IRA promotion bonus and Roth IRA convertion

[Ig-sdlo]

Hi, I have two related questions:

1.Last year, I deposited a non-deductible $1,000 into my IRA. The broker had a promotion that added $100. When reporting this, in addition to Roth IRA conversion, am I correct in reporting in my 8609 that I deposited $1,000 (not $1,100) into the IRA and $1,100 into the Roth IRA, essentially being taxed for only $100 (as the balance was 0 before the contribution)? Do I need to include the $100 bonus in the IRA report or somewhere else? I read that needs to be reported in my income, but then won't I end up paying tax for that twice, one time as income and other time when it comes to Roth IRA as IRA will look like it generated $100.

2.When adding to the 2023 IRA now (additional $1,500), I need to state the total value for the end of 2023. Since my end-of-year value for 2013 was 0, should I add the $1,500?

[dmertz · Accepted solution]

Had the $100 been a bonus provided outside the traditional IRA and then included as part of a total $1,100 of contribution, I would expect that the broker would have been required to issue to you a Form 1099-INT reporting the $100 of income.  Instead, it seems that you made a $1,000 nondeductible traditional IRA contribution and the $100 bonus represents taxable earnings in the traditional IRA, not separately reportable income, but to be certain you would want to review the 2023 Form 5498 from your traditional IRA.  Assuming the latter, with no funds in any traditional IRA at the end of 2023, your Roth conversion would be $100 taxable and $1,000 nontaxable, resulting in $100 of taxable conversion basis and $1,000 of nontaxable conversion basis being added to your Roth IRAs for the purpose of determining the tax consequences of taking a nonqualified distribution from any of your Roth IRAs.

[Ig-sdlo]

@dmertz thanks for answering one of my questions, I got the following forms: 

IRA 5498 - $1000 contribution

Roth IRA 5498 contribution $1100

1099-R,. boxes 1 and 2a show $1100

Based on my reporting I am taxed on $100 when converting as it was an IRA income. Wanted to make sure no other place where I needed to report it. I didn't get 1099-INT

[dmertz]

Sound fine, assuming that the Form 5498 from the Roth IRA shows the $1,100 as a Roth IRA conversion amount in box 3, not in any other box.

[Ig-sdlo]

It is. So to simplify it - I pay tax on the $100 as an earned profit on my IRA and then it is deposited into Roth IRA as the base without any earnings so far?

[dmertz]

In your Roth IRAs, the conversion adds $100 of 2023 taxable conversion basis and $1,000 of 2023 nontaxable conversion basis.

[Ig-sdlo]

@dmertz 

I apologize, but your last comment has left me confus

There's a distinction between taxable and non-taxable amounts, right? Initially, the contributions were after tax, and $100 is being added to the Roth IRA after taxes as I paid taxes on them. So, is it correct that the Roth IRA receives $1,100 as the base amount without distinguishing between the two parts? Can I withdraw the entire $1,100 anytime I want to take out my contribution?

[dmertz]

When you did the $1,100 Roth conversion, your traditional IRA(s) contained $1,000 of nondeductible contributions and $100 of earnings, all of which was converted to Roth.  Because $1,000 of the $1,100 Roth conversion was nontaxable due to having $1,000 of basis in nondeductible traditional IRA contributions, your Roth IRA received $1,000 of nontaxable conversion basis and $100 of taxable conversion basis.

If you take a distribution from the Roth IRA before 2028, the $100 of taxable basis will come out before the $1,000 of nontaxable basis, making he $100 subject to an early-distribution penalty if you are under age 59½ at the time (but no income tax because you already paid tax on that $100).  After 2028 your conversion will have met the 5-year rule for conversions and the penalty on the distribution of the $100 of taxable conversion basis will disappear.  Early-distribution penalties also disappear if you reach age 59½ before making the distribution.

For more details, see the Roth IRA section of IRS Pub 590-B:  https://www.irs.gov/pub/irs-pdf/p590b.pdf

[Ig-sdlo]

@dmertz 

"Roth IRA received $1,000 of nontaxable conversion basis and $100 of taxable conversion basis."

How does the Roth IRA know about this distribution? My 5948 Roth IRA form shows $1100, nothing on this form indicating split between 1,000 and 100

[dmertz]

It is your responsibility to track basis in your Roth IRAs because only you (and the IRS with the filing of your tax returns), not the Roth IRA custodian, knows how your Roth conversion was taxed.  TurboTax assists with this tracking on the IRA Information Worksheet.

[Ig-sdlo]

The only reason why I'm not approving the answer is that I not sure it is correct, to be honest it doesn't make sense.

IRA balance : $1000 non deductible + $100 bonus.

While doing the conversion I pull out the money from IRA and already pay taxes for the $100 in my tax return. 1099-R shows $1100. 

At this point the entire amount was taxed and it goes directly to Roth IRA. 

Roth IRA receives $1100 and 5498 (box 3) shows $1100.  This is the only input that Roth IRA receives, every dollar in this amount was taxed. 

@dmertz @How is it possible to have $1,000 as basis and not considering the entire amount? The way I understand it, my contribution to Roth is $1100 and I can withdraw this entire amount without any split or headache

[dmertz]

You made no Roth IRA contribution.  You did a Roth conversion, $1,000 of which was nontaxable and $100 of which was taxable.

If you have no other money in Roth IRAs, the first $100 that you take out before 2028 will be subject to a 10% early-distribution penalty if you are under age 59½ at the time, but no income tax.  The remaining $1,000 will come out second with no tax or penalty.

Read IRS Pub 590-B.

[Ig-sdlo]

Thanks @dmertz 

I didn't realize that these funds are treated differently depending on how they were transferred - through contribution or conversion.

It seems like every dollar I convert from a non-deductible IRA to a Roth IRA, the 5-year rule applies, and that dollar can be withdrawn with penalties.

Could you please explain why in my case the $1000 out of the total $1100 would be penalty and tax-free? Aren't they sourced with the same conversion?

[dmertz · Accepted solution]

Distributions of funds that ware nontaxable at conversion are not subject to the 10% recapture of an early-distribution penalty because they would not have been subject to the penalty had they simply been distributed from the traditional IRA without converting them to Roth.  Only the portion that would have been subject to an early-distribution penalty had the distribution not been converted to Roth, the $100 of gains, is subject to a recapture of this penalty if distributed before 5-year conversion clock has been completed and you have not reached age 59½.

[Ig-sdlo]

Thanks @dmertz 

Sorry about the confusion!