Discrepancy between form 8606 and 590B worksheet 1-1 pro-rata calculation

[bluecrystal]

Hi,

I have both a backdoor roth conversion ($6k) and a 401k to IRA rollover even in 2021. As a result, the conversion event is subject to pro-rata rule to figure out which part of the $6k is taxable and which part is not. I am unsure whether the portion of post-tax money contributed in 2022 for 2021 can be used in calculating the pro-rata non-taxable basis. 

To provide more detail - I have $6k carry over ira basis in my traditional IRA, I contributed $6k to my traditional IRA for 2021 and converted to roth immediately (but the contribution happened in 2022), and rolled over $80k of 401k in 2021 (with a value of $80k at the end of year).

If I follow the form 8606 calculation, my non-taxable portion will be box 5 (which is  6k contribution for 2021 + 6k ira basis - 6k contributed in early 2022 for 2021 = 6k) divided by box 9 (80k end of year value + 6k roth conversion = 86k). The proportion is 6.9%.

However, if I follow worksheet 1-1, the proportion is (ira basis + contribution for 2021) / (end of year ira value + roth conversion), which is equal to 12k/86k = 13.8%.

I am fairly certain that the worksheet 1-1 calculation is correct, since it is published by IRS, and turbotax uses it on the backend too. I am just a little puzzled by this discrepancy. Is form 8606 not supposed to be filled out directly in this case?

[dmertz · Accepted solution]

There has always been some question as to whether TurboTax is too liberal in its use of Worksheet 1-1.  TurboTax seems to use the worksheet even when there is no question as to whether or not the IRA contribution is deductible, resulting in applying basis acquired from a contribution for the prior year made after the end of the tax year.

[bluecrystal]

Got it. Is it wrong to use the worksheet 1-1 in this case? Or is it "not technically wrong but up for debate" kind of situation? 

[dmertz]

The instructions for Worksheet 1-1 say, "Use only if you made contributions to a traditional IRA for [tax year] that may not be fully deductible and have to figure the taxable part of your [tax year] distributions to determine your modified AGI."  I interpret that as saying that if you are electing to make the IRA contribution nondeductible or the IRA contribution will be either entirely nondeductible or entirely deductible no matter the how much of the IRA contribution might be deductible, the worksheet should not be used, but TurboTax uses it under those circumstances anyway.  I have no information on what the IRS thinks about TurboTax's extremely liberal use of the worksheet.  I haven't heard of the IRS challenging the use of the worksheet, although I have heard about IRS examiners questioning the result because the worksheet is not part of the filed tax return.

[macuser_22]

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@dmertz wrote:

The instructions for Worksheet 1-1 say, "Use only if you made contributions to a traditional IRA for [tax year] that may not be fully deductible and have to figure the taxable part of your [tax year] distributions to determine your modified AGI."  I interpret that as saying that if you are electing to make the IRA contribution nondeductible or the IRA contribution will be either entirely nondeductible or entirely deductible no matter the how much of the IRA contribution might be deductible, the worksheet should not be used, but TurboTax uses it under those circumstances anyway.  I have no information on what the IRS thinks about TurboTax's extremely liberal use of the worksheet.  I haven't heard of the IRS challenging the use of the worksheet, although I have heard about IRS examiners questioning the result because the worksheet is not part of the filed tax return.

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I agree.  Modified AGI (MAGI) is not the same as "taxable amount".  MAGI is only used to determine how much of a contribution is deductible, not how much the tax should be on a distribution.  (TurboTax is not the only software company that used the worksheet when it should not but the IRS does not seem to care and it results in a lower tax.)

[dmertz]

IRS is probably not too concerned because having less taxable now generally means having correspondingly more taxable later.  All of the pretax money eventually ends up in AGI sooner or later.