING ON ROTH IRA
RECHARACTERIZATIONS
______________________________________________________________________________
The California Franchise Tax Board (the “FTB”) recently released Legal Ruling 98-4, which
provides guidance concerning California’s tax treatment of recharacterizations of Roth IRA
contributions. As you were previously informed a recent memorandum1, the governor of California
recently vetoed legislation that would have conformed California’s income tax treatment of the Roth
IRA to the technical corrections provisions contained in the Internal Revenue Service Restructuring and
Reform Act of 1998. Legal Ruling 98-4 states that section 408A(b) of the Internal Revenue Code, as
applicable for California purposes, authorizes the FTB to prescribe the manner for designating an
individual retirement plan as a Roth IRA.
Pursuant to this authority, FTB Legal Ruling 98-4 states that with regard to the 1998 taxable
year, if a taxpayer makes a trustee-to-trustee transfer from a Roth IRA to a traditional IRA that results in
a recharacterization of contribution to the Roth IRA, such trustee-to-trustee transfer will be treated, for
California purposes, as revoking the designation of the individual retirement plan from which such
amounts were transferred as a Roth IRA. The revocation is not applicable for purposes of applying the
one-year rule on rollover contributions to an IRA. However, the Legal Ruling notes that California
taxpayers may not elect out of the 4-year spread for 1998 Roth IRA conversions.
In addition, the Legal Ruling provides two examples of recharacterization scenarios -- example
#1 involves a recharacterization as a result of ineligibility, i.e., AGI in excess of $100,000, and example
#2 involves a recharacterization as a result of a market drop. In both examples #1 and #2, the taxpayer
is treated, for California purposes, as having made an eligible rollover contribution from traditional IRA
#1 to another traditional IRA, IRA #2, and a trustee-to-trustee transfer from traditional IRA #2 to
traditional IRA #3. Further, in both examples, the taxpayer would not include either the rollover
contribution or the trustee-to-trustee transfer in gross income. In example #2, the taxpayer would be
eligible to make another qualified rollover contribution from traditional IRA #3 to a Roth IRA and,
similar to federal tax treatment, the amount includible in income would be based on the value of
traditional IRA #3 at the time of the conversion, i.e., the lower value resulting from the market drop.
- 2 -
In addition, the FTB released Legal Ruling 98-3, which analyzes the taxation of IRA
distributions rolled over to a Roth IRA followed by a change of residence status. Copies of Legal
Rulings 98-3 and 98-4 are attached.
Kathryn A. Ricard
Assistant Counsel
Attachment
Note: Not all recipients of this memo will receive an attachment. If you wish to obtain a copy of the
attachment referred to in this memo, please call the Institute's Library Services Division at (202)326-
8304, and ask for this memo's attachment number: 10429.