Backdoor Roth: Isolating Taxable Portion of Traditional IRA and IRS Publication 590-A

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DarkHelmetII
Posts: 26
Joined: Mon Jul 24, 2017 12:25 pm

Backdoor Roth: Isolating Taxable Portion of Traditional IRA and IRS Publication 590-A

Post by DarkHelmetII » Wed Jan 10, 2018 5:04 am

Hello - as I am running into the pro-rata rule for the backdoor Roth (significant earnings in my traditional IRA even with having made post-tax contributions) and am about to clear the deck for doing such backdoor Roth contributions, I am sharing an excerpt from IRS Publication 590-A (https://www.irs.gov/pub/irs-pdf/p590a.pdf). My understanding is that this is specifically what would allow one to peel off only the taxable portion of Traditional IRA assets into an employer 401k, thereby leaving only the non-taxable portion for a Roth Conversion.

Bolding is mine.

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Tax treatment of a rollover from a traditional IRA to an eligible retirement plan other than an IRA.
Ordinarily, when you have basis in your IRAs, any distribution is considered to include both nontaxable and taxable amounts. Without a special rule, the nontaxable portion of such a distribution could not be rolled over. However, a special rule treats a distribution you roll over into an eligible retirement plan as including only otherwise taxable amounts if the amount you either leave in your IRAs or do not roll over is at least equal to your basis. The effect of this special rule is to make the amount in your traditional IRAs that you can roll over to an eligible retirement plan as large as possible.

Eligible retirement plans. The following are considered eligible retirement plans. Individual retirement arrangements (IRAs).
Qualified trusts.
Qualified employee annuity plans under section 403(a).
Deferred compensation plans of state and local governments (section 457 plans).
Tax-sheltered annuities (section 403(b) annuities).
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The purpose of this post is twofold. First, a final validation that my understanding is correct and I am looking at the right piece of the IRS documentation. Second, to the extent that others are considering a similar strategy, this could serve as a reference point with the IRS specifics.

magicrat
Posts: 127
Joined: Sat Nov 29, 2014 7:04 pm

Re: Backdoor Roth: Isolating Taxable Portion of Traditional IRA and IRS Publication 590-A

Post by magicrat » Wed Jan 10, 2018 8:00 am

Yes, your understanding is correct. I have done exactly what you are proposing. However, keep in mind that 1) not all employer plans allow incoming rollovers, 2) some employer plans that allow incoming rollovers have requirements that you may not be able to meet (example: I had an employer plan that required the current custodian, in this case Vanguard, to certify that the funds to be rolled over were all pre-tax. Vanguard refused to make this certifications), and 3) The IRS may send you an incorrect nasty gram if they review your taxes for the year you do this. Consider getting a CPA to file your taxes this year and be prepared to respond to the IRS should this come up.

DarkHelmetII
Posts: 26
Joined: Mon Jul 24, 2017 12:25 pm

Re: Backdoor Roth: Isolating Taxable Portion of Traditional IRA and IRS Publication 590-A

Post by DarkHelmetII » Wed Jan 10, 2018 8:59 am

Magicrat - thanks for the input. 1) Have confirmed that my 401k plan accepts rollovers. 2) Have NOT confirmed if my employer's 401k requires a certification on what is pre-tax (will have to do this shortly).

On #3, what sort of nasty gram? Is your recommendation on a CPA for a) doing the paperwork correctly this, b) having the CPA in case the IRS starts asking questions, or a little bit of both?

fortunefavored
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Joined: Tue Jun 02, 2015 8:18 pm

Re: Backdoor Roth: Isolating Taxable Portion of Traditional IRA and IRS Publication 590-A

Post by fortunefavored » Wed Jan 10, 2018 9:09 am

I'm looking at this too to unwind some IRA mess and stop having to track basis of non-deductible contributions - is it as simple as taking your tracked non-deductible basis and rolling that amount over to a qualified 401K plan? What "explanation" is the IRS looking for? I have IRA statements showing the contributions that match the basis.

kaneohe
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Joined: Mon Sep 22, 2008 12:38 pm

Re: Backdoor Roth: Isolating Taxable Portion of Traditional IRA and IRS Publication 590-A

Post by kaneohe » Wed Jan 10, 2018 9:15 am

fortunefavored wrote:
Wed Jan 10, 2018 9:09 am
I'm looking at this too to unwind some IRA mess and stop having to track basis of non-deductible contributions - is it as simple as taking your tracked non-deductible basis and rolling that amount over to a qualified 401K plan? ..............................
I think this might be backwards..............it's the basis that goes to Roth.

DarkHelmetII
Posts: 26
Joined: Mon Jul 24, 2017 12:25 pm

Re: Backdoor Roth: Isolating Taxable Portion of Traditional IRA and IRS Publication 590-A

Post by DarkHelmetII » Wed Jan 10, 2018 9:16 am

fortunefavored wrote:
Wed Jan 10, 2018 9:09 am
I'm looking at this too to unwind some IRA mess and stop having to track basis of non-deductible contributions - is it as simple as taking your tracked non-deductible basis and rolling that amount over to a qualified 401K plan? What "explanation" is the IRS looking for? I have IRA statements showing the contributions that match the basis.
Update: agreed with kaneohe, I think the above is "backwards"

My understanding is that you want to rollover your deductible basis into the Traditional (non-Roth) 401k. Basically, anything that would be taxed upon withdrawing from the Traditional IRA, you want to put into your Traditional 401k. Two reasons why funds would be taxed upon withdrawing from the Traditional IRA: 1) you received a deduction when you contributed (sounds like your situation - e.g. line 32 of Form 1040), and 2) investment gains. Based on my understanding, talking about this pro-rata mess there is no distinction between #1 and #2 ... it's simply taxable funds regardless of why they are taxable.

Form 8606 required I believe ... I am also a little hazy on the details and still learning that myself. Multiple other threads on this, just have not yet fully yet digested myself.

magicrat
Posts: 127
Joined: Sat Nov 29, 2014 7:04 pm

Re: Backdoor Roth: Isolating Taxable Portion of Traditional IRA and IRS Publication 590-A

Post by magicrat » Wed Jan 10, 2018 10:38 am

DarkHelmetII wrote:
Wed Jan 10, 2018 8:59 am
Magicrat - thanks for the input. 1) Have confirmed that my 401k plan accepts rollovers. 2) Have NOT confirmed if my employer's 401k requires a certification on what is pre-tax (will have to do this shortly).

On #3, what sort of nasty gram? Is your recommendation on a CPA for a) doing the paperwork correctly this, b) having the CPA in case the IRS starts asking questions, or a little bit of both?
On #2, just read all of the paperwork very closely and ask questions of both custodians. On #3, my recommendation is more for B (but of course A is important). The IRS gets automated reporting from financial institutions and may compare that to your tax return. If they find a discrepancy they will send you a bill for taxes due plus penalties. Often, their assessments are incorrect and may be based on incorrect information from the financial institution (e.g., the financial institution may incorrectly report that a rollover is taxable, when it is not, or they may report that the tax status is unknown). I get a letter like this almost every year related to doing backdoor Roth maneuvers, and got a letter like this when I did what you are planning. My CPA simply responds to their notice telling them why they are wrong, then the IRS sends back a letter saying they agree. I prefer to have a CPA do this, though if it is not necessary if you are comfortable handling these matters.

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