What to do with the $5 dividends generated on traditional IRA after Roth IRA backdoor Conversion

[lunac0231]

I need some advice on how to handle my situation:

In mid Jan 2023 I transferred $6500 post-tax money to a traditional IRA (SPAXX - Fidelity Government Money Market) and converted entire amount to Roth IRA (back door) a few days later. At Jan end, I received $5 of dividends in my traditional IRA. I didn't touch that $5 for the entire year.

Today(Jan 1 2024) while browsing online I suddenly realize that that $5 balance in my traditional IRA may complicate future conversion/tax. What would be the best course of action now? I intend to do the Traditional IRA to Roth backdoor conversion soon for the maximum amount allowed by IRS in 2024 ($7000), should I transfer $7000 post-tax money to my traditional IRA and convert the $7005($7000+$5) to Roth IRA? Or should I transfer $6995 post-tax money to traditional IRA and convert $7000($6995+$5) to Roth IRA? Or is there another better option? And how should I handle my 8606 for 2023? 

Thanks so much!

[dmertz · Accepted solution]

There is no complication.  When preparing your 2023 tax return, make sure to include the year-end balance in this traditional IRA when TurboTax asks for your year-end balance in traditional IRAs.

In 2024, simply include these remaining funds in the conversion when you do your 2024 Roth conversion.  There is no limit on the amount that you are eligible to convert in any one year.  Your only limitation is on the amount that you are eligible to contribute to the traditional IRA for 2024 ($7,000).

Given the current interest rates, it's likely that the same thing will happen again this year where your traditional IRA will receive some amount of dividend after you do the conversion.

[shubham1310]

@dmertz 

I have the same situation. To confirm what you have said:

1. Add the year end balance (4$ in my case) in 2023 tax return. This will then be taxed in 2023 year in federal.
2. Add 2024 conversion money to IRA
3. Convert the entire sum to Roth (say 7000+4$)

This way I will only be taxed once on the 4$ which is in the year 2023. Is that right?

[fanfare]

Your situation is not the same, you left some money in the IRA so a prorated taxable amount will be calculated using Form 8606

@shubham1310 

[dmertz]

@shubham1310 , your 2023 Form 8606 will have $4 on line 14 that will carry forward to line 2 of your 2024 Form 8606 to be added to your, say, $7,000 nondeductible traditional IRA contribution for 2024, resulting in $7,004 of basis to be applied to your $7,004 conversion for 2024 (assuming no interest deposited into the traditional IRA after the conversion that would result in a nonzero 2024 year-end balance in traditional IRAs).

[shubham1310]

@dmertz 

In terms of the course of action for 2024, say I deposit $7000 in my trad-IRA making the balance to be $7004. I convert $7004 to Roth. Now say in the end of month 5$ was accrued as new interest. The best course of action is to convert that 5$ as well or leave it in the IRA?

[dmertz]

I would convert the $5 as well so as to leave a zero year-end balance.  In that case you would have Roth conversions totaling $7,009 to which your $7,004 of basis would be applied, resulting in $5 taxable.

[shubham1310]

@dmertz I will do that. Thanks !!

One last thing, how exactly do I input the 4$ from 2023 when I do the 2024 tax return?

[dmertz]

If you prepare your tax return with 2023 TurboTax and transfer your 2023 tax file into 2024 TurboTax to begin your 2024 tax return, TurboTax will carry forward the $4 from line 14 of your 2023 Form 8606 to line 2 of your 2024 Form 8606.

[shubham1310]

@dmertz That's great. Thanks for all the help!!