Non-deductible Traditional IRA to Roth IRA Backdoor Conversion

[FreakingTax]

Hello,

I've been contributing to a traditional IRA for years. Last few years the contributions were non-deductible due to my income. In 2023 I opened a new clean traditional IRA with different institution and immediately after contributing I converted the cash to Roth IRA using the backdoor conversion rule. At the end of 2023, I received 1099-R with box 2b "Taxable amount not determined" selected, box 7 "Distribution code(s)" = 2 and box "IRA/SEP/SIMPLE" selected. I entered my IRA contributions in TT and as normal it stated that my income is too high, so everything is taxable. TurboTax also tracks my non-taxable basis. When I enter my 1099-R form, TT asks for the total amount of all my traditional IRA accounts, and when I enter that my taxes increase. Since this is a completely new account, and the money was transferred immediately, there are no gains on the account. My old account has gains of course. It looks like that TT breaks down the distributed amount into before tax and after tax proportionately and taxes my gains even though I have not touched those. My questions:

1. Is that how the law is or is this a bug? I expected that no taxes would be incurred since both accounts are after tax and no gains on the converted amount.
2. If that’s the law, is there a better way to convert the whole amount from traditional IRA to Roth IRA using the backdoor conversion rule, hopefully without getting taxed on the gains?

Thank you!

[DanaB27]

1. This isn't a new law. The IRS sees all traditional/SEP/SIMPLE IRAs as one account. Therefore, if you had pre-tax and after-tax funds in those accounts then the pro-rata rule applies. This means that with each distribution/ conversion you will have a taxable and nontaxable part. 

2. No, the only way to avoid the pro-rata rule is to do 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 plans do. 

[FreakingTax]

Thank you for your explanation!