Backdoor Roth IRA conversion of 3 years non-deductible traditional IRA contributions

[vstronge]

I contribute the maximum to my traditional IRA each year with non-deductible income. 

2017 = $5500

2018 = $5500

2019 = $6000

Total now = $17,897.40 of non-deducted income in my traditional IRA.

I usually convert the traditional IRA amount every year using a backdoor Roth IRA conversion, but not for the last 3 years. I now want to convert the 3 years of contributions in my traditional IRA to the Roth IRA this year, and want to determine how much tax (if any) I will owe.

1) How do I determine my basis in traditional IRAs (Line 2 of 8606)? The tax basis chart says it would be $5500 (Line 14 from my previous year 8606) - is that correct, or should it include the full $17,897? Does the basis accumulate?

2) Do I need to report any gains on the traditional IRA over the last 3 years? How and where do I do this?

Thanks in advance.

[Critter]

If you will convert it all in 2019 then all the contributions will be taken into consideration on the 2019 return  ... if so  only the earnings portion will be taxable if you choose to convert the entire balance of the IRA at once.  

[dmertz]

Presumably the 2019 Form 8606 will have line numbering the same as the 2018 Form 8606.  Your 2019 Form 8606 will have:

Line 1 = $6,000 (your contribution for 2019)

Line 2 = line 14 of your 2018 Form 8606, presumably $11,000.

If your the total value of your IRA account(s) is $17,897.40 on the day that you convert the entire amount, the taxable amount will be $17,897.40 - $17,000 = $897.40.

[vstronge]

Line 14 of my 2018 8606 was $5,500. So the taxable amounts work out to $17,897.40 - $11,500 = $6,397.40.

But it doesn't make sense to me why I would need to pay tax on the additional $5500. I think the basis I enter in Line 2 is not correct, but that's the Line 14 of my 2018. 

Instructions say to use the Total Basis Chart: 

IF the last Form 8606 you filed was for a year after 2000 and before 2019,
THEN enter on line 2 the amount from line 14 of that Form 8606

Thanks in advance

[dmertz]

If you properly prepared your 2017 Form 8606, line 14 of the 2017 Form 8606 would have $5,500 that would transfer to line 2 of your 2018 Form 8606.  The separate $5,500 on line 1 of your 2018 Form 8606 would be added to that, resulting in line 14 of your 2018 Form 8606 having $11,000.  The $11,000 from line 14 of your 2018 Form 8606 will transfer to line 2 of your 2019 Form 8606 to be used to determine the taxable amount of your 2019 Roth conversion.

If 2018 TurboTax is not showing the $5,500 on line 2 of the Form 8606, revisit the Traditional IRA contribution section,  answer Yes, you made and tracked nondeductible contributions to your IRA, then enter your $5,500 of basis carried into 2018 from 2017 (the amount shown on line 14 of your 2017 Form 8606).

[vstronge]

I've now realized I didn't file 8606 forms for 2015 and 2016 (I started contributing to traditional IRAs and converting to Roths in 2015). In 2017, I worked with a TurboTax advisor to show the contributions and conversions for 2017 but I don't think it was done correctly. And then I clearly made a mistake on the 2018 8606. 

I think I need to submit new 8606s for 2015 - 2018 and work through each of them to arrive at the correct 8606 for this year. Is that the right thing to do? 

Thanks so much for helping me unravel this mystery.

Vicki

[dmertz]

Forms 8606 are required for any year that you make a nondeductible traditional IRA contribution, you make a distribution from a traditional IRA and you ave basis in nondeductible traditional IRA contributions or you do a Roth conversion.  (Also in years you make a nonqualified distribution from a Roth IRA, but that's not what we're talking about here.)

The fact that you did not file Form 8606 for 2015 or 2016 implies that you neither reported the nondeductible traditional IRA contributions made for those years nor reported the Roth conversions made in those years.  I would prepare these forms for these years to make sure that the result was that the Roth conversion was nontaxable.  I don't know if I would file them, though, since the IRS might charge a $50 late-filing fee for each.  I don't think that there is much chance that the IRS would come after you for unpaid taxes as a result of these transactions; 2015 is a closed tax year (assuming that you filed before September 2016) and 2016 will become a closed tax year in 2020.  Even if the IRS did determine an underpayment, say, because they treat the 2016 Roth conversion as taxable in the absence of reporting any basis in nondeductible traditional IRA contributions, you can just file the late 2016 Form 8606 in response to that.

Edit:  You didn't previously mention any Roth conversion in 2017.  If your contribution for 2016 was made in 2017 and you converted it in 2017, it would probably make sense to file the 2016 Form 8606 to report the nondeductible contribution for 2016.  If that 2016 Form 8606 needed to have an amount on line 2, you would probably need to also file the 2015 Form 8606.

[vstronge]

I "prepared" all of the 8606 documents from 2015 to 2020. I can convert $16,740.07 of the funds in my traditional IRA to a roth with no tax owed. Converting the full amount of $17,897.40 will leave me with about $1k that is taxable. I think this means my basis goes down to zero - not sure what the implications of that are?

As long as this is straightforward to enter into TurboTax, I will go ahead - it was confusing for me and the TurboTax advisor when we did the last conversion and we ended up making mistakes. 

Thanks for your help!

[dmertz]

"I can convert $16,740.07 of the funds in my traditional IRA to a roth with no tax owed. Converting the full amount of $17,897.40 will leave me with about $1k that is taxable."

It sounds like you still have errors in the calculations that you've done.  If your basis is only $16,740.07 (I not sure how that might have happened unless previous conversions were partially taxable and you had a nonzero balance in traditional IRAs at the end of some year) which is less than your balance in traditional IRAs, any conversion will be partially taxable.  You cannot convert just he basis; any conversion is a proportional mix of nontaxable basis and a taxable remainder.  Unless you convert the entire amount and you have no balance in traditional IRAs at year end you'll have some basis remaining.

[vstronge]

You're right - after I posted this, I reviewed the 8606s and realized there were some mistakes. It gets even more complicated.

Where I am now: for 2019, I have a basis of $14,300, a contribution of $6000, and a traditional IRA with $18,066.47 funded will all non-deductible contributions.  If my current calculations are correct, I can convert the entire amount in 2019 and it will all be non-taxable. The basis is higher because I converted a contribution that was made in the 2016 tax year but in 2017. I also made a contribution in 2018 to the 2017 tax year, but I didn't convert in 2017 (or 2018). So I think I am going to owe some taxes due to that error I made in 2016, but I hope I can still rely on the calculations I've done on each 8606.

If I didn't make that conversion-timing error in 2016, I would have a basis of $11,000 and a contribution of $6000, which means I can't convert the entire amount of the traditional IRA tax-free. 

So my question is, what is the correct calculation given that I converted part of my traditional IRA in 2017 that should have been taxable?

[dmertz]

If you filed an incorrect 2017 tax return because the taxable amount determined on Form 8606 was incorrect, you would amend your 2017 tax return to pay the tax that should have been paid.

Because any balance in basis carries over from one year to the next, it's really impossible to know what should have been reported without knowing all of the transactions that have occurred.  As I understand it, the first ever nondeductible traditional IRA contribution you made was for for 2015.  If yo provided a listing all of the month, year and amounts of contributions, the year for which those contributions were made, dates and amounts of regular distributions (if any), month, year and amounts of Roth conversions made in 2015 through 2018 and your year-end balances in traditional IRAs for 2015 through 2018, I could recreate all of your Forms 8606 and tell you what should have been present on each.  Anything else would be based on incomplete information, so I'm not going to make any guesses.

[vstronge]

Here's the data! I tried to do this myself but got a different answer every time. I have a new calculation but would love to make sure it's correct. No distributions from traditional IRA other than conversions to Roth. 

Goal is to determine how much of my traditional IRA i should convert with the lowest tax implications (now and future), when I should convert, and if I should resubmit any 8608 (i.e. 2017). 

I am also not sure why the current value of my traditional IRA is so high. but it is invested as a single account with some other investments (Betterment) - the FMV might be lower when I get my statement at year end.

Calendar Year	Traditional IRA Contributions	Date of Contribution	Conversion to Roth IRA	Date of Conversion	Year End Traditional IRA Value
2015	$4,500.00	09/03/15
	$940.01	9/21/15
			$5,407.27	9/21/15	$0.00
2016	$1,000.00	3/22/16
	$400.00	6/28/16			$1,518.29
2017	$3,300.00 (2016 tax year)	2/21/17
			$4,899.94	3/1/2017
	$2,000.00	03/21/17
	$1,000.00	12/01/17			$3,047.43
2018	$2,500.00 (2017 tax year)	03/08/18
	$3,000.00	03/12/18
	$2,000.00	10/15/18
	$500.00	2/27/19			$9,652.86
2019	$500.00	01/07/19
	$500.00	02/27/19
	$3,000.00	3/18/19
	$2,000.00	03/01/19			$18,066.47 (current value)

[dmertz]

I can see why this is complicated because of the way TurboTax might do 2017.

Treating all contributions as nondeductible:

2015 Form 8606:

Line 1 = $5,440

Line 2 = $0

Lines 3 and 5 = $5,440

Line 6* = $0

Lines 8* and 9* = $5,407

Line  10* = 1.000

Lines 11* and 13 = $5,407

Line 14 = $33

Line 15c = $0

Line 16 and 17 = $5407

Line 18 = $0

* calculation probably done on a separate worksheet by TurboTax but the result is the same

The unrecoverable $33 of basis probably reported as a miscellaneous deduction on Schedule A reducing the basis to zero, but likely less than 2% of AGI so the deduction provides no benefit.   Basis to carry over to 2016 is $0.

2016 Form 8606:

Line 1 = $1,400

Line 2 = $0

Lines 3 and 14 = $4,700

2017 Form 8606 (the method I prefer since you don't need to figure your modified AGI to know that your entire IRA contribution is nondeductible)

Line 1 = $5,500

Line 2 = $4,700

Line 3 = $10,200

Line 4 = $2,500

Line 5 = $7,700

Line 6 = $3,047

Line 8 = $4,900

Line 9 = $7,947

Line 10 = 0.969

Lines 11 and 13 = $4,748

Line 14 = $5,452

Line  15c = 0

Line 16 = $4,900

Line 17 = $4,749

Line 18 = $152

However, because there was a nondeductible contribution for 2017 a distribution (conversion) was also done in 2017, TurboTax does the ratio calculation on a separate worksheet under the assumption that you need to use the worksheet because you do not know how much of your IRA contribution is deductible, resulting in the entire conversion coming from basis:

Line 1 = $5,500

Line 2 = $4,700

Line 3 = $10,200

Line 4 = $2,500

Line 5 = $7,700

Lines 11 and 13 = $4,900

Line 14 = $5,300

Line  15c = 0

Line 16 = $4,900

Line 17 = $4,900

Line 18 = $0

2018 Form 8606

Line 1 = $5,500

Line 2 = $5,452 or $5,300 depending on which way 2017 was done

Lines 3 and 14 = $10,952 or $10,800 depending on which way 2017 was done

2019 Form 8606

Line 1 = $6,000

Line 2 = $10,952 or $10,800

Line 3 = $16,952 or $16,800

Line 4 = $0

Line 5 = $16,952 or $16,800

Line 6 = $0

Lines 8 and 9 = $18,066 (current value)

Line 10 = about 0.930 but the actual value doesn't really matter since you are converting the entire balance

Lines 11 and 13 = $16,952 or $16,800

Line 15c = $0

Line 16 = $18,066 (current value)

Line 17 = $16,952 or $16,800

Line 18 = $1,114 or $1,266

From 2016 through 2019 you will have contributed $21,700 and converted $22,966 resulting in a taxable amount between 2017 and 2018 totaling $1,266.

Regarding the calculation for 2017, TurboTax is using Worksheet 1-1 in IRS Pub 590-B:

https://www.irs.gov/pub/irs-pdf/p590b.pdf

If you choose to file 2017 Form 8606 as prepared by TurboTax using the worksheet, I would probably include a copy of the worksheet prepared by TurboTax.

[vstronge]

Wow!!! 

Thank you so much - not only for helping me calculate the correct amount owed, but helping me learn about this process along the way. On my final set of calculations I came to the same result. 

I looked at the 2017 8606 prepared by TurboTax and they must have used the worksheet as the results are as you describe. 

Now I know what to do and how to report it - wonderful. 

Thanks so much again.

Vicki

[dmertz]

One other thing that might be worth mentioning regarding 2017 and the worksheet:  The reason that the worksheet produces a lower taxable result than doing the calculation directly on Form 8606 is because the worksheet allows the basis added for 2017 in 2018 to be applied to your 2017 distributions and conversions without increasing the 2017 year-end balance in your traditional IRAs while the Form 8606 calculation does not.

The reason I suggested sending a copy of the worksheet used by TurboTax if you send the 2017 Form 8606 after your original filing is because without the worksheet the IRA examiner can't validate the calculation.  The Form 8606 simply includes a notation that the worksheet was used and shows only the final result.

Also, regarding the FMV of your account, the FMV will be zero at the end of 2019 if you convert the entire amount.  With your modified AGI already being high enough to make your traditional IRA contribution nondeductible it seems unlikely that the resulting increase in taxable income of $1,300 would deter someone under age 50 from converting the entire balance.