Backdoor Roth Conversion and Traditional IRA balance due to interest

[chrisnkaryn84]

In December 2022, I performed a Backdoor Roth for my wife.

1. Opened a Traditional IRA (A) with Fidelity.

2. Funded the new Traditional IRA (A) with max of $6000 with core position of SPAXX

3. A few days later, the Traditional IRA (A) received a dividend of $8.69

4. I converted the Traditional IRA (A)  $6000 to existing Roth IRA b/c my understanding was that $6000 was the max for contribution to Roth.

5. There was a Traditional IRA (A) balance of $8.69 after the conversion.  Since then the Traditional IRA (A) balance has grown to $9.08 as of today.

6. A few days ago, I opened another Traditional IRA (B) for my wife with Fidelity and funded it with max of $6500 with core position of SPAXX in preparation for another Backdoor Roth IRA Conversion.

Questions:

1. Since there was/is a balance of $9 in Traditional IRA (A) on 12/31/2022, will the first Backdoor Roth conversion be a taxable event?  If so, how will we be taxed for that event?  Will the Roth now be taxed a second time (post-tax $ invested, taxed again upon withdrawal)

2. Should I have converted the TOTAL Traditional IRA (A) or $6008  balance to the Roth in that first Backdoor Roth Conversion? 

3.  What is the best way to handle the $9 in the Traditional IRA (A) now to minimize taxes?

4. If the Traditional IRA (A) backdoor Roth was a taxable event, will it affect taxes on future Backdoor Roth Conversions (e.g. 2023)?

Thank you.

[Hal_Al]

Q. Should I have converted the TOTAL Traditional IRA (A) or $6008  balance to the Roth in that first Backdoor Roth Conversion?

A. Yes. 

Q.  Since there was/is a balance of $9 in Traditional IRA (A) on 12/31/2022, will the first Backdoor Roth conversion be a taxable event?  If so, how will we be taxed for that event?  Will the Roth now be taxed a second time (post-tax $ invested, taxed again upon withdrawal)?

A. This year's contribution cannot be converted in isolation from any other traditional IRA (TIRA) money.  Assuming that was her only TIRA money. The calculation goes like this: $6008.69 balance in all your existing traditional IRAs and that balance consist of $6000 in deductible contributions and $8.69 in earnings . This year you convert $6000 to a Roth. 99.855% (6000/6008.69) of the $6000 conversion ($5991) will be tax free ($9 of the conversion is taxable income). This is the way the IRS requires it to be done. The calculations will be shown on form 8606.

Just to make it more complicated, you cost basis in your $$8.69 balance, is $8.68.  Rounding, the whole $9 is basis. 

Q.  What is the best way to handle the $9 in the Traditional IRA (A) now to minimize taxes?

A. Include it in the 2023 conversion. 

Q. If the Traditional IRA (A) backdoor Roth was a taxable event, will it affect taxes on future Backdoor Roth Conversions (e.g. 2023)?

A. Yes, the same percentage calculation of the taxable amount will have to be made.  The simple solution is convert everything.  TurboTax can do the calculation. 

[dmertz · Accepted solution]

First, there is no limit on the amount one is eligible to convert to Roth.  A Roth conversion is not a regular Roth IRA contribution.

I'll assume that your wife has no other traditional IRAs.

Because the balance in your wife's traditional IRA on '12/31/2022 was $9, the nontaxable amount of the Roth conversion is calculated as 6,000 * 6,000 / (6,000 + 9) = $5,991, resulting in $9 of the conversion being taxable and $9 of basis in nondeductible traditional IRA contributions remaining in her traditional IRA.  Yes, it would have made sense to convert the entire $6,008, leaving $0 in the traditional IRA on 12/31/2022.  That should have been on your wife's 2022 From 8606.

For this purpose, all of your wife's traditional IRAs are treated as a single traditional IRA, so there was really no point to opening Traditional IRA (B) for your wife when the $6,500 contribution for 2023 could have just been made to your wife's Traditional IRA (A).  Simply convert all of your wife's traditional IRA balances to Roth and if the total amount converted is more than $6,509, the amount in excess of $6,509 will be taxable.  The contribution and conversion will be reported on your wife's 2023 Form 8606 with $9 on line 2 carried over from line 14 of your wife's 2022 From 8606.

[Posted before I noticed that Hal_Al already said the same thing.]

[Critter-3]

Fyi.. going forward it would be wise if you're going to continue this back door Roth conversions that you have it in an account that makes no money. Leave it in cash so that you don't have it earning a few pennies from the day you make the original contribution to the date that you make the conversion. It's basically not worth the effort to fill in the form 8606 for the couple of dollars of interest or dividends that the account makes. It's just a cleaner way to handle things not that you can't do it that way it's just easier to leave it in a non-interest bearing situation.

[dmertz]

Form 8606 is required whether or not there are earnings, only the numbers are different.  Also, cash accounts pay interest these days, as was the case here.  If everything is converted, it doesn't matter much how it's invested prior to the conversion.

[chrisnkaryn84]

Thank you all for your help!!!

[mounty]

Hello dmertz and critter-3 - I'm not sure if you'll see this message, but I think I need to do an amendment to adjust for the situation you were replying about below: I had a balance in my trad IRA, contributed, then converted the amount I contributed and left prior balance alone.

I am know under the impression that this was not correctly accounted for with respect to what is / is not deductible. I'm struggling to figure out how to correct for this in TurboTax in order to do my amendment. Any chance you could provide any guidance on how this is done?

[dmertz]

The traditional IRA contribution and the Roth conversion are entirely separate entries in TurboTax.  A nondeductible traditional IRA contribution adds to that basis on Form 8606 line 1 and the Roth conversion consumes some of that basis, also calculated on Form 8606 Part I.  The amount of basis that is applied to make a portion of the Roth conversion nontaxable is an amount in proportion to the overall balance in your traditional IRAs.

[mounty]

Yes, I'm aware they are separate. Where is the easiest place to check that the basis was correctly entered / calculated? I'm still struggling to confirm I did this correctly.

I received a notice from the IRS that the information they received from my financial institution didn't match what I entered but indicated that the only options are to amend, have the institution correct or to keep being wrong and risk an audit. I checked and all the right amounts are entered (6500 everywhere on the form and in TT) and boxes are checked.

[dmertz]

The results will be on Form 8606 and TurboTax's IRA Information Worksheet.