Traditional and Rollover IRA basis and valuje

Forum|Forum|3 years ago
March 22, 2023
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I make just over the amount to be able to contribute to an IRA or ROTH. Mid 2022 I deposited $5,000 into a traditional IRA as nondeductible and then had the broker recharacterize it the next day into a ROTH IRA. Later in the year, a former company that I worked for ended their pension program and sent a check for the lump sum value of the pension in late December. Which I had payable to the brokerage and placed it into a rollover IRA. On Form 8606 (nondeductible IRA) Line 1 ask for the nondeductible contribution and I showed it as the $5,000. Lines 3 and 5 also work out to be the same number. However, line 6 asks for the value of all the traditional, SEP and SIMPLE IRA as of December 31, 2022. My traditional IRA has 0 balance since it earned no income before it was recharacterized to a ROTH. But do I count the rollover IRA in that total on Line 6? Do I report anything in lines 6 through 13?

DavidD66

Yes. You have to include the value of your rollover IRA in line 6 of Form 8606. Line 8 is the $5,000 you converted to a Roth IRA. Lines 9 through 15a are arrived by performing the arithmetic indicated on the form for each line. Basically, by distributing your pension plan to you, it made a portion of your Roth conversion taxable,

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jmintxAuthor

David66:

I just want to check my understanding of your note. The indicated $5,000 deposited into the Traditional IRA at broker 1 was after-tax money and non-deductible. Broker 1 then made the recharacterization the following day into my Roth IRA at broker 1. That leaves the Traditional IRA account at broker 1 with a 0 balance and a basis of 0. Then four months later the pension program of the company that I worked for earlier is closed and a payout of pre-tax money is then deposited into a new Rollover IRA directly with a new broker 2. Your e-mail indicated that for Line 6, I should add the value of the Traditional IRA ($0) to the Rollover IRA ($X) and report $X on Line 6. Then for Line 8 (conversion to Roth), I should list the $5,000 that was a recharacterization from an IRS to a Roth. Then the calculations on Lines 9 to 11 would make most of the $5,000 of after-tax money subject to tax again and set that amount as the Rollover IRA new basis (the Traditional IRA balance is $0). Is this the correct interpretation? (It feels like I'm paying taxes on the $5,000 twice.)

AnnetteB6

Your interpretation is correct, and due to the unfortunate timing of the pension plan distribution, it does diminish the advantage of your back-door Roth IRA conversion (not recharacterization).

When you take a distribution from a Traditional IRA (as you did when you converted the $5000 to the Roth IRA) and it is reported on your tax return for the year of the distribution (2022), the year-end balance of all Traditional IRA accounts must be considered regardless of whether they are maintained by the same broker.

There is a pro-rata rule with regard to distributions that essentially means that every distribution will be proportionally made up of pre-tax and after-tax money if the Traditional IRA account(s) is not 100% after-tax (non-deductible) money. So, if your pension account is proportionally high on the pre-tax side, then more of the $5000 that was converted to the Roth will be taxed. Mathematically, the $5000 is coming out of your total Traditional IRAs as a whole rather than the specific Traditional IRA account that only existed for the purpose of the back door Roth conversion.

If your only Traditional IRA account had been the one that was subsequently converted to the Roth IRA, then everything would have worked as planned, with a non-taxable event on your return.

Take a look at the following discussion which may further explain the situation:

IRA Conversion to Roth & Pro-Rata Tax Obligation

@jmintx

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