Do I report 401k to ira rollover in form 8606?

[bluecrystal]

Hi,

I changed employer last year (2021) and rolled over my 401k to a traditional ira. In the same year, I made a backdoor roth conversion by contributing $6k to a different IRA and converting the money. Since I did a roth backdoor conversion, I am required to file a form 8606. 

In form 8606 line 6, it asks for the value of ALL of my traditional IRA accounts. Do I include the value of my converted 401k in this line? If I do, then form 8606 will treat the sudden increase of my IRA account value as capital gain from investment, and significantly shrink the non-taxable portion of my backdoor conversion.

To make the example more concrete - I have $6k cost basis from previous year, contributed $6k to traditional IRA in 2021 and immediately converted all the money ROTH IRA. This should be a non-taxable event. In the same year, I also converted $80k in 401k to traditional IRA because I changed jobs. This should be a non-taxable event. However, given how 8606 is structured, if I report $80k as my total IRA value at the end of 2021, then the form will treat the event as me starting at $6k cost basis, growing the money to $80k by the end of the year, and converting $6k of my huge account (totaling $80k in value) to ROTH. If I follow the form, I have $5.5k of taxable amount.

Anyone has any idea on how to report the two non-taxable event appropriately? Should I not include 401k conversion money in line 6 of 8606?

[DanaB27 · Accepted solution]

Yes, you will have to include the value of all your traditional/SEP/SIMPLE IRAs on December 31, 2021. And since you had pre-tax funds from your 401k rollover in your traditional IRA now the pro-rata rule applies. This means that with each distribution/ conversion you will have a taxable and nontaxable part. You can see the remaining basis on line 14 of Form 8606, this basis can be carried forward. Therefore each distribution/conversion in the future will have a taxable and nontaxable part until the basis is all used.

The Backdoor Roth only works if your traditional/SEP/SIMPLE IRAs are empty.  If you plan to use this strategy in the future you might want to think about a reverse rollover where you rollover IRA money to a company plan, like a 401(k). Only pre-tax funds can be rolled from an IRA to a company plan. Therefore, you would isolate the basis and could start the Backdoor Roth procedure fresh. But it only works if your employer allows it, not all 401(k) plans do.