Partial Conversion Traditional IRA to Roth IRA - Why is my remaining Traditional IRA balance affecting my taxes?

[tmnhall81]

I converted a portion of my Traditional IRA to my Roth IRA in 2022. I understand that I owe taxes on the gross distribution amount that was rolled over. When I enter this information in, it adjusts my taxes accordingly. So far so good. What I'm confused about is when I continue through the process it asks for my IRA basis and then asks for my value as of year end in my Traditional IRA. When I input this amount it takes another sizeable amount for taxes. If I change the year end amount the tax impact goes up and down. Why would the remaining value of my Traditional IRA impact the tax I owe? Shouldn't I only be taxed on the amount I converted to a Roth?

[ThomasM125]

Your IRA basis would be the non-deductible contributions you made to your traditional IRA account. That portion of your IRA would not be taxable when you roll it over to the ROTH IRA. Your basis in the IRA at the end of last year and the balance of money in your traditional IRA at the end of this year will allow for the tax free amount of your rollover to the ROTH IRA to be determined, taking into consideration the amount rolled over, as reported on your 1099-R entry. So, changing the value of either number will affect the taxable amount of your rollover.

These questions in TurboTax occur when you answer Yes to the question I made and tracked nondeductible contributions to my IRA. 

[dmertz]

The nontaxable amount of your Roth conversion is in the same proportion as your basis is to the year-end balance in your traditional IRAs plus the amount distributed or converted.  This is calculated on Form 8606 where the year-end value appears on line 6 (or on TurboTax's version of Worksheet 1-1 of IRS Pub 590-B if that worksheet must be used).  The rest of your basis stays with your traditional IRAs and appears on Form 8606 line 14.

Because some portion of the Roth conversion is nontaxable, less than the full gross amount of the conversion is taxable.

[tmnhall81]

Thanks for this answer. I do have a follow-up question. In my specific example there are a few rollovers happening but to focus on the simplest one;

- Contributed $6,000 cash to a traditional IRA in 2022

- Converted the $6,000 cash to a Roth IRA in 2022

- When I enter the 1099-R information for the $6,000 my federal tax changes by $1,733 (29%). This seems correct to me

- The next question as you point out is the nondeductible contributions. Would this $6,000 qualify as that? If not, I think I should be answering no to that question

- Either way, the the follow-up question is the outstanding balance of all traditional IRA's. When I input that value it impacts my federal taxes by another $1,999 which would be a total tax liability of 62% on the $6,000, which seems crazy

- If I just $0 for outstanding on traditional IRA that $1,999 goes away

So why is the tax impact going up based on remaining balance of traditional IRA that was not converted to Roth?

[tmnhall81]

Thanks for this answer. I do have a follow-up question that I asked the other reply as well. In my specific example there are a few rollovers happening but to focus on the simplest one;

- Contributed $6,000 cash to a traditional IRA in 2022

- Converted the $6,000 cash to a Roth IRA in 2022

- When I enter the 1099-R information for the $6,000 my federal tax changes by $1,733 (29%). This seems correct to me

- The next question as you point out is the nondeductible contributions. Would this $6,000 qualify as that? If not, I think I should be answering no to that question

- Either way, the the follow-up question is the outstanding balance of all traditional IRA's. When I input that value it impacts my federal taxes by another $1,999 which would be a total tax liability of 62% on the $6,000, which seems crazy

- If I just $0 for outstanding on traditional IRA that $1,999 goes away

So why is the tax impact going up based on remaining balance of traditional IRA that was not converted to Roth?

[DanaB27]

If you made previous deductible contributions in your traditional IRA then part of each distribution/conversion will be taxable. If you do not take the full amount out (balance is $0) then the basis (nondeductible contribution) is allocated between the conversion and the remaining balance left in the traditional IRA. Therefore changing the remaining balance will affect how much of the conversion is taxable. I would recommend looking at Form 8606 part I to see how the taxable and nontaxable parts are calculated (like dmertz mentioned).

To verify you made the $6,000 contributed in 2022 to the traditional IRA nondeductible (you won't get an IRA Deduction on line 20 of Schedule 1)?  Did you have nondeductible contributions to the traditional IRA from previous years (reported on Form 8606)? Please be aware that the question  "Any nondeductible Contribution to your IRA?" is referring to nondeductible contributions from prior years, not from 2022. 

Please see the instructions below on how to report nondeductible traditional IRA contributions and conversion for additional information.

To enter the nondeductible contribution to the traditional IRA:

1. Login to your TurboTax Account 
2. Click on "Search" on the top right and type “IRA contributions” 
3. Click on “Jump to IRA contributions"
4. Select “traditional IRA”
5. Answer “No” to “Is This a Repayment of a Retirement Distribution?”
6. Enter the amount you contributed
7. Answer “No” to the recharacterized question on the “Did You Change Your Mind?” screen
8. Answer the next questions until you get to “Any Nondeductible Contributions to Your IRA?” and select “Yes” if you had a nondeductible contribution before this tax year.
9. Enter your basis in the Traditional IRA from your 2021 Form 8606 line 14 (if you had a basis in the prior year)
10. On the “Choose Not to Deduct IRA Contributions” screen choose “Yes, make part of my IRA contribution nondeductible” and enter the amount (if you have a retirement plan at work and are over the income limit it will be nondeductible automatically and you only get a warning and then a screen saying $0 is deductible).

To enter the 1099-R conversion: 

1. Click on "Search" on the top right and type “1099-R”  
2. Click on “Jump to 1099-R”
3. Click "Continue" and enter the information from your 1099-R
4. Answer questions until you get to “Tell us if you moved the money through a rollover or conversion” and choose “I converted some or all of it to a Roth IRA”
5. On the "Review your 1099-R info" screen click "continue"
6. Answer "yes" to "Any nondeductible Contributions to your IRA?" if you had any nondeductible contributions in prior years.
7. Answer the questions about the basis from line 14 of your 2021 Form 8606 and the value of all traditional, SEP, and SIMPLE IRAs

@tmnhall81

[tmnhall81]

Thanks. Yes, the $6,000 will not get an IRA deduction. I'm basically doing a backdoor Roth but I think what's new is that in previous years I would contribute $6,000 then do a full balance rollover. This year, their was a 401k that I rolled into a traditional IRA. I did the same $6,000 contribution and rollover but now there is a remaining balance due to the rollover 401k sitting in the traditional IRA.

I guess what I'm really struggling with here is TurboTax has me paying $3,732 in tax ($1,733 impact after I put in the $6,000 rolled over and another $1,999 impact after I put in my remaining traditional IRA balance) on $6,000 that was converted to Roth. This would infer 62% tax rate on the $6,000 that actually moved. I was under the impression that if I rolled over $6,000 today that I would owe my income tax rate on that $6,000, which the $1,733 would seem accurate. $3,732 feels like I'm getting screwed somewhere.

[DanaB27]

Yes, the 401(k) rollover of pre-tax funds complicated your tax situation, and part of your conversion will be taxable as shown on line 4b of Form 1040.

 The Backdoor Roth only works if your traditional/SEP/SIMPLE IRAs are empty. Since you had pre-tax funds from your 401k rollover in your traditional IRA the pro-rata rule applies. This means that with each distribution/ conversion, you will have a taxable and nontaxable part. You can see the remaining basis on line 14 of Form 8606, this basis can be carried forward. Therefore each distribution/conversion in the future will have a taxable and nontaxable part until the basis is all used.

If you plan to use the Backdoor Roth strategy in the future you might want to think about a reverse rollover where you rollover IRA money to a company plan, like a 401(k). Only pre-tax funds can be rolled from an IRA to a company plan. Therefore, you would isolate the basis and could start the Backdoor Roth procedure fresh. But it only works if your employer allows it, not all plans do.

You might want to look into both these articles for additional information: How to FIX Backdoor Roth IRA Screw-ups and When the Reverse Makes Sense: Benefits of a Reverse Rollover. 

If you like I can review your return to verify your entries. You can send us a “diagnostic” file that has your “numbers” but not your personal information. If you would like to do this, here are the instructions for TurboTax Download: 

1. On your menu bar at the very top, click "Online"
2. Select "Send Tax File to Agent"  
3. Click "Send"
4. The pop-up will have a token number
5. Reply to this thread with your Token number. This will allow us to open a copy of your return without seeing any personal information.  

We will then be able to see exactly what you are seeing and we can determine what exactly is going on in your return and provide you with a resolution.

@tmnhall81

[dmertz]

Your tax liability changes when you enter your year-end balance in traditional IRAs because until you do so TurboTax is unable to correctly prepare Form 8606 to determine the taxable amount of your Roth conversion.  Once you make that entry, TurboTax corrects Form 8606 to produce the correct higher taxable amount of the conversion, applying less of your basis and retaining more of your basis in your traditional IRAs as dictated by the proportions now able to be determined properly.  Failing to enter your year-end balance will result in you underpaying your tax liability.