Backdoor Roth IRA

Two questions:
1) How can I move part of traditional IRA balance (cash) to Roth IRA account?  trustee to trustee conversion 

2) How should I report backdoor roth IRA conversation when filing tax return next year? Since traditional IRA contribution is also after tax money, I should not need to pay tax for the conversation. But how should I deal with IRS?  Simply enter the 1099-R that will be issued next year and read/follow the screen instructions in that section.  You should have a basis listed on the 2020 form 8606 that will carry forward from the 2020 return if you used TT last year. 

@Critter-3 When broker generates 1099-R, how can broker know that my traditional IRA contribution is non deductible? Traditional IRA account balance does not change (I keep it as cash balance), so there is no income on traditional IRA. I should not pay tax for backdoor roth conversion.

Thanks.

When broker generates 1099-R, how can broker know that my traditional IRA contribution is non deductible? 

They don't  need to know ... it is immaterial to them.  They will simply convert the funds and report it on the 1099-R  and the form 5498.  

The information that it is non deductible is reported on the tax return form 8606 in the year you make the non deductible contribution on the form 8606.   Then the basis on the 8606 is used as well in the year of the conversion.

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 2020 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 you  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 2020.     (Usually zero unless you also made a 2019 or earlier non-deductible contribution. If you do have prior year basis then enter the last filed 8606 line 14 value.).

Enter the 2020 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 2020, 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

@Critter-3 

Thank you very much, it is too complicated to understand, may I ask a few more follow up question related to your response?

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.

Questions:

1) What does it mean? I opened traditional IRA long time ago, but did not contribute too much money there.

2) Hard to understand. In general, roth contribution is after tax money (non deductible), while tradition IRA contribution is before tax money (contribution should be deductible for some people). 

3) What do you mean shortly? If I made the traditional contribution years ago and money sitting there for years, can I transfer $10k to Roth IRA ($10k of backdoor roth conversion)?

4) There is no way to make partial conversion? And leave some asset in traditional IRA?

@VAer - please read @Critter-3 's comments closely.   I think I am reading into your ask that you want to move ALL the after tax dollars to the Roth from the Trad IRA but leave the pre-tax dollars in the TRad IRA.  I don't belive you can do that.  

@Critter-3 states:

"Otherwise the conversion will be partly taxable."

@NCperson No, all my traditional IRA contribution was not deductible (I have work retirement plan and my income is over limit), no investment activity on traditional IRA, no capital gain on traditional IRA, the account just sits there on cash/contribution.

I want to transfer some money from traditional IRA to roth IRA (backdoor roth conversion), but I also want to leave some money in traditional IRA (so that a positive balance of traditional IRA account can remain open).

First you may want to talk to the IRS custodian for more clairty... 

1) What does it mean? I opened traditional IRA long time ago, but did not contribute too much money there.  If you made deductible and non deductible contributions to ANY traditional IRA  then you cannot just convert the non deductible part by itself.

2) Hard to understand. In general, roth contribution is after tax money (non deductible), while tradition IRA contribution is before tax money (contribution should be deductible for some people).  This is a correct statement. 

3) What do you mean shortly? If I made the traditional contribution years ago and money sitting there for years, can I transfer $10k to Roth IRA ($10k of backdoor roth conversion)?  Do you mean you have had an IRA for several years with no earnings ?  You cannot convert ONLY the deductible contributions ... the conversion would be a % of the earnings, deductible and non deductible contributions.  

4) There is no way to make partial conversion? And leave some asset in traditional IRA?   You can convert any amount you wish each year  from just  $1 to the entire IRA balance however you cannot ONLY convert the non deductible contributions ... the form 8606 is used to compute the taxable portion of the conversion. 

@Critter-3 

2) If my statement is correct, then why you say "The Tradition IRA contributions must be reported on a 8606 form as non-deductible"?

3) I actually only made small amount on traditional IRA before (my contribution is not deductible due to income limit), and no investment activity on that account, so no capital gain. The balance is just the contribution.

@VAer - a few comments 

1) the IRS is not going to let you move ONLY  the non-deductible dollars to the Roth and then leave you with a tax free benefit for the next 30-50 years while the deductible dollars remain in the Trad IRA until you have to begin RMDs.. The IRS would get nothing for all those years until the RMD begins

2) let's say all the dollars invested into the Trad IRA are non-deductible and grows over time.  The part that 'grows' - the capital gains, dividends, etc.  has not been taxed and must be when distributed, so those dollars need to be distributed at the same rate as the non-deductible dollars when flipping to a Roth,  

The Fed wants their money and finds ways to get it from you! 

@Critter-3 - are the taxable dollars subject to the 10% penalty if under 59.5 years old?????

@NCperson The traditional IRA contribution is not deductible for my case due to income limit. No investment activity on traditional IRA, no capital gain on traditional IRA.

@NCperson    @Critter-3 - are the taxable dollars subject to the 10% penalty if under 59.5 years old?????  Not when it is a conversion since it is not a distribution.

@VAer 

Ok ... you have posted conflicting information so if all the contributions to all your traditional IRA accounts were made with non deducible contributions and there were no earnings then everything is converted to the ROTH tax free.  Otherwise only part of the conversion will be tax free.   For instance ... 

Traditional IRA contributions to all IRA accounts = 4000 deductible + 4000 non deductible = 8000 + 2000 earnings over the time you had the IRA for a total balance of $10,000.   Now you convert  4000 to a ROTH.  You cannot just convert the 4000 non deductible portion of the total.  The % of non deductible to the entire balance is 40%  thus only 40% of the conversion is tax free and the rest of the 60% conversion is not tax free ... the form 8606 will do this computation automatically.

@NCperson Ok, when I say "partial backdoor conversion", I mean transfer partial of money from Traditional IRA to roth IRA, and leave some money on traditional IRA. For example, I made $3000 non-deductible contribution into traditional IRA before, and it remains as $3000 due to no investment activity (maybe a few cents of interest income), now I want to convert $2000 into roth IRA and leave $1000 in traditional IRA.

So even if traditional IRA contributed was made long time ago (previous year), can it still be convert to roth IRA (backdoor roth conversion)?

Thanks.

@VAer 

So you are saying that at some time in the past you made $3000 of non deductible contributions to the traditional IRA AND there have been no earnings so there is still $3000 in the account then you can convert any amount you wish tax free.  In the year you made the non dedictible contribution a form 8606 had to have been filed thus you will report the non deductible basis amount contributed in the past  and the converted amount will reduce that basis automatically on the form 8606 leaving the balance. 

Indeed there is form 8606, I did not pay attention to it, I don't know much about so many tax forms either.

I actually made the tradition IRA contribution on 12/11/2020 (for year 2020). If I convert it to Roth IRA now(August 2022), what will exactly happen to 2022 tax return?

Thanks.

Another question: If I make $6000 traditional IRA contribution in January 2023 (for year 2022), then convert it to roth IRA (backdoor roth IRA) in January 2023, right after traditional IRA contribution, can the converted roth IRA  stillbe reported on 2022 tax return form (while the conversion is done in January 2023)?  

The reason I want to make IRA contribution in January 2023, since I am not sure about my income (my salary allows me to make Roth IRA contribution but stock capital gain could disqualify me from making roth IRA contribution directly), so when it comes to January 2023, I will know if I make roth IRA directly or doing backdoor roth IRA.

Another question: If I make $6000 roth IRA contribution now (August 2022), but I lost almost all money on roth IRA (account also goes to $0). Later this year, I make quite some money on individual brokerage account, and it ends up I am actually not qualified the make the $6000 roth IRA contribution. In 2023, I am promoted and my salary is significantly higher and I will never be qualified to make roth IRA contribution again, what should I do with excessive $6000 roth IRA contribution?

@Critter-3 

@Critter-3 @NCperson 

Example: if I make $6000 traditional IRA non deductible contribution (for year 2022) in January 2023, then there is Form 8606 will be on 2022 tax return. In the same month (January 2023), I make $5000 backdoor roth conversion, will backdoor conversion be reported in 2022 tax return form or 2023 tax return form? If backdoor roth conversion is reported in 2023 tax return form (following year), then I don't need to do the backdoor roth conversion right after traditional IRA contribution.

Or I can do both traditional IRA non deductible contribution and backdoor roth conversion in late December, by the time, I should know if I am qualified to make roth IRA contribution directly or not, depending on stock market (option trading, annual gain/loss is high unpredictable). If no capital gain, my current salary  (around 127k, slightly under income limit  129k) still barely allows me to make Roth IRA full amount contribution directly.

Example: if I make $6000 traditional IRA non deductible contribution (for year 2022) in January 2023, then there is Form 8606 will be on 2022 tax return. In the same month (January 2023), I make $5000 backdoor roth conversion, will backdoor conversion be reported in 2022 tax return form or 2023 tax return form?  conversion on the 2023 return ... the non deductible contribution on the 2022 return

If backdoor roth conversion is reported in 2023 tax return form (following year), then I don't need to do the backdoor roth conversion right after traditional IRA contribution.  True but why would you let the money sit there any longer than needed if it is earning nothing ?   Better to make the conversion right away and get the money earning something. 

Or I can do both traditional IRA non deductible contribution and backdoor roth conversion in late December, by the time, I should know if I am qualified to make roth IRA contribution directly or not, depending on stock market (option trading, annual gain/loss is high unpredictable). If no capital gain, my current salary  (around 127k, slightly under income limit  129k) still barely allows me to make Roth IRA full amount contribution directly.  Why make things more complicated than needed ?  If you make an IRA contribution then the ROTH conversion (back door)   does it really matter if you can make a "front door" ROTH contribution at all ?  The "can I - can't I" issue is unneeded worry ... just do the back door and be done with it.  It all works out the same in the end. 

@Critter-3 Thanks, you are correct. 

Now I know:

1) Backdoor Roth conversion activity is reported on current calendar year's tax return; while IRA contribution can be done for previous year, as long as it is done before deadline (around April 15).

2) Yes, based on what I have learned, I can always do backdoor roth conversion for current year, if I am uncertain about my income. I was asking the question, since I am not familiar with so many things, just in case of messing some tax forms.  I really support flat tax rate without so many loophole. It makes things complicated, but I still need to know the loophole of backdoor roth conversion, in order to take advantage of loophole. 

Thanks again, I have learned a lot about backdoor Roth conversion after this post. Now I need to summarize some note, in case of forgetting it in the future.

For some (myself included) it takes a long time to figure out Form 8606 even if you have examined it and studied Pub590 many times.

Eventually you will understand.

Otherwise you have to answer the TurboTax step-by-step questions exactly correctly for correct results.

Sometimes the questions are misleading !

the two main factors determining the taxable amount are:

your basis.

your total IRA value at the end of the tax year

This is an over-simplification, since there are other factors.