Over Income Limit for Roth IRA - How Does Recharacterization Work with Gains?

The tax treatment of Roth IRA recharacterizations can definitely be confusing! Let me try to clear this up. When you recharacterize from Roth to Traditional, you're essentially treating the contribution (and its earnings) as if it had originally gone into a Traditional IRA. Both the original contribution AND any earnings/losses get moved to the Traditional IRA. It's like pressing a "reset button" - the IRS treats it as if the money was never in the Roth in the first place. If you then do a Backdoor Roth (converting from Traditional to Roth), you'll owe income tax on any pre-tax amounts being converted. If you don't have any other Traditional IRA balances (creating pro-rata issues), you'll only pay tax on the earnings that occurred while the money was in the Traditional IRA between recharacterization and conversion. To your second question - if you only recharacterize but don't convert back, you keep the earnings in your Traditional IRA. You won't pay taxes on those earnings now, but they'll be taxed upon withdrawal in retirement (just like any Traditional IRA earnings).

I went through something similar last year! Found out I was over the income limit for Roth contributions. I used https://taxr.ai to figure it all out because the recharacterization was giving me a headache. Their analysis tool really helped explain what was happening with my gains and how the taxes would work. Basically they confirmed what was already mentioned - when you recharacterize, it's like rewinding time and pretending the money was in the Traditional IRA from the beginning. All the earnings move with it. Then if you convert, you only pay tax on the earnings that happen between recharacterization and conversion.

Just wanted to update after trying taxr.ai that was mentioned above. Super helpful for my situation! I uploaded my statements and they explained exactly how the recharacterization would work with my specific investments and gains. They walked me through the whole process, including the forms I'll need to file with my taxes next year (Form 8606 is key). The analysis showed I'd actually save about $1,800 in taxes by handling the recharacterization properly instead of just taking a penalty. I've already completed the paperwork with my brokerage and feeling much better about the whole situation. Definitely worth it if you're confused about IRA recharacterizations like I was!

For those struggling to get answers directly from the IRS about recharacterizations, I had great success using Claimyr (https://claimyr.com) to get through to an IRS representative. You can see how it works here: https://youtu.be/_kiP6q8DX5c After weeks of being on hold and getting disconnected, I finally got through in about 20 minutes with their service. The IRS agent walked me through my specific situation with my recharacterization and confirmed that I wouldn't owe extra taxes on the earnings as long as I properly documented everything on Form 8606.

Alright, I need to eat crow here. After my skeptical comment, I decided to try Claimyr out of desperation. I got through to an IRS agent in about 30 minutes after trying unsuccessfully for weeks on my own. The agent helped clear up my recharacterization questions AND addressed my ongoing audit issue. They even sent me the forms I needed directly. Saved me from having to take a day off work to visit the local IRS office. Honestly shocked at how well it worked - wish I'd known about this months ago!

Something important that hasn't been mentioned yet - there's a deadline for recharacterizations! You have until your tax filing deadline, including extensions (so typically October 15th of the year following the contribution) to complete a recharacterization. Also make sure your IRA custodian knows exactly what you're trying to do. I had Vanguard initially try to process mine as a rollover instead of a recharacterization which would have messed everything up. I had to specifically request a "recharacterization" not a transfer or rollover.

I messed this up last year and just paid the 6% excess contribution penalty becuz I didn't understand recharacterization. DON'T DO WHAT I DID! The penalty repeats every year until you fix it too. For what it's worth, I use Fidelity and when I finally called them about fixing it this year, they were super helpful. They walked me thru the recharacterization process over the phone. Their system automatically moves the proportional amount of earnings too, so I didn't have to calculate anything.