Traditional IRA to Roth IRA conversion

[lfflys]

Last year, I contributed $6000 to my traditional IRA account, all of which is non-deductible. This is my first year opening an IRA account. After I converted the $6000 to Roth IRA, I suddenly got a small amount of earnings ($2), which showed up in the form 5498 as year-end market value for my traditional IRA account. I entered this small amount of earnings as TurboTax asked, it turns out this small amount of earnings is considered taxable. I took a look at the generated form 8606, it seems that it considers $5998 of the total distribution as non-taxable. I wonder whether this is correct. My understanding is that the earnings are tax-deferred. If I convert my 2020 contributions plus these earnings to my Roth IRA, does the earnings count as non-deductible or not (i.e., do I need to pay tax for the conversion)? I understand this is a small amount of money, but just want to fully understand how it's taxed to avoid over-tax on the Roth IRA conversion in the future.   

[macuser_22 · Accepted solution]

The earnings are tax deferred, but the $6,000 of basis must be prorated between the conversion and the earnings, so only $5,998 of the basis can be used to offset the taxable amount of the $6,000 conversion, leaving $2.00 of basis on line 14 of the 8606 to carry forward.     The $2 tax is on the conversion, not the earnings that remain in the IRA.

[lfflys]

Thanks for the reply. If I convert my 2020 contributions, together with the $2 earnings to Roth IRA this year (assuming no earnings for the new contributions), do I need to pay tax for this conversion?  

[macuser_22]

Most people do ti that way.  They make a 2020 contribution and immediately convert to a Roth before there can be any earnings so they do not need to account for the earnings later.

For 2020 convert the entire amount, including any earnings  to a Roth and the $2 carry forward basis will add to the new basis.