how rollover IRA impact my back door to Roth

[tianwaifeixian]

Here is the time line on what happend:

1. 2012, I contributed more that we could to Roth IRA, so part of the contribution was recategorized to a Traditional IRA, say $3000 at the time. 

2. Since I didn't know there is backdoor, I let the $3000 sit in traditional IRA, which now become say, $7000

3. thi syear,  I was aware of the back door, so I contributed $6000 for 2019 and $6000 for 2020 in March this year(2020).

4. I then back doored eevrything to Roth IRA.

5. I did the samething for my husband's traditional and Roth IRA.

6. Yesterday, I learned that my husband had a rollover IRA that he did a couple of years ago (don't ask me why he didn't tell me that, we already had a long discussion on that). The amount in that rollover IRA account is about 280k.

I did some research online. It looks like in my case, for my husband's part, the amount I back doored to Roth IRA (12000 +7000 =19000) may most likely will need to be fully taxed due to the pro-rata rule, which means, the $12000 +3000=15000 will be double taxed.

Am I understanding that correctly? If so, is there anything I can do to fix the issue? For instance, if I ask my husband to convert his Rollover IRA to 401K, will it make any difference when I file my 2020 return?

Thank you all! 

[dmertz · Accepted solution]

Nothing will be double taxed, but your husband's Roth conversion in 2020 will be largely taxed, with only a small amount of his basis being applied to make that portion of his Roth conversion nontaxable.

If I understand correctly, he'll have roughly has $280,000 in traditional IRAs at the end of 2020, has $15,000 of basis in traditional IRA contributions and did a Roth conversion of $19,000.  If these amounts were exact, this means that the nontaxable portion of the $19,000 Roth conversion would be:

$19,000 * $15,000 / ($280,000 + $19,000) = $953

and the remainder of the conversion, $18,047 would be taxable.  The $14,047 of basis that is not applied to this conversion will remain with his traditional IRAs to be applied to all future distributions from his traditional IRAs until he has no more money in traditional IRAs at the end of the year that he finally drains all of his traditional IRAs.  (This is why there is no double taxation.)  The calculation is done on Form 8606 (or partially on TurboTax's IRA Deduction Worksheet if TurboTax shows asterisks on lines 13 and 15 of Form 8606.

If your husband can roll the $280,000 to his 401(k) with this distribution from the IRA occurring before then end of 2020, that would leave a $0 balance in traditional IRAs at the end of 2020 and would allow all $15,000 of his basis to be applied to the $19,000 Roth conversion.  The rollover to the 401(k) can only be from pre-tax money, so none of the basis moves to the 401(k).

[macuser_22]

You can NEVER withdraw ONLY the nondeductible part - it must be prorated over the entire value of ALL Traditional IRA accounts which include SEP and SIMPLE IRA's. (For tax purposes you only have ONE Traditional IRA which can be split between as many different accounts as you want, but for tax purposes they are all added together).

For example using rough figures: if you had $60K of nondeductible contributions in an IRA with a total value of $600K (10:1 ratio), then when you take a $60K distribution from any IRA account $6,000 would be nontaxable and $54,000 would be taxable (same 10:1 ratio) , with the remaining $54K of basis staying in the IRA for future distributions. As long as there is any money in the IRA, there will be some basis.

TurboTax will ask for your non-deductible "basis" and then the *Total Value* of *all* Traditional IRA, SEP and SIMPLE accounts as of Dec 31, of the tax year. That is so the prorating of the basis can be properly proportioned between the current years distribution and the remaining IRA value. That is done on the 8606 form.

========

The "Backdoor Roth" does not exist in tax law. It is a procedure used by some to take advantage of a quirk in tax law that allows making a non-deductible contribution to a Traditional IRA when one cannot contribute to a Roth IRA, and the immediately converting the Traditional IRA to a Roth IRA, thereby getting the money into the Roth via "backdoor".

That "procedure" can only work of all these requirements are met:
1) No Traditional IRA account whatsoever can exist (that includes any SEP or SIMPLE IRA accounts) at the start.
2) The Tradition IRA contributions must be reported on a 8606 form as non-deductible.
3) The conversion to a ROTH must be shortly after the contribution to avoid taxable gains.
4) The entire Traditional IRA value must be zero that the end of the year of conversion.

Otherwise the conversion will be partly taxable.

First you must enter your Traditional IRA contributions (if there were 2019 contributions).

IRA contribution
Federal Taxes,
Deductions & Credits,
I’ll choose what I work on (if that screen comes up),,
Retirement & Investments,
Traditional & Roth IRA contribution.

Be SURE to answer the follow up that the are choosing to make this contribution NON-DEDUCTIBLE - if that screen comes up. (DO NOT say that you moved (recharacterized) the money to a Roth) – this is a conversion, not a recharactorazition.

Then enter the 1099-R that shows the distribution.

Federal Taxes,
Wages & Income
I’ll choose what I work on (if that screen comes up),,
Retirement Plans & Social Security,
IRA, 401(k), Pension Plan Withdrawals (1099-R).

Answer the follow-up questions answer the question that you moved the money to another retirement. The screen will open up with choices of where it was moved. Choose you converted it to Roth IRA.

When asked if you have made any non-deductible contributions say " "yes" if you did then enter the non-deductible contributions made for tax years before 2019.     (Usually zero unless you also made a 2018 or earlier non-deductible contribution. If you do have prior year basis then enter the last filed 8606 line 14 value.).

Enter the 2019 year end value of your Traditional IRA a "0" (zero) - if it is in fact zero - this tax free Roth conversion will not work if it is not zero.

[If you had any other Traditional IRA at the end of 2019, then the nondeductible "basis" must be pro-rated over the current distribution and the total IRA value and only a portion of the Roth conversion will be non taxable and part will be taxable, with the remaining non-deductible basis carrying forward for future distributions. You can never only withdrew the nondeductible basis as long as the IRA exists and has a value more than zero.]

The non-deductible amount of your contribution will be subtracted from the taxable amount of the conversion on then 8606 form and enter on line 4a of them 1040 form and a zero taxable amount on line 4b if you did it right.

Also see this TurboTax FAQ:
https://ttlc.intuit.com/questions/4350747-how-do-i-enter-a-backdoor-roth-ira-conversion

[tianwaifeixian]

Ahaa! that makes lot of sense now, especially the part of $14,047. I was not aware of that. thanks a lot!

His rollover IRA is with Fidelity which only has funds from his previous empolyer's 401K and 403b plan. His Traditial IRA is with Vanguard.

So to be clear, even if I have already moved the money from his Vanguard traditial IRA account to his Vanguard Roth IRA account, as long as he convert his fidelity Rollover IRA to his current empolyer's 401K, we will be good when we file the return next year, right?

Thank you again! 

[tianwaifeixian]

Thank you macuser_22, I definetly will remember your advise when I prepare the tax next year. This is a big lesson learned for me.

[dmertz]

Correct.  The relative timing of the Roth conversion and the rollover of the remainder of the traditional IRA balance to the 401(k) is irrelevant as long as both are reportable on the 2020 tax return.

[tianwaifeixian]

Thank you! So I have to do this by the end of 12/31/2020 I guess. Thanks again!