Backdoor Roth IRA conversion - pro-rata caculation

[daisy123]

I have $11,000 as my total basis in traditional IRAs (non-deductible contributions). The value of all my traditional IRAs (because of the 401(k) pre-tax funds rollover) is $160,697 as of 12/31/2019. In 2019 I made a conversion to Roth in the amount of $7,947. To determine how much of  $7,947 will be taxable, I did the following calculations: 

$11,000 / $160,697 = 6.85% - that's non-taxable share of the converted amount

100% - 6.85% = 93.15% - that's taxable share of the converted amount

$7,947 * 93.15% = $7,403 - that's the taxable amount of the converted funds

However, Turbotax calculated the taxable amount to be $7,429. The difference is small - $26, but it's still there - I would like to know if I am doing my calculations wrong as I can't attribute this difference to a rounding error.

[dmertz]

You calculated incorrectly by failing to add the conversion amount to the year end value used in the denominator.  The correct calculation of the nontaxable amount is:

$7,947 * $11,000 / ($7,947 + $160,697) = $518

resulting in a taxable amount of

7,947 - $518 = $7,429

exactly in agreement with TurboTax's calculation.

[daisy123]

Thank you very much!

[daisy123]

Thank you again for the answer.

Now there is a new twist - I made a $3,500 non-deductible contribution to traditional IRA in 2020 for tax year 2019, so I went to update it in Turbotax. From what I can see, this shouldn't change any of the calculations below (at least when I manually complete form 8606, I get the same $7,429). However, TurboTax now calculated the taxable amount to be $7,264. Any idea how they got to this number? This is driving me crazy...

[dmertz]

When you added the nondeductible traditional IRA contribution for 2019, TurboTax switched to using Worksheet 1-1 of IRS Pub 590-B to calculate that taxable amount; Worksheet 1-1 adds the $3,500 of new basis to the original $11,000 of basis:

$7,947 * $14,500 / ($7,947 + $160,697) = $683

resulting in a taxable amount of

7,947 - $683 = $7,264

Commentary:  Worksheet 1-1 is supposed to be used only when your traditional IRA contribution "may not be fully deductible and [you] have to figure the taxable part of your 2019 distributions to determine your modified AGI."   I think that TurboTax uses this worksheet more liberally than intended.  I think it's inappropriate for TurboTax to use this worksheet if it's certain that none of your traditional IRA contribution is to be treated as deductible and, therefore, the worksheet is not needed to determine your MAGI, as is the case here.  It's my opinion that this worksheet should only be used when MAGI in in the phase-out range for a deduction for the traditional IRA contribution and a deduction will be claimed.

[daisy123]

Thank you for the detailed answer!

So, if I know that my contribution to traditional IRA is nondeductible, what am I supposed to do about this situation? Obviously, Turbotax's calculation is wrong. Is the only way to fix this to file a tax return without including this nondeductible contribution and then filing an amended form 8606?

[dmertz]

I'm not aware of the IRS disallowing TurboTax's liberal use of Worksheet 1-1, but from some of the questions I've seen on this forum I suspect that the IRS has questioned a number of them because TurboTax does not include the details of the calculation in an explanation statement the way some other tax software does.  As far as I know there is no way that TurboTax includes in a e-filing any indication that Worksheet 1-1 was used, so the IRS would have to infer that from the blank lines 6 through 12 on Form 8606.

[Gasman]

Help me here! Pro rata means proportionally. 50% pretax...means 50% post-tax. 20% pretax mean 20% post tax. Take $11000 add it to $160,697 you get $171,697. 11000/171697=0.0641 or 6.41%. 6.41% of $7947 is $509.41 That is not taxable... the rest or $7437.60 is taxable. This is supposed to be pretty simple....Going through Turbo tax this year I have found Turbo tax is taking my NEW basis....that is the number after it calculates what is not taxed ….subtracts it from my old basis and is adding it to my taxable income.  To make matters worse.....I looked at last years (2019) and it did the same thing...I have been doing Roth conversions for years and am not sure how far back this goes. in 2018 my non deductible (previously taxed) basis was $1194..then in 2019  It did the pro rata calculation and lowered my basis to $908. It did this by doing the calculation as outlined above....again pretty simple. Shown on a worksheet in turbo tax itself.... It then added the $908 to my taxable income for 2019...so in short, I paid taxes on the $1124 already...then in 2019 paid taxes on $908 of it AGAIN!! now... in 2020, while doing the taxes the pro-rata calculation lowered my basis from $908 to $771...and then added the $771 to my taxable income ... ...meaning I will pay taxes on $771 of the 2018....original amount of  $1124...yet...AGAIN. As I stated...I am not sure how far back this goes so maybe someone can help answer what is going on here? HELP 

[dmertz]

Gasman, your own calculations regarding the original example are flawed, so if you use the same flawed methodology in calculating the taxable and nontaxable amounts of your own distribution, you'll get the wrong result.  If you entered everything into TurboTax correctly, TurboTax is giving you the correct result an you are not getting taxed twice on anything.

"20% pretax mean 20% post tax."  No, 20% pre-tax would mean 80% post-tax.  Your traditional IRAs combined contain a certain total amount with some amount being after-tax basis in nondeductible contributions and the rest being pre-tax.

The $11,000 of basis is already part of the $160,697 + $7,947 = $168,644.  It makes no sense to add it again.  The percentage of basis is $11,000 / $168,644 = 6.5226%.  The amount of basis in the distribution is therefore 6.5226% of $7,947, which is $518.35 (rounds to $518 on Form 8606).

Whatever amount of basis is included in your distribution reduces the basis that remains in your IRAs.

If your 2018 Form 8606 shows $1,194 on line 5 and $908 on line 14, it means that $286 of your Roth conversion in 2018 was nontaxable and the rest of the distribution was taxable.  One can also infer that your Roth conversion was about 23.95% of the Roth conversion amount plus your 2018 year-end balance in traditional IRAs.

You description of your transactions in 2018 and 2019 seem to suggest that you are thinking that you can convert to Roth just your basis in nondeductible traditional IRA contributions without taking into account the rest of your traditional IRA funds.  The law doesn't allow that.

[Gasman]

I fully understand the rules and the pro rata requirements. After a lot of number crunching what I have found is turbo tax deducts the previous year basis from the taxable amount early on. that is 100% of it.....I have to assume it assumes a new zero value for your combined traditional IRA's. That allows for a full non deductible basis conversion. When you enter you current value of your IRAs' it adds back in the new basis...it no longer allows the full conversion per the IRS rules....the difference is what is not taxed. IE the pro rata amount of the nondeductible IRA. That number makes sense and is indeed correct. It has to do with turbo tax and you need to follow it through conclusion, and yes it is correct. I stand by my explanation on pro rata. Conversion of 50% of your non deductible amount means you have to  convert 50% of your deductible amount. The same stands on the 20% and 20%. If you want to convert all of your previous non deductible contributions...IE that which you already paid taxes on...you can. You just need to do it pro rata with ALL of your IRA deductible contributions...IE 100% of that also. Turbo tax even supplies a worksheet to show the calculation as I laid it out. I stand on the pro-rata discussion. 

[dmertz]

When you said 20% pre-tax and 20% post tax, you didn't say 20% of what.  I assumed you were talking about percentages of the distribution and is the calculation discussed prior to your post.  However, it's now apparent that you meant that if your distribution is 20% of the sum of your year-end balance plus distributions and conversions, your distribution consists of 20% of your basis and 20% of your taxable money.  That's an alternative way of calculating the nontaxable and taxable amounts, essentially a rearrangement of the order of the mathematical operations, but is not the way it is done on Form 8606.  In the case where there is a combination of regular distributions and Roth conversions (for which the nontaxable and taxable amounts of each are required to be determined separately), the way it's done on Form 8606 is simpler, involving only one division instead of two.

[Gasman]

Didn't say 20% of what? I thought we were talking Roth conversion. I apologize, I thought that was intuitive. When you convert a $$ amount to Roth it needs to be done in pro rata (equal proportions of before tax money and after tax money. 100-100...50-50..20-20..what ever percent you want. Very simple. I also stand by my previous statement on percentage calculation. I again apologize as I didn't fully read Daisy's post...my bad. I assumed the 10697 was his /her total IRA balance...before and after tax....before the conversion.... it wasn't. so again..to find the portion that is not taxed..it is a simple pro-rata (proportional calculation). Before tax money divided by the total before and after tax money. (before the conversion)  It this case...11000/(160697+7947) or 11000/168644 = 0.0652. This is the portion that is not taxed of the conversion 0.0652*7947 = 518. a very simple calc..In fact as dmertz indicates as simple as form 8606...because it IS the exact same calculation. in 2019 line 6 was the value of ALL IRA's as of 12/31/2019...this is after the money to be converted has been taken out...that is line 8..put that back in....that gets you to the number you had before your decided to convert..IE to line 9....160697 (line 6) put back in 7947 (line 😎 line 9 is 168644. that is the denominator. the numerator is the pretax money...IE 11000..line 5..the basis. divide 11000 by 168644 you get .0652...the pro rata...or proportional amount of the conversion that has already been taxed and will not be..518. the rest is taxed.. if you take the 518 and divide it by the 11000..you get .0471 or 4.71 percent of the conversion is already taxed money....if you take the pretax money...IE the total 168644...less the already taxed...11000...you get 157644. this is the amount before the conversion that is pretax....multiple that by the same 4.71% and you get 7425...wow 7425 plus 518...gets you to your conversion amount....(less the small error due to rounding.) math is a cool thing..now going forward if Daisy or anyone  wants to know what amount will be taxed..all one needs to do is take the amount of ones IRA's that has already been taxed and divide it by the sum of all of their IRA's...pre and post tax and you get a percentage. Multiple that by what you want to convert and that is what will not be taxed..simple