Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

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fund
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by fund » Thu Mar 10, 2016 2:44 pm

alfaspider wrote:
fund wrote:
My feeling is that Roth conversions are explicitly permitted and therefore lawful.

I don't think the ability to do a Roth Conversion for those who can't contribute directly has ever really been in doubt after the 2010 income limit elimination. Where there is some doubt is the practice of making the IRA contribution, converting the Roth the next day, and doing that every single year. The only real question is whether it's worth waiting a year or two and paying the "toll charge."
But doesn't this go back to earlier posts in this thread by others who said that such a practice still looks, walks, and quacks like a duck? If you're doing this over and over and over, it's a duck, and your intentions are clear. The IRC does not prescribe a time limit that one must wait before a conversion may be done. I don't see how waiting a year or more would in any manner obviate or even mitigate the applicability of the step transaction doctrine if such is, in fact, applicable here (and accepting, for the sake of argument, that it is). You've established a pattern or practice; your intent is clear. Therefore, it doesn't matter how long you wait prior to conversion.

The fact that certain taxpayers may make conversions tax-free as a result of the 2010 legislative change is immaterial in my estimation. That's a by-product of the law, and lots of laws have lots of by-products; are those by-products as a result all illegal? Let me explain further: the legislative change did not say that a taxpayer may do Roth conversions only if that taxpayer is subject to the pro-rata rule in an amount, for example, equal to or greater than 50 percent. And it didn't say that a taxpayer may do Roth conversions only if that taxpayer is subject in any amount to the pro-rata rule. Rather, the law is entirely silent on the matter. If a taxpayer has to pay tax on one percent of his or her conversions due to the pro-rata rule, that's clearly ok. If the taxpayer has to pay tax on 95 percent of his or her conversions due to the pro-rata rule, that's also clearly ok. So where do we draw the line? One percent and you're good to go, but zero percent no?

Editing to add: and if the pro-rata rule subjects only one percent of your conversion to taxation, isn't, then, the majority - the vast, overwhelming majority - of your conversion "excess"? So at what percentage applicability of the pro-rata rule is it ok to do backdoor Roths?

More fascinating than waiting any amount of time or whether the pro-rata rule is applicable if we're seeking to justify the legislative change solely in terms of allowing taxpayers with previously existing IRAs to make Roth conversions is the concept, expressed by an earlier poster, of putting the money into, say, an S&P 500 index fund rather than a MM fund so there is some gain or loss that can be shown prior to conversion.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by alfaspider » Thu Mar 10, 2016 3:08 pm

fund wrote:
alfaspider wrote:
fund wrote:
My feeling is that Roth conversions are explicitly permitted and therefore lawful.

I don't think the ability to do a Roth Conversion for those who can't contribute directly has ever really been in doubt after the 2010 income limit elimination. Where there is some doubt is the practice of making the IRA contribution, converting the Roth the next day, and doing that every single year. The only real question is whether it's worth waiting a year or two and paying the "toll charge."
But doesn't this go back to earlier posts in this thread by others who said that such a practice still looks, walks, and quacks like a duck? If you're doing this over and over and over, it's a duck, and your intentions are clear. The IRC does not prescribe a time limit that one must wait before a conversion may be done. I don't see how waiting a year or more would in any manner obviate or even mitigate the applicability of the step transaction doctrine if such is, in fact, applicable here (and accepting, for the sake of argument, that it is). You've established a pattern or practice; your intent is clear. Therefore, it doesn't matter how long you wait prior to conversion.
In other contexts, there have been presumption rules applied to the step transaction doctrine (or other analogous doctrines). For example, transactions occurring within 2 years of each other are presumed to be related, but transactions outside that time period are presumed independent. The presumption can be rebutted with evidence to the contrary (such as a memo setting forth a plan to do a second step after two years have passed).

If the IRS wanted to get aggressive (and to be clear, there's no evidence they necessarily would), they could say a pattern of annual IRA contributions with a conversion exactly a year later should be stepped together because it establishes a clear plan and is within the presumption rules of other analogous substance over form rules that require a waiting period. However, if you contributed to an IRA for 3 years, converted, started another IRA and contributed for 5 years and then converted, the transaction would be extremely difficult to attack under the step transaction doctrine- the pattern is not consistent and the time period is sufficiently long that you could easily argue you made an independent decision to convert to a Roth.

Note: Aside from whether the IRS actually would want to do this, it's another question of whether they would win. I'm just stating the case that could be made. And, as I said before, I can't advise anybody else on what they should be doing with their own personal retirement contributions.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by retiredjg » Thu Mar 10, 2016 4:50 pm

Wagnerjb wrote:On the other hand, the IRS agent will spend an awful lot of time chasing down these people, corresponding with them, meeting with them, looking at documents....only to come back to the office with ZERO additional tax. OK, maybe $200, whatever. For the IRS - even if we were to agree that this may not be clearly acceptable under the rules - this is number 99 out of 100 things they are chasing. It is a money loser for the IRS. (I think #100 is probably wash sales by the small investor....also a time waster and a net loser of money).
Made me laugh. :D There certainly is no monetary incentive for them to spend money tracking down these back door tax-payers. They have enough problems with inadequate budget without adding this problem to their radar.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Iorek » Thu Mar 10, 2016 8:40 pm

Spirit Rider wrote:
Iorek wrote:If people want to make a judgment that the likelihood of the IRS challenging their specific transaction is exceedingly low, and the issue will be addressed (if ever) by legislation, then I am not going to argue with them. However, when people say that they have made a judgment that the step transaction doctrine can't/won't apply (regardless of the fact pattern) then I wonder on what basis and expertise they have reached that conclusion.
I wonder on what basis and expertise people make an opposite judgement or conclusion without any evidence that the IRS has, will, or could even demonstrate an intent in this direction.
I hope you realize the difference between whether the IRS has or will pursue this issue and whether they could. I don't know of any evidence that they have or will, but while that fact might be pretty important to individual taxpayers, it's pretty irrelevant to the question of whether they could. As to that question, there is about 75 years of case law as evidence if you want to read it.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by BolderBoy » Sat Mar 12, 2016 11:46 am

letsgobobby wrote:Furthermore this strategy was explicitly described in a 2006 WSJ article, so (assuming Congress members read the Journal) even then Congress would have had several years to raise the issue and 'fix' the perceived problem. It was on the basis of this article that we began making non-deductible IRA contributions in 2006, in anticipation of being able to convert those IRAs to Roth IRAs beginning in 2010. If I could read the WSJ article and figure out what was possible beginning in 2010, Congress certainly had plenty of opportunities to remedy the issue. The fact that they didn't suggests they didn't think it was a major problem, much less 'illegal.'
Completely agree with letsgobobby's analysis. The strategy was also explained in a 2006 Money Magazine article which set me on the same planning-for-2010 path.
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by DireWolf » Sat Mar 12, 2016 11:57 am

Much ado about nothing.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by ParkersPaPa » Sat Mar 12, 2016 12:21 pm

alfaspider wrote:
MarkNYC wrote:
AviN wrote:In an interview with Christine Benz about Backdoor Roth IRA's back in January, Michael Kitces says: "We’ve heard from a couple of people now who just on a random audit had an IRS agent come in saw it [a Backdoor Roth IRA contribution], caught it, said uh uh that’s not appropriate...."
"Not appropriate"? Unless this is paraphrasing, this is odd language for an IRS auditor. Tax transactions are either allowed or disallowed based on the law. Not sure what "not appropriate" means.

Leaving aside the murky language, Jeffrey Levine is an IRA technical expert with Ed Slott's company and has written an interesting and in-depth explanation why he and Slott's team believe the backdoor Roth does not violate the Step Transaction Doctrine. (part-way down in the article)

https://www.irahelp.com/slottreport/bac ... conversion
I would say his point #2 (that no court has ruled against it) is spurious. I'm also of the opinion that his other points, while having varying levels of validity, are not ironclad. The article is far from a comprehensive technical analysis and his background is not suggestive of someone qualified to perform one.

Given that the strategy has only been available since 2010, we are only just now getting to the point that a backdoor Roth case would have the potential to be litigated. It typically takes years for a transaction to go from execution to litigation. It's not unusual in the tax world to litigate a case relating to events happening a decade ago. The potential penalties for a backdoor Roth (6% excess contribution per year) are such that the amount in controversy would be insufficient for someone to be likely to fully litigate the strategy for many years. An audit commencing 2 years after a conversion could result in a penalty of only a few hundred bucks- few are going to litigate over that. But an audit looking into 20 years of serial backdoor Roth conversions could potentially produce a huge liability- something much more likely to be litigated.

I think it's more likely that Congress or the IRS will weigh in directly before it ever gets to the point of someone fighting 20 years of excess contribution penalties. At least I hope that's the case.
Agree. This route may well be closed soon.

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nedsaid
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by nedsaid » Sat Mar 12, 2016 1:23 pm

AviN wrote:In an interview with Christine Benz about Backdoor Roth IRA's back in January, Michael Kitces says: "We’ve heard from a couple of people now who just on a random audit had an IRS agent come in saw it [a Backdoor Roth IRA contribution], caught it, said uh uh that’s not appropriate, and the people actually had unwound it, in part because it was easier to unwind it than fight the IRS which is expensive compared to a $5500 IRA contribution."

Source: http://www.morningstar.com/cover/videoc ... ?id=741998

Avi
The IRS can be and often are wrong. At all levels of government people have been retiring and replacements have been hired, the IRS is no exception. It is possible that these auditors were newer and less experienced. Even IRS letters sent to taxpayers can be wrong. It is the old saying that if you call the IRS several times on the same question, you will get different answers.
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by fortyofforty » Sat Mar 12, 2016 10:54 pm

nedsaid wrote:
AviN wrote:In an interview with Christine Benz about Backdoor Roth IRA's back in January, Michael Kitces says: "We’ve heard from a couple of people now who just on a random audit had an IRS agent come in saw it [a Backdoor Roth IRA contribution], caught it, said uh uh that’s not appropriate, and the people actually had unwound it, in part because it was easier to unwind it than fight the IRS which is expensive compared to a $5500 IRA contribution."

Source: http://www.morningstar.com/cover/videoc ... ?id=741998

Avi
The IRS can be and often are wrong. At all levels of government people have been retiring and replacements have been hired, the IRS is no exception. It is possible that these auditors were newer and less experienced. Even IRS letters sent to taxpayers can be wrong. It is the old saying that if you call the IRS several times on the same question, you will get different answers.
You're absolutely correct. However, with the IRS, they can accuse you of something then force you to prove you were doing things correctly. I wish there was absolute clarity, but there isn't. So, I will keep making non-deductible contributions to my traditional IRA, then converting the entire amount to my Roth IRA. I might stop calling it "backdoor" since that implies it's underhanded or inappropriately exploiting a loophole. I will try to think of another term. How about "revolving door Roth contribution"?
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by neurosphere » Sat Mar 12, 2016 11:12 pm

fortyofforty wrote: I might stop calling it "backdoor" since that implies it's underhanded or inappropriately exploiting a loophole. I will try to think of another term. How about "revolving door Roth contribution"?
I prefer "Indirect Roth contribution". Indirect doesn't have the connotation of "sneaky" or "loophole".

We can refer to the regular contributions as "Direct" roth contributions, and the backdoor contributions as "Indirect" contributions.

Thoughts? :D

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by DaftInvestor » Sun Mar 13, 2016 6:41 am

Great discussion with lots of us drawing our own conclusions. With all the magazines, papers, news sources, mutual fund companies, etc covering the backdoor don't you suppose one of them would have reached out to the IRS for comment and had they received comment that this maneuver went against the step doctrine don't you think one of them would have published this fact? Maybe I am being naive here but based on the fact folks are getting audited and the backdoor is being allowed and the fact that there is no comment from the IRS in any of the dozens of news snippets on this puts the issue to rest in my mind.

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munemaker
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by munemaker » Sun Mar 13, 2016 12:25 pm

So what?

If it is legal, I would not let some vague statement about what auditors approve of or not approve of defer me, if that is what I wanted to do.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by alfaspider » Mon Mar 14, 2016 10:06 am

DaftInvestor wrote:Great discussion with lots of us drawing our own conclusions. With all the magazines, papers, news sources, mutual fund companies, etc covering the backdoor don't you suppose one of them would have reached out to the IRS for comment and had they received comment that this maneuver went against the step doctrine don't you think one of them would have published this fact? Maybe I am being naive here but based on the fact folks are getting audited and the backdoor is being allowed and the fact that there is no comment from the IRS in any of the dozens of news snippets on this puts the issue to rest in my mind.
That's not how the IRS works. You can't just call them up and ask them to clarify a broadly applicable uncertain point of law. You might get an opinion from an IRS official (with an explicit disclaimer that the official does not speak for the IRS), but the only way you will get an official position is through published guidance. The IRS has not published guidance on the serial backdoor Roth and the applicability of the step transaction doctrine. There are many reasons why the IRS might choose not to issue guidance. It may be they are still uncertain how they want to come out on the issue. It may also be there simply aren't resources available to devote to issuing guidance.

In theory, you could pay an enormous sum of money ($50k+ after attorney's fees) and ask for a private letter ruling which would only apply to you personally, but I doubt the IRS would be willing to rule on the issue. Even if they did, such a ruling would be explicitly non-precedential and limited only to the specific facts.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Buffetologist » Tue Mar 15, 2016 9:43 am

Why does Michael Kitces think that there is anything special about a year?

I'd like to have this all done in the same tax year.
If I buy the TIRA in Jan and convert in Dec, can that still be considered a step transcation.
Would it matter if I buy the next year's TIRA the next January?
Would buying and selling at 6 month intervals make more sense?

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by retiredjg » Tue Mar 15, 2016 10:09 am

Buffetologist wrote:Why does Michael Kitces think that there is anything special about a year?
In the interview, he mentions that the IRS previously ruled that a certain thing would not be considered a violation of the step doctrine if a period of a year passed between action 1 and action 2. In that case, apparently a line had to be drawn somewhere and it was decided to draw it there.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by fortyofforty » Wed Mar 16, 2016 8:06 pm

After thinking more about it, I propose "Two Step Roth Contribution" as the name. No doors. No indirection. Just two steps to the final destination.
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Miriam2 » Wed Mar 16, 2016 8:16 pm

fortyofforty wrote:After thinking more about it, I propose "Two Step Roth Contribution" as the name. No doors. No indirection. Just two steps to the final destination.
How about - "Roth conversion."
After all, a Roth conversion and a backdoor Roth are the same thing.

There are two basic ways to contribute to a Roth:
1 -- direct contribution to a Roth, or
2 -- if you are over the earning limits, then the Roth conversion - you convert your IRA to a Roth
So there is either a Roth contribution or a Roth conversion.

I never understood the backdoor idea, although I guess it was coined because the Roth contribution is the "front door" directly into the Roth, so the Roth conversion is the "backdoor" by going into it the other way.
The "backdoor" image/concept has proven to be more complicated than it really is.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by fortyofforty » Wed Mar 16, 2016 8:49 pm

Miriam2 wrote:
fortyofforty wrote:After thinking more about it, I propose "Two Step Roth Contribution" as the name. No doors. No indirection. Just two steps to the final destination.
How about - "Roth conversion."
After all, a Roth conversion and a backdoor Roth are the same thing.

There are two basic ways to contribute to a Roth:
1 -- direct contribution to a Roth, or
2 -- if you are over the earning limits, then the Roth conversion - you convert your IRA to a Roth
So there is either a Roth contribution or a Roth conversion.

I never understood the backdoor idea, although I guess it was coined because the Roth contribution is the "front door" directly into the Roth, so the Roth conversion is the "backdoor" by going into it the other way.
The "backdoor" image/concept has proven to be more complicated than it really is.
It's "backdoor" because it's a way around the rule prohibiting people earning over a certain amount to contribute directly to a Roth IRA. Anyone can convert a traditional IRA to a Roth, but for some of us, it's the only way to fully fund our Roth IRAs. Otherwise we'd be restricted to contributing to non-deductible traditional IRA, which really serves no purpose. The notion of backdoor I think was fitting, but with negative connotations. Thus, two step.Roth contribution.
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Miriam2 » Wed Mar 16, 2016 8:56 pm

fortyofforty wrote:It's "backdoor" because it's a way around the rule prohibiting people earning over a certain amount to contribute directly to a Roth IRA. Anyone can convert a traditional IRA to a Roth, but for some of us, it's the only way to fully fund our Roth IRAs. Otherwise we'd be restricted to contributing to non-deductible traditional IRA, which really serves no purpose. The notion of backdoor I think was fitting, but with negative connotations. Thus, two step.Roth contribution.
Congress already created the "way around the rule prohibiting people earning over a certain amount to contribute directly to a Roth IRA" - it's called a Roth conversion.

What is the difference between a Roth conversion and a backdoor Roth?

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by fortyofforty » Wed Mar 16, 2016 9:51 pm

Miriam2 wrote:
fortyofforty wrote:It's "backdoor" because it's a way around the rule prohibiting people earning over a certain amount to contribute directly to a Roth IRA. Anyone can convert a traditional IRA to a Roth, but for some of us, it's the only way to fully fund our Roth IRAs. Otherwise we'd be restricted to contributing to non-deductible traditional IRA, which really serves no purpose. The notion of backdoor I think was fitting, but with negative connotations. Thus, two step.Roth contribution.
Congress already created the "way around the rule prohibiting people earning over a certain amount to contribute directly to a Roth IRA" - it's called a Roth conversion.

What is the difference between a Roth conversion and a backdoor Roth?
Intent. Anyone can convert a traditional IRA to a Roth IRA, no matter their income level, if she changes her mind after contributing to a traditional IRA. The traditional IRA might be fully or partially deductible for that taxpayer. But the only way someone earning over a certain amount is able to contribute a cent to a Roth IRA is the two step Roth contribution. I can't explain it any clearer than that. If you still don't get it, I can't help you.
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by letsgobobby » Wed Mar 16, 2016 11:33 pm

fortyofforty wrote:
Miriam2 wrote:
fortyofforty wrote:It's "backdoor" because it's a way around the rule prohibiting people earning over a certain amount to contribute directly to a Roth IRA. Anyone can convert a traditional IRA to a Roth, but for some of us, it's the only way to fully fund our Roth IRAs. Otherwise we'd be restricted to contributing to non-deductible traditional IRA, which really serves no purpose. The notion of backdoor I think was fitting, but with negative connotations. Thus, two step.Roth contribution.
Congress already created the "way around the rule prohibiting people earning over a certain amount to contribute directly to a Roth IRA" - it's called a Roth conversion.

What is the difference between a Roth conversion and a backdoor Roth?
Intent. Anyone can convert a traditional IRA to a Roth IRA, no matter their income level, if she changes her mind after contributing to a traditional IRA. The traditional IRA might be fully or partially deductible for that taxpayer. But the only way someone earning over a certain amount is able to contribute a cent to a Roth IRA is the two step Roth contribution. I can't explain it any clearer than that. If you still don't get it, I can't help you.
But the law does not say that only IRA contributions or Roth IRA conversions with certain intent are permitted. Nor does it say that only those with no basis or a pro-rated basis are permitted to convert. Politically we can presume Congress was willing to allow anyone to convert because it wanted revenue now over revenue later. There's a cost to that. The cost is that not everyone will pay a lot of revenue when they convert. Some will pay a lot. That's what a compromise is.

Congress could fix this easily: Roth IRA conversions are not permitted if no tax is owed on the conversion. They haven't done that yet.

This entire thread is purely speculative and the original article, despite Kitces' generally good reputation, is rather dubious.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by fortyofforty » Thu Mar 17, 2016 6:58 am

letsgobobby wrote:
fortyofforty wrote:Intent. Anyone can convert a traditional IRA to a Roth IRA, no matter their income level, if she changes her mind after contributing to a traditional IRA. The traditional IRA might be fully or partially deductible for that taxpayer. But the only way someone earning over a certain amount is able to contribute a cent to a Roth IRA is the two step Roth contribution. I can't explain it any clearer than that. If you still don't get it, I can't help you.
But the law does not say that only IRA contributions or Roth IRA conversions with certain intent are permitted. Nor does it say that only those with no basis or a pro-rated basis are permitted to convert. Politically we can presume Congress was willing to allow anyone to convert because it wanted revenue now over revenue later. There's a cost to that. The cost is that not everyone will pay a lot of revenue when they convert. Some will pay a lot. That's what a compromise is.

Congress could fix this easily: Roth IRA conversions are not permitted if no tax is owed on the conversion. They haven't done that yet.

This entire thread is purely speculative and the original article, despite Kitces' generally good reputation, is rather dubious.
Speculative? Sure it is, as are many of the posts in this forum. The law doesn't say anything about "intent" but Congress set the tax code to prevent people earning over a certain income from contributing DIRECTLY to a Roth IRA. If Congress and the IRS didn't care, they'd just have allowed everyone to contribute the maximum to a Roth IRA. But they didn't. It has the appearance of a loophole, used by those "in the know" but not generally known outside of some internet forums. Thus, the backdoor way to get around the locked front door.
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by EddyB » Thu Mar 17, 2016 10:53 am

fortyofforty wrote:It has the appearance of a loophole, used by those "in the know" but not generally known outside of some internet forums. Thus, the backdoor way to get around the locked front door.
It's hard to argue that tax planning techniques described in "USA Today" are secret or esoteric.

http://usatoday30.usatoday.com/money/pe ... 9_CV_N.htm

http://www.usatoday.com/story/money/201 ... /30514319/

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by fortyofforty » Fri Mar 18, 2016 6:37 am

EddyB wrote:
fortyofforty wrote:It has the appearance of a loophole, used by those "in the know" but not generally known outside of some internet forums. Thus, the backdoor way to get around the locked front door.
It's hard to argue that tax planning techniques described in "USA Today" are secret or esoteric.

http://usatoday30.usatoday.com/money/pe ... 9_CV_N.htm

http://www.usatoday.com/story/money/201 ... /30514319/
It's hard to argue that I used the term "secret" when I merely stated that the technique was not generally known. If it were, you wouldn't have to have articles written about it, telling you to "get it done" and urging you to sneak "into a Roth through the backdoor". I don't know anyone not staying in a hotel that still reads USA Today, but perhaps there are some, and a smaller subset that reads the finance section. The technique has been available since 2010: "In 2010, though, lawmakers repealed the income limit on Roth conversions." It is nice to see that the Motley Fools also used the term "two step" as I proposed.
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by GKSD » Fri Mar 25, 2016 3:47 pm

AviN wrote:In an interview with Christine Benz about Backdoor Roth IRA's back in January, Michael Kitces says: "We’ve heard from a couple of people now who just on a random audit had an IRS agent come in saw it [a Backdoor Roth IRA contribution], caught it, said uh uh that’s not appropriate, and the people actually had unwound it, in part because it was easier to unwind it than fight the IRS which is expensive compared to a $5500 IRA contribution."
May be I misundertood something here. But the IRS Publication 590a https://www.irs.gov/pub/irs-pdf/p590a.pdf talks about converting from Traditional IRA to Roth IRA. Cutting and pasting from the pub -
Page 28
Converting From Any Traditional IRA Into a Roth IRA
Allowable conversions. You can withdraw all or part of
the assets from a traditional IRA and reinvest them (within
60 days) in a Roth IRA. The amount that you withdraw and
timely contribute (convert) to the Roth IRA is called a conversion
contribution.
Page 46
Conversions
You can convert a traditional IRA to a Roth IRA. The conversion
is treated as a rollover, regardless of the conversion
method used. Most of the rules for rollovers, described
in chapter 1 under Rollover From One IRA Into
Another, apply to these rollovers. However, the 1-year
waiting period does not apply.
Page 2
Application of one­rollover­per­year limitation. Beginning
in 2015, you can make only one rollover from an
IRA to another (or the same) IRA in any 1-year period regardless
of the number of IRAs you own. However, you
can continue to make unlimited trustee-to-trustee transfers
between IRAs because it is not considered a rollover.
Furthermore, you can also make as many rollovers from a
traditional IRA to a Roth IRA (also known as “conversions”).
For more information, see Can You Move Retirement
Plan Assets? in chapter 1.
Vanguard blog at http://vanguardblog.com/2016/03/23/roth ... portfolio/ post has this below comment at the bottom of the post.

Beginning in 2015, individuals can make only one rollover from one IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs owned. The limit applies to all of an individual’s IRAs, including SEP and SIMPLE IRAs, traditional, and Roth IRAs. Direct transfers of IRA money (i.e., IRA trustee to IRA trustee) are not limited.

The comment in the blog-post matches what is in IRS pub (page 2) however, there is an additional comment in the IRS pub -.. you can also make as many rollovers from a traditional IRA to a Roth IRA (also known as “conversions”)... which Vanguard blog does not mention. And this got me confused.

Following IRS pub, seem to me -
1. Traditional IRA to Roth IRA rollover (also called conversion) is allowed. Seem like the this is legit. Many sites call this conversion Backdoor Roth.
2. There is no limit, in a given year, on number of such rollovers or conversions from Traditional IRA to Roth IRA

Others have same understanding as well?

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by retiredjg » Fri Mar 25, 2016 4:16 pm

GKSD wrote:Following IRS pub, seem to me -
1. Traditional IRA to Roth IRA rollover (also called conversion) is allowed. Seem like the this is legit. Many sites call this conversion Backdoor Roth.
Almost. A conversion is a conversion. It is not a back door Roth contribution. It is just a conversion.
Others have same understanding as well?
I think your understanding of conversions is fine, but a Roth conversion is not the back door. It is only one step of the back door.

Kitces' concern is that the 2 steps that people use to do the back door allow them to do what one is otherwise prohibited. It is a loop-hole, something that happens when different laws are made a different times. In the past, it has been ruled that at least one similar 2 step approach around a prohibition is not allowed.

There is no such ruling in this case, but that does not mean it could not happen. Kitces is indicating his thoughts on how one might avoid problems when using the 2 step approach to get around a prohibition.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by GKSD » Fri Mar 25, 2016 4:38 pm

Thanks retiredjg. Yes right. I think mentally I had this understanding right but did not phrase accurately when typing.
Backdoor Roth = Contribution to Traditional IRA and then subsequent conversion to Roth IRA for that contribution; applicable to individuals who cannot make direct contributions to Roth IRA due to income limits.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by fortyofforty » Sun Mar 27, 2016 9:19 am

It still seems there are several issues in play here:

Intent - what is the intent of the taxpayer? Does the IRS have to prove intent, when it disallows one process or another? I believe the IRS can make an allegation and force a taxpayer to fight to allow something she did. In other words, the presumption seems to be that the IRS is right and the taxpayer is wrong. So, is the taxpayer's intent to get around what the lawmakers in Congress and the rule-interpreters in the IRS believe is proper? How could the IRS prove intent? Does it have to?

Ability - does the taxpayer using the two-step Roth contribution have the legal ability to contribute to a Roth IRA directly? If she does, then it would come down to the decision to convert maybe based on a change of heart, or something she read or heard. If the taxpayer is legally able to contribute directly to a Roth IRA, there is nothing the IRS could argue about deciding if or when to convert all or part of a traditional IRA contribution. If the taxpayer doesn't have the legal ability to contribute to a Roth IRA directly, then any attempt to do so--whether technically within the law or not--might be viewed askance by unelected IRS rule-makers.

Timing - if a taxpayer does not have the legal ability to contribute to a Roth IRA, and instead chooses to contribute to a traditional IRA, then convert to a Roth, when does the conversion take place? If it is months later, does the IRS view it differently than if it were converted within a week? If so, why would this be? It would seem that it goes back to the intent of the taxpayer. Does the IRS view an immediate conversion as an attempt to skirt the law, while a longer waiting period tends to indicate a change of heart?

Disclaimer: I have used the Two-Step Roth Contribution for several years, and will continue to use it until told otherwise. I have no wish to become the test case for this process, however. Those with the money to hire the best tax lawyers to fight the IRS probably don't care much about Roth IRAs, traditional IRAs, or any other minor details that are practically rounding errors in their enormous portfolios.
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Archie Sinclair » Sun Mar 27, 2016 10:06 pm

fortyofforty wrote:After thinking more about it, I propose "Two Step Roth Contribution" as the name. No doors. No indirection. Just two steps to the final destination.
As explained earlier in this thread, the name of the legal doctrine that might make it illegal is the "step transaction doctrine," so I don't think that using the word "step" to describe it is a good idea.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by fortyofforty » Mon Mar 28, 2016 6:23 am

Archie Sinclair wrote:
fortyofforty wrote:After thinking more about it, I propose "Two Step Roth Contribution" as the name. No doors. No indirection. Just two steps to the final destination.
As explained earlier in this thread, the name of the legal doctrine that might make it illegal is the "step transaction doctrine," so I don't think that using the word "step" to describe it is a good idea.
As I have explained many times above, I am not too worried about this issue, and one of the main people concerned seems to be Michael Kitces (who, coincidentally, has many articles on the subject). I will keep calling it the Two Step Roth Contribution, until a more apropos name is proposed. You are free to call it whatever you want. As the White Coat Investor writes,
[T]he IRS has no idea how long I waited to convert. The date of conversion isn’t supplied to them on my tax return or on the paperwork Vanguard sends them.... Notice how there is no place on the [tax] form to put the date when you made the contribution or the date when you made the conversion. It isn’t on the form your IRA custodian sends to the IRS (1099-R) either.
Again, if the issue is "intent" then repeated traditional-to-Roth conversions, year after year, would seem to prove you intended to convert all along. It wouldn't seem to matter that you waited a month every year if you did it five years in a row, in my opinion.
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Miriam2 » Mon Mar 28, 2016 10:05 am

Johno's post below makes good sense to me. I re-thought the direction of this thread and am deleting my "intent" post :happy
Last edited by Miriam2 on Mon Mar 28, 2016 11:37 am, edited 1 time in total.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Johno » Mon Mar 28, 2016 10:25 am

I think 'much ado about nothing' is rising in the ranks of most relevant posts on this thread as it goes on. In my view there's a quite high chance the 'two step' or 'backdoor' will be be disallowed by legislation before many more years. It's been formally proposed by the current administration to disallow the technique, so it's now 'on the shelf' as a small revenue raiser, and just a matter of time till it's pulled down and enacted as part of some small tax/spend compromise unless a bigger tax reform makes it moot. The proposal IMO also tends to refute the idea that it's a 'little known technique', or something that's actually against the rules as now written. So in contrast and partly because of the proposal and what it shows, I see a smaller chance that non-elected rule makers make a rule change or 'clarification' saying it's not allowed. But in either of those cases you'd just stop doing it when and if disallowed, nothing to worry about particularly. I think it's just over cautiousness (I won't use the P word) to worry about some retroactive penalty or otherwise 'getting in trouble'. That kind of concern IMO is more suited to things potentially classifiable as 'step transactions' that actually are esoteric.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by FinancialDave » Mon Mar 28, 2016 5:01 pm

JonnyDVM wrote:That was a very vague "A couple of people had problems". It didn't say what else they were audited for. I'm not scared of an audit. I do worry that the loophole will get closed. However, as the article notes, there really hasn't been any sort of successful tax policy changes in quite some time. I'm not acutely fine tuned into tax policy but the backdoor roth seems like a relatively small fish to come after.
I have never done a backdoor Roth and never hope to do one! One of the main reasons is that even though "everyone" says it is legal, there is no particular IRS verbiage that makes it so. Therefore, I don't even believe it would take an act of Congress to change it, just a "position paper" by the IRS stating it is not legal.

All that being said there is no big incentive for them to do so, in fact they probably laugh to themselves every time someone does one, or a Roth conversion for that matter, because it just keeps that tax income a flowing, as opposed to putting the money in a IRA where they may not see it for 40-50 years. If they didn't do a backdoor Roth the incentive might be to open an HSA account and get the triple tax deduction instead. Especially in a market that is flat to down, like the last couple years, there is no tax loss from having someone put their money in a Roth at all.

I suspect they are quite happy with all the talk about the need to do Roth conversions as well. With the trillions coming due from IRA's over the next few years, worrying about a few dollars of earnings inside a Roth account is peanuts!

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Leesbro63 » Mon Mar 28, 2016 6:21 pm

The last post is not quite right. If high income folks who currently do back door Roth IRAs found them to become prohibited, the most likely alternative would be to do non-deductible traditional IRAs. They would NOT be allowed, under current law, to make traditional IRA contributions and take a current deduction, thus deferring tax on that contribution for 40-50 years...as claimed in the last post. Forcing high earners to only have non-deductible traditional IRAs available would not cost the government anything in lost current taxes. In fact there would be no downside, ever to the government. There would be huge long term upside, as all the earnings on those non-deductible IRAs eventfully get taxed upon withdrawal. This difference is why, by the way, the backdoor Roth IRA for high income folks is a no-brainer for as long as it lasts.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by FinancialDave » Mon Mar 28, 2016 7:02 pm

Leesbro63 wrote:The last post is not quite right. If high income folks who currently do back door Roth IRAs found them to become prohibited, the most likely alternative would be to do non-deductible traditional IRAs. They would NOT be allowed, under current law, to make traditional IRA contributions and take a current deduction, thus deferring tax on that contribution for 40-50 years...as posited by in the last post. Forcing high earners to only have non-deductible traditional IRAs would not cost the government anything in lost current taxes. In fact there would be no downside, ever to the government. There would be huge long term upside, as all the earnings on those non-deductible IRAs eventfully get taxed upon withdrawal. This difference is why, by the way, the backside Roth IRA for high income folks is a no-brainer for as long as it lasts.
Leesbro,

You are partially true, but you make assumptions ("huge long term upside?") that can sway the analysis. Remember in the case of either a Roth (no matter how you get there) and a non-deductible traditional IRA, tax is only deferred on the earnings. In this regard you have to remember what some of the data by Vanguard or others point out, as to how well the general investor does in relation to the overall market returns and what the real dollar returns on some of these accounts are.

Also, I do know plenty of individuals that are NOT maxing out their 401k, but are doing the backdoor Roth, just because the employer does not offer a Roth and they are above the income limit. Which begs to tax inefficiency when you consider the tax-rate paid on that Roth money.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Leesbro63 » Mon Mar 28, 2016 7:08 pm

Not true that no matter how you get there that tax is deferred on Roth earnings. Tax never happens, ever, on Roth earnings. It's not just "mere deferral". Versus the non-deductible traditional that has "mere deferral".

And I stand by my "huge upside" comment for why the government might want to limit/end backdoor Roths by IRS regulations or enforcement of the "step transaction" rules (or by new legislation). All the earnings will eventually be taxed (if they restrict the back door Roth) versus never being taxed under current back door Roth IRA practice. This is a huge advantage now for the Roth contributor and would be a huge advantage for the tax coffers to end this. In fact this is the no-brainer reason to do a backdoor Roth vs the only other IRA available to the high earner, the non-deductible traditional IRA. The original reason to allow Roth conversions was to get big tax bucks, on years of prior accumulated IRA contributions and earnings, immediately. Now that most of those inclined and able to do that have already had a 6 year window, there's very little upside for the tax man to continue offering this. I'm not taking a position here; just pointing out how we got here and why a hungry tax coffer might look at ending something that no longer brings in current (or future) tax bucks but would definitely bring in at least some future tax bucks.

As to doing a deductible 401k versus a non deductible back door Roth for high income earners...that goes back to the old problem of trying to guess if your current marginal tax rate is lower than what it will be in retirement...not a unique issue to backdoor Roths

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Alan S. » Mon Mar 28, 2016 7:52 pm

[quote="FinancialDave]
I have never done a backdoor Roth and never hope to do one! One of the main reasons is that even though "everyone" says it is legal, there is no particular IRS verbiage that makes it so. Therefore, I don't even believe it would take an act of Congress to change it, just a "position paper" by the IRS stating it is not legal.
fd[/quote]

Not correct. Making a non deductible IRA contribution is clearly authorized by the tax code, and as of 2010 all income and marital filing restrictions were eliminated allowing everyone to convert to a Roth IRA. In fact, to encourage these conversions from higher income taxpayers, the legislation added the incentive to report the income from these conversions over two years starting in the year after the conversion year.

Further, over the last 15 years, Congress has passed dozens of portability expansions, allowing balances to be rolled into most other retirement account types, conversions directly from employer plans, HSA funding distributions, and IRA rollovers into employer plans from non rollover IRA accounts. All kinds of additional options were created which could be used for the advantage of the taxpayer. In plan Roth rollovers were added a couple years back and the trend continues. Perhaps the most urgent concern of our times is that people do not save enough for retirement, so to make it easier new retirement plans are being devised by state and local governments.

Other examples of so called short term step transactions that we never hear about are:
1) Rolling an IRA into an employer plan to access the age 55 separation exception
2) " " " to avoid RMDs for still working taxpayers
3) Recharacterizations are basically a do over that can be used to retroactively gain a tax advantage.
4) Making large 401k contributions knowing you are about to separate for another job, rolling the 401k over to an IRA, and then taking penalty free distributions from the IRA using exceptions not available from qualified plans.

If Congress does not want taxpayers to have all these portability options, then they should not have expanded portability, or they should have been smarter about it. About the only clear advice regarding the back door Roth is to use it while you can, because the current tax code allows it.

It is interesting to note that AGI is often being manipulated to secure ACA subsidies as well. This is generally the case with any benefit that is phased out using AGI thresholds.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by dmcmahon » Mon Mar 28, 2016 9:58 pm

ryman554 wrote:
wolf359 wrote:I think this discussion is focusing on the wrong part of the interview. The point isn't that there's some hearsay about some people who got audited and reversed it. Kitces provides valuable information about the grounds that the IRS would use to object to the practice, as well as how to avoid running afoul of it.

The IRS precedent is called "The Step Transaction Rule." If an affluent investor is prohibited from contributing to a Roth IRA due to income restrictions, but instead follows a series of legal actions to get around the prohibition, the IRS will attempt to disallow it because it violates that original prohibition. A backdoor Roth conversion is exactly that.

The solution is to STOP BACKDOOR ROTH IRAs. Do nothing to circumvent the Roth IRA contribution limits.

Invest in non-deductible IRAs because you're out of deductible space, and want the tax-deferred compound interest on earnings. Invest those funds for the long term, in equities. This is a legitimate, legally defensible action, and it has nothing to do with trying to avoid any income prohibitions. (There are NO income limits on non-deductible IRAs.) If, after a year or more has passed, you change your mind and decide to convert all your non-deductible IRA holdings to a Roth IRA -- well, that's not a backdoor contribution. That is a change in your investment strategy, if you believe that it is appropriate to make it at that time.
Except that that still fails the IRS "step transaction" test for the reason that, upon initially contributing the non-deductible moneys, it was presumably impossible to contribute directly to a ROTH. No rational investor would choose to place money in an account which has tax-deferred growth when one has a tax-free growth available, along with *better* access to the invested basis.

No, "undoing" this transaction or "changing ones mind" would not be to covert tIRA funds to a ROTH a year later; it would be but an extension of the intended plan. "Changing ones mind" would be removing it from the tIRA completely and investing anew in a different platform; be it taxable, tIRA or ROTH.

So, I give you that you could perhaps do this "not a backdoor" for one year, as long as you have a year in which you meet the ROTH criteria. But if all you do is wait one year before converting, and do this every year, well, that duck still quacks and looks the same.
Yeah, I hear you. After becoming aware of the step transaction rule some years ago I opted to cease Roth conversions indefinitely while continuing to make tira contributions. I will consider conversion after I retire. I may pay some tax on the modest gains I make in those few years, but I'll steer clear of the issue just in case. If I were younger with more years until retirement, I guess what I would do is convert when circumstances favored it, e,g, in a year when my income was lower, etc. By having no specific plan or schedule to convert in future I believe I could avoid the issue, or at least defend my position better.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Me2 » Mon Mar 28, 2016 10:30 pm

Sorry if this has already been asked, but out of curiosity, what would be the statute of limitations on audits if the backdoor were deemed to fall afoul of the step transaction doctrine?

Would it be only three years since we're not understating income, or would it be unlimited since it could be considered fraudulent?

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by FinancialDave » Tue Mar 29, 2016 12:27 am

Leesbro63 wrote:
And I stand by my "huge upside" comment for why the government might want to limit/end backdoor Roths by IRS regulations or enforcement of the "step transaction" rules (or by new legislation).

Now that most of those inclined and able to do that have already had a 6 year window, there's very little upside for the tax man to continue offering this. I'm not taking a position here; just pointing out how we got here and why a hungry tax coffer might look at ending something that no longer brings in current (or future) tax bucks but would definitely bring in at least some future tax bucks.
I'll just finish up by agreeing with the poster who said this is "much to do about nothing." While I could easily see the government estimating millions saved by the elimination of the Roth for high income earners, I could easily make the opposite case that not a nickel in extra tax could be realized, at least for many years in the future, by buying something as simple as a deferred annuity. The reason being if someone want's to avoid taxes they usually will find a way.

The insurance industry would probably love to see the backdoor Roth go away and that would just give them more of a foot in the door to push some of their products, and develop new ones. After all there have always been taxpayers that will go to any lengths and ridiculous expense to eliminate or defer a few taxes.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by FinancialDave » Tue Mar 29, 2016 12:46 am

Alan S. wrote:[quote="FinancialDave]
I have never done a backdoor Roth and never hope to do one! One of the main reasons is that even though "everyone" says it is legal, there is no particular IRS verbiage that makes it so. Therefore, I don't even believe it would take an act of Congress to change it, just a "position paper" by the IRS stating it is not legal.
fd
Not correct. Making a non deductible IRA contribution is clearly authorized by the tax code, and as of 2010 all income and marital filing restrictions were eliminated allowing everyone to convert to a Roth IRA. In fact, to encourage these conversions from higher income taxpayers, the legislation added the incentive to report the income from these conversions over two years starting in the year after the conversion year.

Further, over the last 15 years, Congress has passed dozens of portability expansions, allowing balances to be rolled into most other retirement account types, conversions directly from employer plans, HSA funding distributions, and IRA rollovers into employer plans from non rollover IRA accounts. All kinds of additional options were created which could be used for the advantage of the taxpayer. In plan Roth rollovers were added a couple years back and the trend continues. Perhaps the most urgent concern of our times is that people do not save enough for retirement, so to make it easier new retirement plans are being devised by state and local governments.

Other examples of so called short term step transactions that we never hear about are:
1) Rolling an IRA into an employer plan to access the age 55 separation exception
2) " " " to avoid RMDs for still working taxpayers
3) Recharacterizations are basically a do over that can be used to retroactively gain a tax advantage.
4) Making large 401k contributions knowing you are about to separate for another job, rolling the 401k over to an IRA, and then taking penalty free distributions from the IRA using exceptions not available from qualified plans.

If Congress does not want taxpayers to have all these portability options, then they should not have expanded portability, or they should have been smarter about it. About the only clear advice regarding the back door Roth is to use it while you can, because the current tax code allows it.

It is interesting to note that AGI is often being manipulated to secure ACA subsidies as well. This is generally the case with any benefit that is phased out using AGI thresholds.[/quote][/quote]

Alan S,

Thanks for stopping by and adding clarifications to my post.

It sounds like what everyone is saying is that all the rules dealing with the fact that there is a limit on income to allow you to contribute to a Roth, basically do not matter, because there is an easy (relatively) way around these rules. I doubt you would get the IRS to admit this however. I certainly have never seen it in print.

I like your comment about how people don't save enough, and the more obvious solution to me is not to close down the backdoor Roth but make it useless by eliminating the income limit in the first place.
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Spirit Rider » Tue Mar 29, 2016 1:08 am

When the income limit on Roth conversions were lifted starting in 2010, the congressional record shows it was intended as a short term revenue enhancer to be scored to fund other changes in the bill. So congress plays games themselves.

My other main point that has gone unnoticed in this thread, is that the IRS has weighed in on this subject indirectly. They explicitly blessed the so called Mega Backdoor Roth with Notice 2014-54. This provided a favorable ruling to condone the action of after-tax 401k contributions rolled over to a Roth IRA and any earnings to a traditional IRA. This allows someone whose earnings are well above the limit to make tens of thousands in additional Roth contributions each year. These are exactly the same two steps as a backdoor Roth, except on a grander scale and even more beneficial that there is no prorated taxation on earnings because you can roll the earnings to a traditional IRA. In my mind this blows Michael Kitces spore theory right out the window. If the IRS had any step transaction doctrine problems, would they endorse a process clearly involving such steps?

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by fortyofforty » Tue Mar 29, 2016 7:43 am

Would it be wrong to call this the "Taxes Two-Step"? :mrgreen:
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Johno » Tue Mar 29, 2016 8:56 am

Me2 wrote:Sorry if this has already been asked, but out of curiosity, what would be the statute of limitations on audits if the backdoor were deemed to fall afoul of the step transaction doctrine?

Would it be only three years since we're not understating income, or would it be unlimited since it could be considered fraudulent?
If you review the whole thread you can see an exchange where a poster makes an argument that since it would be necessary to file a Form 5329 *if* a Roth conversion of previous non-deductible IRA contributions (IOW a 2-step or backdoor Roth) was an 'excess contribution', which you would not file* if believing the 2-step is legitimate, and since the Form 5239 has its own separate statute of limitations clock from filing date, that the IRS could penalize people for 2-steps made at any time in the past according to the rules for excess IRA contribution. I think this is a far fetched argument, and the poster might even agree and say it's just a matter of laying it out for everyone to judge. Nothing says the maneuver is an excess contribution. Some explicit IRS guidance (as on after tax 401k>Roth conversions) implies it's not. And the fact legislation is proposed to disallow it (current admin's budget specifically proposes the 2-step be disallowed from 2017, albeit perhaps not likely to pass this year) also tends to imply it's not against the current rules.

Much less 'fradulent', that's a baseless worry, just in my opinion. But since there is no absolutely direct rule or guidance, some people's imaginations will run wild, and if something is going to make you worry all the time it's probably not good for your overall well being to do it. I personally see no reasonable basis to worry about 'getting in trouble' over this type of transaction. It might one way or another be disallowed for future years and then you'd stop. However again I don't claim there's airtight proof of this position and absolutely zero reason to worry, if one is highly inclined to worry.

*and since filing forms with all zeroes doesn't necessarily count as filing them.

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by FinancialDave » Tue Mar 29, 2016 7:24 pm

Spirit Rider wrote:When the income limit on Roth conversions were lifted starting in 2010, the congressional record shows it was intended as a short term revenue enhancer to be scored to fund other changes in the bill. So congress plays games themselves.

My other main point that has gone unnoticed in this thread, is that the IRS has weighed in on this subject indirectly. They explicitly blessed the so called Mega Backdoor Roth with Notice 2014-54. This provided a favorable ruling to condone the action of after-tax 401k contributions rolled over to a Roth IRA and any earnings to a traditional IRA. This allows someone whose earnings are well above the limit to make tens of thousands in additional Roth contributions each year. These are exactly the same two steps as a backdoor Roth, except on a grander scale and even more beneficial that there is no prorated taxation on earnings because you can roll the earnings to a traditional IRA. In my mind this blows Michael Kitces spore theory right out the window. If the IRS had any step transaction doctrine problems, would they endorse a process clearly involving such steps?
Here's a wild thought for you. Why do we need a limit on Roth deductions that is based on income, it really makes no sense. Most know there is no mathematical difference between the Roth and IRA given equal tax rates in and out, so why do we waste thousands and thousands of hours trying to believe we know one is better than the other. Why not just do away with the IRA and make all tax-deferred accounts a Roth, either employer sponsored or individual and put a total yearly contribution limit on the amount you can contribute each year. Can you imagine how much money would suddenly begin flowing into the government.

I know that's way to simple, would put multitudes of tax accountants out of work.

:oops:
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by Tier1Capital » Tue Mar 29, 2016 11:28 pm

Interesting article from Financial Planning titled "It's Not About Timing: IRS on Backdoor Roth Conversions" - requires free registration. IRS spokesman says in an email on immediate conversions, there is "no caveat about waiting", between contribution and conversion. That sounds pretty clear to me.

http://www.financial-planning.com/news/ ... 153-1.html

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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by fortyofforty » Wed Mar 30, 2016 7:51 am

Tier1Capital wrote:Interesting article from Financial Planning titled "It's Not About Timing: IRS on Backdoor Roth Conversions" - requires free registration. IRS spokesman says in an email on immediate conversions, there is "no caveat about waiting", between contribution and conversion. That sounds pretty clear to me.

http://www.financial-planning.com/news/ ... 153-1.html
As the White Coat Investor pointed out in the paragraph I quoted, the IRS doesn't know when the conversion took place unless and until they conduct an audit and request that information. If they are auditing a taxpayer, it would be based on something other than whether or not she waited a "reasonable" period of time before converting, in order to keep up some pretense of changing her mind.
"In a time of universal deceit, telling the truth becomes a revolutionary act." - George Orwell | There are many roads to doublin'. | Original Vanguard Diehard

autolycus
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by autolycus » Wed Mar 30, 2016 8:30 am

Johno wrote:And the fact legislation is proposed to disallow it (current admin's budget specifically proposes the 2-step be disallowed from 2017, albeit perhaps not likely to pass this year) also tends to imply it's not against the current rules.
You are not the first to raise this point. I think it is assuming too much. Lots of laws are changed to clarify prohibitions that ended up being more ambiguous than intended. That there are legislative proposals to definitively lock a door shut does not mean that the door is currently open wide enough for people to actually use without getting cut up very badly in slipping through. This is not me saying that I think backdoor Roth IRAs are not currently legal. It's just me saying that I do not buy the reasoning that is suggested in the quote above, and I encourage people considering using the backdoor Roth to base their decision on something else.

autolycus
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by autolycus » Wed Mar 30, 2016 8:41 am

fortyofforty wrote:If they are auditing a taxpayer, it would be based on something other than whether or not she waited a "reasonable" period of time before converting, in order to keep up some pretense of changing her mind.
Interesting, and accurate, way of putting it. The Step Transaction Doctrine is supposed to help the IRS deal with situations in which there might be some "pretense of changing her mind" but in which there is no actual decision possible in the first place. If the taxpayer couldn't have done the Roth IRA contributions in the first place, her only choice when the first transaction occurred was non-deductible contributions. So the concept of delaying in order to show some sort of evidence that a choice was being made is, IMHO, pointless.

I assume the intention in removing the income limits on Roth IRA conversions was that there were taxpayers who:
1) Had made non-deductible IRA contributions prior to the existence of Roth IRAs
2) Who might have been eligible for Roth IRA contributions instead of non-deductible contributions
3) Who have had a rise in income that had made them ineligible for conversions

That, plus tax revenue now instead of later. :D

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GKSD
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Re: Michael Kitces says IRS auditors disapprove of Backdoor Roth IRA's

Post by GKSD » Thu Mar 31, 2016 8:34 am

Here is another rebuttal opinion to Kitces article -
https://www.irahelp.com/slottreport/bac ... conversion

Look for 'Step Transaction Concerns' section halfway through the article. There are multiple reasons cited justifying Backdoor Roth being A-OK.

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