Q&A: I missed the recharacterization deadline. What happens now?
Q: I have now just realized that my 1998 conversion to a Roth IRA is invalid. I did not recharacterize by the December 31, 1999 deadline. Will the IRS grant another extension? Otherwise, what happens now?

A: As of now, the IRS has not granted another extension. The December 31, 1999 deadline holds. It appears any further extension will have to come from Congress.

What happens now is not pretty. You will have to file an amended 1998 income tax return to reflect the improper conversion. Instead of only reporting 25% of the conversion amount as income, you will have to report 100% of the improper conversion as income. In addition, if you are under 59½ you will owe the additional 10% early withdrawal surtax. Lastly, because the money went into the Roth IRA when it shouldn't have, you owe a 6% excess contribution tax on the amount that went into the Roth. The only possible saving feature here is that if you were eligible to make a Roth contribution, and you previously did not, you can treat the first $2,000 as your 1998 Roth contribution, and only owe the 6% excess contribution tax on the amount over $2,000.

The 6% excess contribution tax is payable for every year that an excess contribution remains in an IRA, in this case Roth IRA. Since it has remained in the Roth improperly through 1999, you owe the 6% excess contribution tax on your 1999 return also, except that you can reduce the amount subject to the 6% tax if you are eligible to claim $2,000 as a 1999 Roth contribution. If you do not remove the excess money from the Roth IRA by December 31, 2000, you will owe the 6% for 2000 also. When you do remove the excess money from the Roth, you also have to withdraw all applicable income. That income is taxed in the year removed, and will be subject to the 10% early withdrawal surtax if you are under 59½.

Make sure you don't include the 25% of the conversion amount on your 1999 return, as you owe all the tax on that income on the 1998 return.

Once the excess money is removed from the Roth, you cannot put it back in your traditional IRA. It will end up in a regular taxable account. In other words, you have lost the ability to have this money grow on a tax deferred basis.

As I said, put it all together with the tax, extra taxes and loss of tax deferred growth, it isn't pretty.

There is a procedure whereby you can request an extension from the IRS to do the recharacterization. This extension request is not as simple as sending in a form or a letter. Rather, it is an extensive, and expensive process, and there is absolutely no guarantee that the request will be granted. If the amount of the improper conversion is large enough, it may pay to take a shot. If it is relatively small, you're probably better off biting the bullet.