[13222]
March 2, 2001
TO: PENSION MEMBERS No. 14-01
PENSION OPERATIONS ADVISORY COMMITTEE No. 21-01
RE: GUIDANCE ON ROTH IRA ISSUES
The Internal Revenue Service and the New Jersey Division of Taxation have recently
released guidance on various issues concerning Roth IRAs. The guidance is summarized below:
Roth IRA 5-Year Testing Period:
In Information Letter 2000-0159, the IRS describes the five-year period for determining
whether a Roth IRA distribution is a qualified distribution. Under Treasury regulation 1.408A-
6, A-2, the 5-year period begins on the first day of the taxpayer’s taxable year for which the first
regular contribution is made to any Roth IRA of the taxpayer, or if earlier, the first day of the
taxpayer’s taxable year for which the first conversion contribution is made to any Roth IRA of
the taxpayer. The same 5-year period is used to determine the qualified status of distributions
from any Roth IRA owned by the taxpayer.
Calculating Net Income Attributable to Recharacterizations
In Information Letters 2000-0163 and 2000-0180, the IRS explains that Treasury
regulation 1.408A-5, A-2(b) and (c) provides two methods for calculating the net income
attributable to a contribution that is being recharacterized under 408A(d)(6). Under the first
method, if the contribution being recharacterized was contributed to a separate IRA and no
distributions or additional contributions have been made from or to that IRA at any time, then
the contribution is recharacterized by the trustee transferring the entire account balance. The
net income or loss for the contribution being recharacterized is the difference between the
original contribution and the amount transferred. Under the second method, which is required
in all other cases, the net income for a contribution being recharacterized is calculated under
Treasury regulation 1.408A-4(c)(2)(ii) (disregarding parenthetical clause in 1.408-4(c)(iii)).
The letters also discuss the calculations applicable to calculating the net income for
excess contributions made to an IRA and returned before the due date. The letter references the
proposed new method for such calculation under Notice 2000-39.
2Abatement of Individual Estimated Tax Penalties Relating to Conversions
In Service Center Advice 200105062, IRS counsel has advised Service Centers that it
cannot abate individual estimated tax penalties that result from income from conversion of
traditional IRAs to Roth IRAs. IRS Counsel was asked for advice regarding the significant
number of requests for abatements from taxpayers who were assessed estimated tax
underpayment penalties for 1999 for failing to include income recognized from Roth IRA
conversions in figuring their estimated tax payments.
IRS Counsel advised that conversion to a Roth IRA is a taxable distribution from the
traditional IRA. Income from such an event must be included in estimated tax calculations
absent a waiver from the IRS. Section 6654(e)(3) limits waiver of estimated tax penalties to
situations in which the underpayment results from “casualty, disaster, or other unusual
circumstances.” Thus, the waiver provisions would not apply to Roth conversions.
New Jersey Clarifies Rules for Roth and Traditional IRAs
The New Jersey Division of Taxation has released Tax Topic Bulletin GIT-2, IRA
Withdrawals, which provides guidance concerning the tax treatment of IRA contributions and
withdrawals. The bulletin states that contributions to both a traditional and Roth IRA are
subject to New Jersey income tax in the year they are made. It clarifies that the New Jersey
Gross Income Act does not include any provisions similar to the Internal Revenue Code, which
permits an individual to deduct contributions to a traditional IRA. Therefore, amounts that are
withdrawn from either type of account are not taxable as they were taxed at the time of
contribution. However, interest, dividends, and other earnings credited to the account, as well
as amounts “rolled over” into an IRA account from a pension plan are subject tax upon
withdrawal. An exception exits where the interest received by a taxpayer on an IRA
distribution is from exempt obligations which are directly owned by the taxpayer in the IRA
plan.
Copies of the IRS and New Jersey Division of Taxation guidance are attached.
Kathryn A. Ricard
Associate Counsel
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