Correcting mistakes in IRA Reporting

[psychoanalyst]

Hello,

During the course of preparing my 2021 returns, I realized that I have been stupid and naive about IRA tax reporting. I am hoping you can help me figure out how best to correct the mistakes I have made. Below are the details of my situation:

1. I opened my first traditional IRA account in 2016 prior to the 2015 tax deadline. I then added a non-deductible contribution of $5500 (max limit in that tax year) for the 2015 tax year: I however failed to report that using Form 8606. 

2. In 2016, I switched jobs. Not wanting to maintain multiple 401K accounts, I rolled over 100% of my 401K money with my old company (a) partly into the IRA account I opened in 2016 and (b) rest in my new company's 401K. Please don't ask me why I did this...I was a complete tax/finance idiot at that time.  So at this point, my IRA account has a mix of deductible and non-deductible contributions. 

3. I received a 1099-R from my old company's 401K account documenting the rollover distribution, which I then reported in my 2017 taxes. 

4. I opened my 2nd  traditional IRA account in 2021. I made 2 non-deductible contributions (a) $6000 for Tax year 2020: again failed to report that in Form 8606 and (b) $6000 for Tax year 2021, which I will be reporting this year. 

5. I converted 100% of funds in my 2nd IRA account into a Roth in 2021. 

So far I have figured out how to handle #4 and #5: I will be doing a late submission of Form 8606 documenting my 2020 non-deductible IRA contribution. I know what to do for my 2021 taxes as well. 

What I am very confused about is how do I go about correcting/documenting my transactions from 2017 and earlier? Should I:

1. Submit a 2015 8606 documenting the $5500 non-deductible contribution? 

2. Report the $5500 as the basis on my 2020 8606? I am assuming that my pre-tax rollover funds should not be considered as part of the basis. 

3. Report $5500 + $6000 as the basis on my 2021 8606 (handled by Turbotax...I don't intend on manually filling in 8606 for my 2021 taxes). 

I would really appreciate the advice here. Didn't realize how much I had ignored reading basic information about the IRA before venturing into it. Lesson learned and will be applied 2022 onwards. 

Many thanks!

Avi

[FangxiaL]

Here is what you should do regarding Form 8606:

• File all the missing 8606 forms by themselves without amending your prior years' returns
• Explain to the IRS what happened and ask for penalty relief if lucky (reasonable cause defense)

Regarding your Roth IRA conversion:

• A separate IRA account won't make all of the conversion tax-free, because all your IRA accounts are aggregated
• If you have a 401(k) with your current employer, ask if the plan accepts rollovers from your IRA account. Try to roll over the old 401(k) money out of your IRA so that you can convert after-tax IRA contributions to your Roth IRA in the future, otherwise, a chunk of your rollover is taxable.  

Here is a link to all prior years' 8606 forms.

[psychoanalyst]

Thanks so much. I will mail in the prior year 8606 forms.

Did I get the details of filling the 8606 forms correct? 

Regarding my 1st IRA: I understand that that funds will get taxed post retirement.....I will take a closer look at it after I am done with taxes this year. 

[dmertz]

Yes, 1, 2 and 3 are all correct.  The $5,500 that results on line 14 of the 2015 Form 8606 carries forward to line 2 of the 2020 Form 8606 to be added to that year's nondeductible contribution and the $11,500 result on that form's line 14 carries forward to line 2 of your 2021 Form 8606 to be combined with the $6,000 nondeductible contribution for 2021 and used in calculating the taxable amount of your Roth conversion.

Since you apparently still had some funds in a traditional IRA at the end of 2021, only some of your basis in nondeductible traditional IRA contributions will be applied to the Roth conversion with the remainder of the basis to be applied to subsequent distributions from your traditional IRAs.  If the amount rolled over from the 401(k) to your traditional IRAs was greater than $17,500 and all pre-tax, more than half of your 2021 Roth conversion will be taxable.

[psychoanalyst]

Not sure if it makes a difference, but the $5500 in my first traditional IRA account remains in that IRA account...I never converted that to a Roth. 

"If the amount rolled over from the 401(k) to your traditional IRAs was greater than $17,500 and all pre-tax, more than half of your 2021 Roth conversion will be taxable."

It was greater than $17,500. But again....I have left that money in my traditional IRA and never converted that. 

I have basically left my first IRA as is as I really didn't to deal with the tax gymnastics of a Roth conversion. Instead, I am doing that with my 2nd IRA acount.

[dmertz]

With regard to the tax treatment, your traditional IRAs are all treated together as if they were a single account.  It doesn't matter which one received nondeductible contributions and which one a Roth conversion is done from, the taxable result is the same.

[psychoanalyst]

Since you apparently still had some funds in a traditional IRA at the end of 2021, only some of your basis in nondeductible traditional IRA contributions will be applied to the Roth conversion with the remainder of the basis to be applied to subsequent distributions from your traditional IRAs.  If the amount rolled over from the 401(k) to your traditional IRAs was greater than $17,500 and all pre-tax, more than half of your 2021 Roth conversion will be taxable.

I am not sure how to account for this when I do taxes this year. 

[dmertz]

Just answer all of TurboTax's questions carefully and accurately without overthinking them.  TurboTax will automatically prepare 2021 Form 8606 to determine the taxable amount of your Roth conversion.  Line 14 of that form will carry forward to line 2 of the next Form 8606 that you next need to file when you take another traditional IRA distribution in the future.

Be sure to click the Continue button on the page that lists the Forms 1099-R that you have entered, otherwise you might not have reached all of the questions needed to obtain the information needed to complete Form 8606.

[psychoanalyst]

"

• If you have a 401(k) with your current employer, ask if the plan accepts rollovers from your IRA account. Try to roll over the old 401(k) money out of your IRA so that you can convert after-tax IRA contributions to your Roth IRA in the future, otherwise, a chunk of your rollover is taxable.  "

I just realized that...after accounting for my earlier IRA, I just went from a refund due to an amount owed. 

Since my first IRA has a combination of 401K and non-deductible $ and the funds have been growing since 2016, how do I specifically roll over my 401K money separate from my non-deductible funds? 

[psychoanalyst]

I think I understood everything. 

I will ask my brokerage if they can do a reverse roll over from my IRA to a 401K of my pre-tax $$ and then attempt a Roth conversion of my post-tax $$s. Although I am not clear how I can sort between pre and post tax $s in my IRA since I invested both. 

Either way, I think I am screwed for the 2021 tax year since I had a substantial balance in my IRA as of Dec 31 2021 and pro rata comes to bite me. But if I can do the above, I can still hopefully clear up my basis going forward. 

Serves me right for not doing proper due diligence before getting into backdoor conversions! 

[dmertz]

The pre-tax balance in your traditional IRAs is the amount by which your total balance in traditional IRAs exceeds your basis in nondeductible traditional IRA contributions.  Your basis is the number that appears on line 14 of your 2021 Form 8606.

Right, nothing you can do about 2021 now.

[psychoanalyst]

You guys are just amazing to patiently walk me through this! Really really appreciate it and thanks to you, the situation is becoming clear to me. I am glad I caught the mistake now when my IRA balance is still < $50K.....had this continued (since I plan on doing a back door Roth every year going forward), pro rata would have really screwed me over. 

I am going to work my company brokerage now to start the process of emptying out my first IRA (the one that has the combination of pre and post tax $$). 

One remaining question. I now know how to calculate the % of my IRA that is composed of pre and post tax money.  If I do the 401K rollover today, I am assuming the amount of the rollover will be based off the total balance of all my IRAs today. 

Here are my rough numbers as of today:

1. Total IRA balance: $44000 in my first IRA (mix of pre and post tax) + $6000 (2022 after-tax IRA contribution ear-marked for Roth conversion...I paused on the conversion because I caught the mess I am in) in my second IRA = $50000. The first IRA is the one I want to zero out right now. 

However, since the $44000 is invested, the exact number is going to fluctuate...that is part of my confusion. 

2.  Total of all my after-tax dollars: $5500 from 2015 IRA + $6000 from 2020 IRA + $6000 from 2021 IRA + $6000 from 2022 IRA = $23, 500. 

3.  Current basis of my IRA : I just manually filled in 2021 8606 and Line 14 = $13,924. Link to my 2021 8606 is here. 

4. Pre-tax balance in my IRAs that I should roll-over into my 401k today: $50000-$13,924 -$6000 = $30, 076

Is this correct? 

[dmertz]

The percentage basis is your current basis (Line 14 of your 2021 Form 1099-R plus the amount that you've contributed for 2022) divided by your current total balance in traditional IRAs.  However, you don't need to calculate the percentage.  You just need to move the pre-tax amount (total balance minus basis) to the 401(k).  You are not permitted to move any of the basis to the 401(k), so on the day of the distribution that is rolled over to the 401(k) you must leave an amount in your traditional IRAs that is equal to the amount of your basis.

If your current basis in traditional IRAs is $13,924 and your current balance in traditional IRAs is $50,000, yes, the pre-tax amount in your traditional IRAs is currently $50,000 - ($13,924 + $6,000) = $30,076.

[psychoanalyst]

I think I am almost there. 

Here is my plan:

1. Since IRA#1 (the one that I want to zero out) has a $44,000 balance right now, I will request the pre-tax portion = $44,000 - $ 13,924 = $30,076 of it to be moved into my 401K. 
2. That leaves me with the post-tax balance of $44,000 - $30, 076 = $13,924, which I plan to roll-over into IRA#2 (purely for the sake of account consolidation), which already has $6000 in post-tax funds.
3. At this point, IRA#1 will have a balance of $0. 
4. I will then do a backdoor Roth conversion of the entire $19, 924 in IRA#2. IRA#2 will then have a balance of $0 as well 

I think this resets everything and makes my backdoor Roth conversions in the future indeed 100% tax-free. To confirm that, I filled a mock 2022 8606 here. I would really appreciate it if you could review it and confirm that everything looks ok.

Also: as I understand it, my IRA balance has to be $0 as of Dec 31st of the conversion year. So I could technically execute the above steps later (but well before Dec 31st of course) since all this is only relevant when I do my taxes again in 2023? 

[fanfare]

The good 'ole "Backdoor Roth" does not work unless you start with a zero balance in your Traditional IRA and end with zero balance in your traditional IRA.

Otherwise your just doing a conversion.