I followed the instructions for my Traditional to Roth IRA conversion. Turbo Tax automatically sets the taxable distribution as $5,607 instead of $0. How can I change it?

[ssf-gm]

This was a clean conversion with no earnings on the Traditional. So there should be $0 taxable.

[fanfare]

what is the starting and ending values of your IRA before and after you converted some money?

and what was your basis in the IRAs?

These are all important factors. 

[ssf-gm]

OK, so I did some more research and it looks like because I converted my previous traditional 401k to traditional IRA last year as well, it treats it pro-rata. The number is still a little off, I calculated $5579 pro-rata instead of the $5607 from Turbo Tax, but at that point not a big deal.

So does this mean any conversion I do in the future will effectively be double-taxed?

I contribute after-tax to Traditional, and then when I convert I get taxed on most of it because of the pro-rata rule...

And if I don't convert right away, I have the added hassle of keeping track of what percent is after vs pre-tax in my traditional.

[DavidD66]

When you make a non-deductible contribution to your IRA, you have to file form 8606, which will track the value of your IRAs, and the amount contributed after tax. So that's how you keep track of what percent is pretax.

Instead of looking at it as being taxed twice, you can look at as make a non-deductible contribution, and converting some of your 401(k) rollover.

[ssf-gm]

Makes sense, I suppose it's not technically being taxed twice. But it still removes a lot of the benefit from being able to do the Roth conversion when so much of my traditional IRA is pre-tax. Effectively, any time I do the conversion, I'll have to pay my current high tax bracket on a large portion of the pre-tax funds, which I was hoping to avoid until retirement when my tax bracket will be lower.

Now I'm not even sure if contributing to an IRA will even offer me much of a tax advantage to be worth giving up on the liquidity of keeping it in non-retirement accounts. I guess I should've kept my 401k instead of rolling over to a Traditional...the power of hindsight!

Thanks for your help.

[macuser_22 · Accepted solution]

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.

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.

[ssf-gm]

Follow-up question: What do earnings in the traditional IRA count towards when determining the basis?

Is the formula to determine the taxable amount of the conversion:

(1-(after-tax contributions/total IRA value including earnings))*Roth conversion

or should the denominator not include the earnings?

[macuser_22]

Only YOUR non-deductible contribution are basis.  Any earnings  converted will be taxable.

And if you are under age 59 1/2 the taxable earnings will also be subject to a 10% penalty.

That is why a "true" backdoor Roth is usually converted within minutes of the contribution, to avoid any earnings.