Tax Liability Increases after Entering My Traditional IRA Value on Backdoor Converstion

[ADDIEDCA]

For the previous 15 years, I have performed a backdoor Traditional to Roth IRA conversion, as I was over the income threshold to contribute directly to a Roth IRA.  Every of those years, the backdoor conversion has not been taxed, with the exception of the $1 or $2 of interest income earned prior to the conversion. Every of those years, my year end Traditional IRA balance was $0 as I had not otherwise ever contributed to my Traditional IRA.

For 2025, I did the same backdoor conversation in January, leaving my Traditional IRA balance at $0 for most of the year. However, in November I changed jobs and rolled over my 401K into my Traditional IRA account. When I went to enter in the Traditional IRA balance for December 31, TurboTax is now saying that most of that $7,000 conversation is taxable. Is this correct? My understanding is that it should not be. If I put the ending balance as $0, my tax liability decreases and TurboTax only taxes the $1 in interest income earned prior to the conversion. I know that Form 5498 will be sent to the IRS, so I don't want to enter $0 for the December 31 value as it would trigger an audit.

For clarification, the 401K to IRA rollover is not being taxed by TurboTax, just the backdoor conversion.

[SusanY1 · Accepted solution]

This is correct.  When you have a balance in any traditional IRA, including a rollover from a 401(k), your conversion becomes subject to the pro-rata rules and a portion becomes taxable. 

The percentage of the Roth conversion that is taxable depends on the balance in the rollover IRA.  If it was a fairly large rollover, most of the conversion will be taxable.  

There isn't any way to correct this if you've already made the conversion for this year, but for future years you could potentially avoid the pro-rata rule by either converting all of your Traditional IRA (and paying the tax on this conversion) or by doing a "reverse" rollover and moving the traditional funds back to a 401(k) plan with a new employer - if this applies to you and the plan allows for it.