Post-tax Traditional to Roth IRA backdoor marked as taxable

[s4v68759eb]

I performed several things last year and want to make sure I didn't totally screw up my tax situation by doing so:

• Rolled-over a previous employer-sponsored 401k into my Traditional IRA
• Made excess contributions to my Roth IRA, which I then recharacterized as Traditional (minus capital loss)
• Made post-tax contributions to my Traditional IRA, which when combined with the Roth contribs equals $6000
• Backdoored the $6000 (minus the loss that occurred in the Roth) from the Traditional to the Roth
• My Traditional IRA balance was not $0 at the end of the year due to the 401k rollover into the traditional.

I have to the best of my knowledge supplied every one of these transactions to TurboTax

• 1099-R for the 401k -> IRA
• 1099-R for the Roth IRA -> Traditional IRA recharacterization
• 1099-R for the Traditional IRA -> Roth IRA conversion

However, when I check my form 1040, Line 4b is showing a taxable distribution of nearly $6000 which I am not expecting to see as I understood all of my actions to be nontaxable. Did I do something wrong in TurboTax or did the 401k rollover mess up my ability to do the backdoor in a nontaxable manner?

[DanaB27 · Accepted solution]

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. 

Instructions for review:

To enter the recharacterization and nondeductible traditional IRA contribution: 

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" and “Roth IRA”
5. Answer “No” to “Is This a Repayment of a Retirement Distribution?”
6. Enter the amount you contributed to the traditional IRA
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. Roth IRA
11. Answer “No” to “Is This a Repayment of a Retirement Distribution
12. Enter the Roth contribution amount 
13. Answer “Yes” to the recharacterized question on the “Did You Change Your Mind?” screen and enter the contribution amount (no earnings or losses)
14. TurboTax will ask for an explanation statement where it should be stated that the original $xxx.xx plus $xxx.xx earnings (or loss) were recharacterized.
15. On the screen "Choose Not to Deduct IRA Contributions" answer "Yes" (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 form 1099-R for the conversion
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 "add 1099-R" and enter your 401(k) rollover
6. Carefully answer the questions
7. On the "Review your 1099-R info" screen click "continue"
8. Answer "yes" to "Any nondeductible Contributions to your IRA?" if you had any nondeductible contributions in prior years.
9. Answer the questions about the basis from line 14 of your 2021 Form 8606 and the value of all traditional, SEP, and SIMPLE IRAs

[s4v68759eb]

thanks for the response @DanaB27 , just to be sure, this applies even if I did the 401k rollover after the backdoor conversion which was marked as a Total Distribution? 

[DanaB27]

Yes, it even applies if the rollover happened after the backdoor conversion since you have to enter the value of the IRA at the end of 2022 on Form 8606 to calculate the taxable part.

@s4v68759eb