SECTION 2. BACKGROUND

Under § 408(d) of the Code and A–7 of § 1.408A–4 of the regulations, any amount that is converted from a traditional IRA to a Roth IRA is includible in gross income as a distribution for the taxable year in which the amount is distributed or transferred from the traditional IRA. In the case of a conversion involving property, the conversion amount generally is the fair market value of the property on the date of distribution or the date the property is treated as distributed from the traditional IRA. Under A–1 of § 1.408A–7, any amount converted from a traditional IRA to a Roth IRA is treated as a distribution for which a Form 1099-R must be filed by the trustee maintaining the traditional IRA.

Temporary regulations under § 408A regarding the valuation of annuity contracts upon conversion of a traditional IRA were published in the Federal Register on August 22, 2005 (T.D. 9220, 2005–39 I.R.B. 596 [70 FR 48868]). Section 1.408A–4T, A–14 of the temporary regulations states that, when a traditional individual retirement annuity is converted to a Roth IRA, the amount that is treated as distributed is the fair market value of the

annuity contract on the date the annuity contract is converted. Similarly, when a traditional individual retirement account holds an annuity contract as an account asset and the account is converted to a Roth IRA, the amount that is treated as distributed with respect to the annuity contract is the fair market value of the annuity contract on the date the annuity contract is distributed or treated as distributed from the traditional IRA.

A–14 of § 1.408A–4T does not apply to a conversion of a traditional IRA where the conversion is accomplished by the complete surrender of an annuity contract for its cash value and the reinvestment of the cash proceeds in a Roth IRA, but only if the surrender extinguishes all benefits and other characteristics of the contract. A–14 of § 1.408A–4T does not apply in that circumstance because the contract is not being converted. Instead, the cash from the surrendered contract is reinvested in the Roth IRA.

A–14 of § 1.408A–4T also provides rules for determining the fair market value of an annuity contract in the case of a conversion. These rules vary depending on certain factors, including whether the conversion occurs soon after the contract was sold, whether there has been a material change in market conditions, and whether future premiums are to be paid. A–14 of § 1.408A–4T applies to any conversion where an annuity contract is distributed or treated as distributed from a traditional IRA on or after August 19, 2005. As indicated in the preamble to the temporary regulations, no implication is intended concerning whether or not a rule adopted in the regulations is applicable law for earlier conversions.

The temporary regulations also provide authority for the Commissioner to issue additional guidance regarding the fair market value of an annuity contract, including formulas to be used in determining fair market value. The Service and Treasury requested and received comments regarding this anticipated guidance. Commentators indicated that a more specific methodology for valuing the annuity contracts is needed and noted that they are currently implementing the method under A–12 of § 1.401(a)(9)–6 of the regulations for valuing annuity contracts that have not yet been annuitized.

January 17, 2006 315 2006–3 I.R.B.