IRA Conversion to Roth & Pro-Rata Tax Obligation

[djgarcia99]

Hello,

I am considering the conversion of a Traditional IRA to a Roth IRA and looking for guidance on how to calculate the tax obligation.

The Traditional IRA was opened and funded in November 2017 via a rollover of $30,000. A non-deductible $5,500 contribution was made in March 2019 for calendar year 2018. The account grew via two ETF funds and resulting dividends to $41,000 this January, before falling back to $35,000 today.

I believe the pro-rata rule applies...Is that correct...or...Is there an alternative?

According to an Investopedia article on the pro-rata rule:

Tax Free Percentage = Total Non-Deductible Contributions / (Sum of Year-End Value of all IRA Amounts + Conversion Amount)

The Tax Free Percentage is...$5,500 / ($35,000 + $35,000) = 7.9%...Thus...the Taxable Percentage would be 92.1%.

Am I on the right track?

Thanks 🙂

[dmertz · Accepted solution]

Yes, the pro-rata rule applies.  There is no alternative unless you can roll the pre-tax portion into a qualified retirement plan like a 401(k), leaving only the after-tax portion in your IRAs to convert.  Rollovers from IRAs to qualified retirement plans are permitted to consist only of the pre-tax money from your IRAs.

Your year-end balance used in the calculation is to include only traditional IRA balances, not the Roth IRA balance.  In your example where you convert the entire $35,000 leaving a $0 year-end balance in your traditional IRAs, the tax free percentage would be:

  $5,500 / ($0 + $35,000) = 15.7%

The calculation that you did would have been correct if after converting $35,000 you were left with $35,000 in traditional IRAs at year end.

In the case where you convert all of your traditional IRA money to Roth, there is actually no need to calculate the percentage that is basis.  In that case the nontaxable portion is simply your $5,500 of basis.  In any case, TurboTax prepares Form 8606 to calculate the nontaxable and taxable amounts.

[djgarcia99]

Thanks VERY much @dmertz for confirming pro-rata and correcting my math!!!

As a double-check, regardless of whether the initial $30,000 rollover balance or the subsequent $5,500 non-deductible contribution were in cash positions, invested and earned or lost value, all contributions are considered co-mingled...so, no need to calculate different positions, as the pro-rata formula prevails?

[dmertz]

Correct.

[djgarcia99]

Awesome, Thanks again very much @dmertz  😀

[jking53092]

So I calculated my pro rata tax obligation and need to add that taxable amount into Turbo Tax.  How / where does that get added to TT?  Struggling where to find it

[dmertz]

TurboTax automatically prepares Form 8606 Parts I and II to determine the taxable amount of the Roth conversion after you enter the Form 1099-R, answer the immediate follow-up questions, then click the Continue button on the Your 1099-R Entries page and answer the additional questions regarding your basis in nondeductible traditional IRA contributions and your year-end balance in traditional IRAs.

[PianoMan12]

@dmertz I have a strange situation for which I can't find an answer on what the rule is and of course how to handle in Turbo Tax. Early January 2020 I did a $6000 backdoor Roth contribution by first making a non-deductible contribution to a Traditional IRA (that had a zero balance) and then converting that entire 6K to a Roth a few days later.  That would be a simple back-door contribution situation with no taxes. However in August, I rolled a conventional 401K into the same Traditional IRA and subsequently converted $50K (which is only a portion of the balance) to the Roth. My 1099-R shows a distribution of 56K.  

Based on the lack of co-mingling of any of the pre/post tax funds at any time, I would assume that the 50K is 100% taxable while the 6K should sail through with no taxes (as opposed to an application of the pro-rate formula to the entire 56K). Am I right?  If I'm correct, how do I handle it in Turbo Tax to have the 50K taxed and the 6K not be taxed?

[ibarde]

My conversion of a small part of my Traditional IRA  (only pre-tax contributions from years past but zero in 2021)  is fully taxable.  The question of basis does not arise because none of my Traditional IRA accounts, including the one from which the conversion amount came, contains any after-tax contribution.  I received a 2021 Form 5498 only for the Roth IRA account which received the rollover/conversion, but not from the other Traditional IRA accounts from where the rollover amount was withdrawn.  I entered 1099-R for the rollover which shows the taxable amount (box 2a) is equal to the gross distribution (box 1), but the Taxable amount not determined (box 2b) is checked.  

I subsequently said (i) Yes to the TurboTax query if all or part of the withdrawal was rolled over to Roth and (ii) No, I did not make and track nondeductible contributions to my IRA.  The question of pro-rata basis calculation of (a presumed) back-door conversion and/or withdrawal from a Traditional IRA that is funded with after-tax money does not arise.  Please advise how to tell TurboTax that the entire conversion amount is taxable and no calculation of basis is necessary

[dmertz]

If you indicated that you converted the entire amount to Roth and you indicated that you have no basis in nondeductible traditional IRA contributions, TurboTax will treat as taxable the entire amount converted.  You'll see it included on Form 1040 line 4b.  With no basis in nondeductible traditional IRA contributions, TurboTax will only prepare Part II of Form 8606, not Part I.

TurboTax tends to reserve the word 'rollover' to refer to rollovers from traditional to traditional or Roth to Roth even though a Roth conversion is defined in the tax code as a taxable rollover.  If you are not seeing the correct taxable amount on Form 1040 line 4b, make sure that you have indicated that this was a Roth conversion rather than a rollover.