All earnings in a traditional IRA are tax-free until withdrawn, regardless of where the funds came from. That's the whole purpose of a traditional IRA. Therefore, if you make a $7000 non-deductible contribution, and you convert $7003 to a Roth IRA, the $3 is taxable at time of conversion.
Looking at form 8606, and assuming that:
a. you have no other funds in any traditional IRA that would implicate the pro-rata rule
b. you contribute $7000 of non-deductible funds
c. you do a backdoor conversion a few days later for $7003, then
Form 8606
line 1 is $7000
line 2 is $0 (this is your prior basis from last year's form 8606)
line 6 is $0 (your year-ending balance on 12/31/2024 will be zero if you do a full backdoor conversion)
line 8 is $7003
line 10 is 1.000 (because $7000÷$7003 = 0.99957 and that rounds up to 1.000.
line 12, non-taxable portion is $7003.
line 14, basis is $0 (this is your new IRA basis at the end of 2024, it's zero because you did a full conversion).
Essentially, because of the rounding rules, the $3 of interest that should have been taxable gets to be tax free. However, if you had $4 of interest, $7000÷$7004 = 0.9994289, which rounds to 0.999, and $7004 x 0.999=$6997. So by application of the rounding rules, if you earn $3 of interest, it's tax-free, but if you earn $4 of interest, you pay tax on $7 of the conversion.
