Interest earned before Backdoor Roth Conversion

[VAer]

About me: Covered by a Retirement Plan at Work, single, income $140k is above the limit in below link, so my traditional IRA is not tax deductible. Below is for 2023 data, but it should be similar to 2024 data, just an example, 2024 data is not available online.

https://www.irs.gov/retirement-plans/2023-ira-deduction-limits-effect-of-modified-agi-on-deduction-i... 

Fidelity IRA uninvested cash interest rate is relatively high when comparing with other brokers.

https://digital.fidelity.com/prgw/digital/fdic-interest-rate/ira 

I may have capital gain from stock market, so I never do Roth IRA  contribution directly, I always choose backdoor Roth conversion for all IRA contribution. My traditional IRAs are used for backdoor roth conversion only, no trading activities, when I made contribution, it will be transferred to Roth IRA immediately after fund is settled (same year), usually it takes 4 business days. I used to earn very little interest with TD Ameritrade, just a few penny, when it is rounded down, IRA contribution amount is same as Backdoor Roth Conversion amount.

I just opened IRAs with Fidelity, if I do backdoor Roth Conversion at Fidelity, and I expect to have a few dollars of interest. If I make $7000 Fidelity traditional IRA then transfer those $7000 to Fidelity Roth IRA after fund settlement (4 business day, no trading activities). At the end of the money, Fidelity deposits $3 interest for those 4 days of interest, then I make another $3 dollar of backdoor Roth Conversion. I just make up the example, the interest may not be $3, but it should be greater or equal to $1.

Case #1: Let us move back to the example, 2024 beginning IRA balance $0, traditional IRA contribution $7000, total backdoor Roth conversion $7003, traditional IRA ending could be $0 or $0.01. If $0.01 is interest of the $3. So what would 2024 form 8606 looks like in this case?

Case #2: Same example, if I make $7000 traditional IRA contribution in June 2024, and make $7000 backdoor Roth Conversion, and $3 interest is left on the account till December 31, 2024, and traditional IRA ending balance of 2024 is $3.25, what would 2024 form 8606 looks like? Where $0.25 is interest from $3 for 6 months period.

Case #3: Same example, if I make $7000 traditional IRA contribution in December 2024, and make $7000 backdoor Roth Conversion, and $3 interest is deposited on 1/1/2025. Technically, traditional IRA ending balance of 2024 is $0, and traditional IRA beginning balance of 2025 is $3. what would 2024 form 8606 and 2025 form 8606 loo like?

All numbers related to interest are just made up, for asking questions purpose.

For my case #1, is earned $3 interest taxable income? Why? My traditional IRA contribution is not taxable anyway, which is similar to Roth IRA contribution.

Thanks.

[Opus 17]

All earnings in a traditional IRA are tax-free until withdrawn, regardless of where the funds came from.   That's the whole purpose of a traditional IRA.  Therefore, if you make a $7000 non-deductible contribution, and you convert $7003 to a Roth IRA, the $3 is taxable at time of conversion.  

Looking at form 8606, and assuming that:

a. you have no other funds in any traditional IRA that would implicate the pro-rata rule

b. you contribute $7000 of non-deductible funds

c. you do a backdoor conversion a few days later for $7003, then

Form 8606

line 1 is $7000

line 2 is $0 (this is your prior basis from last year's form 8606)

line 6 is $0 (your year-ending balance on 12/31/2024 will be zero if you do a full backdoor conversion)

line 8 is $7003

line 10 is 1.000 (because $7000÷$7003 = 0.99957 and that rounds up to 1.000.

line 12, non-taxable portion is $7003.

line 14, basis is $0 (this is your new IRA basis at the end of 2024, it's zero because you did a full conversion).

Essentially, because of the rounding rules, the $3 of interest that should have been taxable gets to be tax free.  However, if you had $4 of interest, $7000÷$7004 = 0.9994289, which rounds to 0.999, and $7004 x 0.999=$6997.  So by application of the rounding rules, if you earn $3 of interest, it's tax-free, but if you earn $4 of interest, you pay tax on $7 of the conversion.