Backdoor Roth Conversion and SEP IRA

[sdavis81]

About 5 years ago, I was using a tax person to help with filing.   I started using TurboTax for lower costs.

During that time, he was sponsoring two yearly actions.   1)   opened a SEP IRA, and contributed to that based on my income from consulting, outside of my primary job.   2)   Yearly "Backdoor Roth conversion" where I have an traditional IRA account which is empty, but yearly contribute non-deductible money to, and then convert into a Roth IRA that was opened.

So I have 3 accounts in play:

1)   SEP account- recieves 2-5K yearly, value around 30K

2)   traditional IRA account- empty usually

3)   Roth IRA- has about 40K in it now.

As I was preparing to do this, I began reading and I worry that the yearly Roth conversions, which I thought were non-deductible, might not have been permissible because I have a SEP IRA.   (The SEP may have actually lost money over time, not sure).   

can anyone clarify how this works, or how to sort it out?

[dmertz]

You are correct, your past Roth conversions were not entirely nontaxable due to your nonzero balance in traditional IRAs at year end due to the nonzero balance in the SEP IRA, which is a type of traditional IRA.  The balance in the SEP-IRA must be included on line 6 of the Form 8606 reporting the nondeductible traditional IRA contributions and traditional IRA distributions.

Depending on your actual tax liability each year with an incorrectly prepared Form 8606, the statute of limitations for the IRS to make a tax assessment for the underpayment of taxes might have expired (the statute of limitations is either 3 year or, if the underreporting was substantial, 6-years).  Still, just because some of the basis should not have been applied to those conversions, that doesn't mean that you can now claim that that basis was not actually used unless those tax returns are corrected and additional taxes paid.  The principle of consistency prohibits you from treating the basis as used on one tax return and treating it as not having previously been used when preparing a later year's tax return.  Given how long it has been since the erroneous reporting on Forms 8606, it might be the case where you would just do things correctly going forward.

[sdavis81]

Thank you!

This was also done for my wife, we file jointly, using an IRA to Roth Conversion.   Her Roth is in her name, can we keep doing that one?

I will need to figure out how to track the basis of the SEP in the TT system to decide if continuing mine makes sense or not.  Maybe more time than is worth it.  I guess if my SEP is below cost basis, then I could continue?  I think that may be the case.  Couple bad decisions there.

[dmertz]

If your wife has no other money in any kind of traditional IRA such that her total balance in traditional IRAs is zero at year end (unlike yours), all of her basis in nondeductible traditional IRA contributions will be applied to the Roth conversion and none will remain with her traditional IRAs to be applied to future traditional IRA distributions and conversions.  Ideally, that's what you want when doing the backdoor method.