Backdoor Roth conversion seems to overtax us, but I am not confident I'm thinking clearly

[KAS007]

I've read many posts on this forum, but I'm still not clear on how to enter our situation. I appreciate the expert help.

We slightly exceed the Roth contribution income threshold (let us assume $250k for each year of 2019-21). We are both over 50 years of age. I participate in a 401(k) at my employer; my wife does not contribute to a workplace retirement plan. I believe we have been ineligible to deduct the IRA contributions due to our income level. If this is correct, then our IRA contributions are made with after-tax money--the funds below have been taxed once, except for the $8k gains I describe in my wife's traditional IRA, below. Given this, I question if the funds should be taxed in the 2021 conversion year, because they have already been taxed prior to contributing to the IRA. I admit my logic could be erroneous.

Myself:

In 2020, I contributed $14k for 2019 and 2020 traditional IRA contributions. 

In 2021, I contributed $7k for a 2021 traditional IRA contribution.

In September 2021, I converted $21k to a Roth IRA. 

The traditional IRA account balance at EOY 2021 was, let's say, $210k to use round numbers.

My wife:

In 2020, contributed $12k for 2019 and 2020 traditional IRA contributions.

In 2021, contributed $7k for 2021 traditional IRA contributions.

In September 2021, converted this $19k plus $8k of gains to a Roth IRA. 

Her traditional IRA balance was zero at EOY 2021.

When I enter our two 1099-R forms into TT for our 2021 return, our taxes due increases by a steep $10k. While I could be wildly mistaken, I believe that we should be taxed only on the $8k of gains in my wife's traditional account upon conversion, because I believe the other converted funds have already been taxed. 

I need help determining if I am mistaken, and then help entering in TT to correct this.

Thank you.

[DanaB27 · Accepted solution]

If you made nondeductible contributions to your traditional IRA in the past then you should have 2020 Form 8606 with a basis on line 14 to enter into TurboTax if it isn't carried over. Please check your 2019 and 2020 tax returns for Forms 8606 for you and your spouse (if you made nondeductible contributions in other years then check these too.) Your 2020 Form 8606 should have the total basis for 2020 and prior years on line 14 if you filed Form 8606 correctly in the previous years.

Please be aware, that if you had pre-tax funds (deductible contributions) and after-tax funds (nondeductible contributions, basis) then the pro-rata rule will apply and each distribution/ conversion will have a taxable and nontaxable part.

Please review the instructions below to make nondeductible contributions and enter a conversion.

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. If you had a basis in the Traditional IRA before then enter the amount.
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 "Your 1099-R Entries" 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 2020 Form 8606 and the value of all traditional, SEP, and SIMPLE IRAs

[KAS007]

Thank you for this excellent help. 

In checking Forms 8606 for 2019 and 2020 I discovered two errors in 2020: A failure to report the 2019 basis on my form and no 8606 at all in 2020 for my wife. This is surprising because I try to follow the TurboTax interview questions meticulously. 

I gather I should file two corrected 8606 for 2020 along with an explanation requesting relief from any penalty.

I assume I should also use the corrected basis for both of us when filing our 2021 return.

[DanaB27]

Yes, you will have to file an amended 2019 and amended 2020 return to correct Form 8606 each year. Please see How to amend (change or correct) a return you've already filed.

Yes, you should include an explanation requesting relief from any penalty when you mail your amended returns.

Yes, you will use the corrected basis on your 2021 return.

@KAS007

[fanfare]

If you already had a Traditional IRA, there's no Backdoor Roth conversion for you.

It only works if you start with an IRA balance of zero.

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if nothing happened, Form 8606 is not required in that tax year.