Backdoor Roth and Traditional IRA Conversion

[bfiegoli]

Hello,

My wife and I have been maxing out our 401ks have done backdoor ROTHs for a few years. This year, my wife switched jobs and her employer had only offered a traditional IRA. When she left the job we rolled the money into a traditional IRA and then right to a ROTH fully knowing we would have to pay tax on the money that we converted from ROTH to traditional. Since we have cleared out the traditional IRA do we have to think about the pro rata rule when doing the backdoor roth? From everything we can find online, I believe if at the end of the 2020 year (the year we did the 401k rollover) we do not have any pro rata rule to worry about. To summarize, the traditional IRA would have 0 dollars and the ROTH would have both the backdoor contribution AND the newly rolled over money from the IRA. Any help would be great!

Another thing I was also discussing with a friend is if you can roll the full balance of a traditional IRA to a ROTH IRA (pay the tax) and then also do a backdoor ROTH in the same year. I believe this should also be possible since again the balance is 0 in the traditional IRA for that calendar year. 

Thanks,

Brandon

[dmertz]

Correct.  As long as the balance in traditional IRAs at year-end is zero (and you had no outstanding rollovers that were completed early the following year that would need to be added back to your year-end balance), all of your basis in nondeductible traditional IRA contributions will be applied to your Roth conversions.  You'll still have Form 8606 showing the calculation since Form 8606 is where you indicate that your year-end balance in traditional IRAs was zero.

[bfiegoli]

Thanks so much for the quick reply. Could you clarify your point about rollovers completed earlier the following year? Technically, we did the backdoor Roth in Jan 2020 and then the 401k traditional to ROTH IRA rollover in July as we didn’t know my wife would be switching jobs. Does this still work?

Thanks,

Brandon 

[dmertz]

For example, if your traditional IRA balance was zero on December 31 2020 and you made a nondeductible traditional IRA contribution for 2020 in January 2021, this traditional IRA contribution would go on your 2020 Form 8606.

Depending on your other Roth conversions, TurboTax may or may not treat the basis resulting from this contribution as being applicable to any 2020 Roth conversions through the use of Worksheet 1-1 of IRS Pub 590-B, which is why I chose to be a bit vague with respect to this aspect of the reporting.  TurboTax seems to be rather liberal with the use of this worksheet.  If TurboTax does use the worksheet in this case, the basis from the contribution for 2020 made in 2021 might be used to reduce the taxable amount of the 2020 distributions and the basis so used would therefore not be carried forward to be used to reduce the taxable amounts of Roth conversions done in 2020 or later.  It's not that any basis is lost or you end up paying taxes twice on any money, it just affects which year's tax return shows the taxable amounts.

[bfiegoli]

I think I understand. Thank you so much. Would you then recommend making the backdoor Roth for this year after April? 

[dmertz]

My general suggestion, assuming you know that you will have the necessary compensation to support the contribution, is to make the traditional IRA contributions for a particular year during that particular rather than in the following year before April 15.  That avoids weird-looking results from Worksheet 1-1 that differ from the results calculated on Form 8606 when the entire traditional IRA contribution is nondeductible.

[bfiegoli]

Makes total sense. We always make the contributions in the calendar year. It just feels cleaner for us. Also thank you for clearing up that both the 401k rollover and the backdoor in the same year will not be an issue. 

Thank you!