Retirement tax questions

---

@ira2021 wrote:

Hello @macuser_22 

I read your post couple of times and it seems my situation is similar. But I do still have a question. Here is my scenario:

In year 2017, my spouse had made a one-time "deductible" contribution of ~$4K to traditional IRA.

Then last year in 2020, she did a backdoor $6000 "non-deductible" contribution to traditional IRA and then immediately converted $6000 to Roth IRA. Her form 5498 for year 2020 shows a IRA contribution of $6000, but it also shows a fair market value of $4.5K (its not zero). Now in turbotax, we followed all the steps to do backdoor roth, but we see a taxable distribution of ~$2500. What is this amount and what are the various options to make it $0? Can she convert her entire traditional IRA balance to Roth in 2021 to avoid this tax? Is there any other option to avoid this tax? Or is it too late?

---

The "Backdoor Roth" does not exist in tax law. It is a procedure used by some to take advantage of a quirk in tax law that allows making a non-deductible contribution to a Traditional IRA when one cannot contribute to a Roth IRA, and the immediately converting the Traditional IRA to a Roth IRA, thereby getting the money into the Roth via "backdoor" tax free.

That "procedure" can only work of all these requirements are met:
1) No Traditional IRA account whatsoever can exist (that includes any SEP or SIMPLE IRA accounts) at the start. If existing IRA's contain any before-tax money or earnings then it will be partly taxable.
2) The Tradition IRA contributions must be reported on a 8606 form as non-deductible.
3) The conversion to a ROTH must be shortly after the contribution to avoid taxable gains.
4) The entire Traditional IRA value must be zero that the end of the year of conversion.

Otherwise the conversion will be partly taxable.

The reason for #1 & #4 is the following:

You can NEVER withdraw ONLY the nondeductible part - it must be prorated over the entire value of ALL Traditional IRA accounts which include SEP and SIMPLE IRA's. (For tax purposes you only have ONE Traditional IRA which can be split between as many different accounts as you want, but for tax purposes they are all added together).

For example using rough figures: if you had $60K of nondeductible contributions in an IRA with a total value of $600K (10:1 ratio), then when you take a $60K distribution from any IRA account $6,000 would be nontaxable and $54,000 would be taxable (same 10:1 ratio) , with the remaining $54K of basis staying in the IRA for future distributions. As long as there is any money in the IRA, there will be some basis.

TurboTax will ask for your non-deductible "basis" and then the *Total Value* of *all* Traditional IRA, SEP and SIMPLE accounts as of Dec 31, of the tax year. That is so the prorating of the basis can be properly proportioned between the current years distribution and the remaining IRA value. That is done on the 8606 form.