Backdoor IRA bug in Deluxe 2022: incorrect non-taxable & taxable amounts with a dirty IRA

[buckshothastings]

The Taxable IRA Distribution Worksheet (WS) doesn't calculate the correct non-taxable and taxable amounts of just a distribution, just a conversion, and a distribution/conversion combination with a dirty IRA. A dirty IRA is a shorthand term that is sometimes used to refer to a contribution that is made between January and April of the next year but reported in the current year. The WS uses line 3 of the 8606, instead of line 5 of the 8606 as the numerator for the non-taxable fraction. Line 5 has the subtraction for a dirty IRA that is part of basis in a following year (line14), but is not part of basis in the current year for calculating lines 5 - 13 of the 8606.

An example: Non-deductible dirty IRA: 5K, basis from earlier years: 10K, distribution & conversion: 4K, ending balance: 96K. The non-taxable fraction should be .10 (10K/100K) (excludes the dirty IRA), but is .15 (15K/100K) (includes the dirty IRA) in the WS post-tax numerator. The corresponding correct amounts are 3,600 and 400, but the WS calculates them as 3,400 and 600. The workaround is to override line 3 of the WS and change 15K to 10K. The WS is wrong, but the 8606 has the correct non-taxable and taxable amounts, which prevents the need for an amended return.

On April 7, 2023, I spent about three hours talking to customer service, including a supervisor who wasn’t aware of any related WS issue, but forwarded it to their investigative team. I also do taxes for seniors. We use TaxSlayer, which calculates this example correctly.

[dmertz]

Under the circumstances, TurboTax is using Worksheet 1-1 from IRS Pub 590-B to calculate the taxable and nontaxable amounts.  Worksheet 1-1 allows the basis resulting from a contribution for 2022 made in 2023 to be applied to 2022 distributions.

[buckshothastings]

Thank you for the info regarding Pub 590-B. I found it interesting that it allows dirty IRAs to be used as basis in the reported tax year, and the 8606 instructions suspend it as basis until the next tax year. Also, since I use both TurboTax and TaxSlayer, TT does it the 590-B way and TS does it the 8606 way.

[fanfare]

if your tax software puts it in 2023, you did not properly inform the tax software that the non-deductible contribution was for 2022.

@buckshothastings 

[Critter-3]

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".

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.
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.

First you must enter your Traditional IRA contributions (if there were 2022 contributions).

IRA contribution
Federal Taxes,
Deductions & Credits,
I’ll choose what I work on (if that screen comes up),,
Retirement & Investments,
Traditional & Roth IRA contribution.

Be SURE to answer the follow up that you  are choosing to make this contribution NON-DEDUCTIBLE - if that screen comes up. (DO NOT say that you moved (recharacterized) the money to a Roth) – this is a conversion, not a recharactorazition.

Then enter the 1099-R that shows the distribution.

Federal Taxes,
Wages & Income
I’ll choose what I work on (if that screen comes up),,
Retirement Plans & Social Security,
IRA, 401(k), Pension Plan Withdrawals (1099-R).

Answer the follow-up questions answer the question that you moved the money to another retirement. The screen will open up with choices of where it was moved. Choose you converted it to Roth IRA.

When asked if you have made any non-deductible contributions say " "yes" if you did then enter the non-deductible contributions made for tax years before 2022.     (Usually zero unless you also made a 2021 or earlier non-deductible contribution. If you do have prior year basis then enter the last filed 8606 line 14 value.).

Enter the 2022 year end value of your Traditional IRA a "0" (zero) - if it is in fact zero - this tax free Roth conversion will not work if it is not zero.

[If you had any other Traditional IRA at the end of 2022, then the nondeductible "basis" must be pro-rated over the current distribution and the total IRA value and only a portion of the Roth conversion will be non taxable and part will be taxable, with the remaining non-deductible basis carrying forward for future distributions. You can never only withdrew the nondeductible basis as long as the IRA exists and has a value more than zero.]

The non-deductible amount of your contribution will be subtracted from the taxable amount of the conversion on then 8606 form and enter on line 4a of them 1040 form and a zero taxable amount on line 4b if you did it right.

Also see this TurboTax FAQ:
https://ttlc.intuit.com/questions/4350747-how-do-i-enter-a-backdoor-roth-ira-conversion

[dmertz]

TurboTax seems to be rather liberal in its use of Worksheet 1-1.  I would argue that if the MAGI would be over the limit even if the entire traditional IRA contribution could be treated as deductible, or if the taxpayer explicitly chooses to make the entire traditional IRA contribution nondeductible, Worksheet 1-1 should not be used because there is no question that the entire traditional IRA contribution is nondeductible.  However, TurboTax does not seem to implement these limitations on the use of Worksheet 1-1.

[fanfare]

I take it back, depending on the circumstances, your non-deductible contribution for 2022 after Jan 1 can end up entirely in basis for next time, Line 14.

(The notation does say, "for 2022 and earlier")

--

" rather liberal in its use of Worksheet 1-1"

how is that not a bug ?

[dmertz]

"how is that not a bug ?"

That's for the IRS to decide.  I do not recall seeing any posts here indicating that the IRS has challenged the liberal use of Worksheet 1-1