IRS questioning my backdoor roth?

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WarChest
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IRS questioning my backdoor roth?

Post by WarChest »

Got a nice notice in the mail from the IRS saying I didn't report $11k of income and thus owe tax on it. Interesting.

Started calendar year with regular IRA with $0.
Made 2 after tax contributions of $5500 in Feb (one for calendar year before and one for the as of then current calendar year) for a total of $11k.
The next day I rolled the $11k from regular IRA at Vanguard to Roth IRA at Vanguard.

For some reason the IRS thinks I took a distribution...I am writing them a letter and attaching form 5498 which shows that the $11k was rolled to the Roth IRA.

Questions: Why doesn't the IRS already have the 5498 showing this? Did I do something wrong? I did the same backdoor roth move for a few more current tax years and now I am figuring the same issue is going to pop up going forward. How do I avoid this drama? HELP! (and thanks!)
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retiredjg
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Re: IRS questioning my backdoor roth?

Post by retiredjg »

Sounds like you did not file the 2 Forms 8606 indicating that you made a non-deductible contribution to tIRA. One form for each year.
island
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Re: IRS questioning my backdoor roth?

Post by island »

retiredjg wrote:Sounds like you did not file the 2 Forms 8606 indicating that you made a non-deductible contribution to tIRA. One form for each year.
Does this happen automatically when using Turbo Tax and filing electronically?
livesoft
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Re: IRS questioning my backdoor roth?

Post by livesoft »

Send the IRS the Form 8606 that you already sent them with your tax return.

If you tell TurboTax (or any other tax software like H&RBlock) that you did this conversion, then yes, TurboTax will report it. What did you tell TurboTax? Since you printed out your forms from TurboTax for safe-keeping, you can just look at them and tell us what they say.
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retiredjg
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Re: IRS questioning my backdoor roth?

Post by retiredjg »

island wrote:
retiredjg wrote:Sounds like you did not file the 2 Forms 8606 indicating that you made a non-deductible contribution to tIRA. One form for each year.
Does this happen automatically when using Turbo Tax and filing electronically?
It should happen if you answered the questions right. I suspect that you did not report it correctly.

What calendar year are you talking about? If you mean you made a contribution for 2015 and 2016 and converted both in 2016….some of that paperwork is not even due yet so they can't be talking about that.

Tell us the specific dates you made these contributions and the conversion.
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WarChest
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Re: IRS questioning my backdoor roth?

Post by WarChest »

2013 and 2014
Topic Author
WarChest
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Re: IRS questioning my backdoor roth?

Post by WarChest »

Also, I guess I'm focusing on Form 5498 because that is one of the forms they mention in their letter saying that if it is a rollover to please provide that form. I haven't gone back in and looked at my turbo tax return to see about the other forms you folks are mentioning.
DSInvestor
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Re: IRS questioning my backdoor roth?

Post by DSInvestor »

You need to make sure that you entered your Traditional IRA contributions into turbotax 2013 and 2014. If you do not enter these contributions, there is no basis recorded in your 8606 forms and the 11K conversion will be taxable.
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WarChest
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Re: IRS questioning my backdoor roth?

Post by WarChest »

Thanks, I just checked and did not file any form 8606. I guess since I knew everything was legit and a non-taxable event I didn't think to make sure I was reporting it via a specific form. I used Turbo Tax and not sure why it didn't have me fill out that form. Maybe I skimmed over that because "why would I need to tell Turbo Tax about this tIRA contribution if I am over the limits to deduct it anyways"...

Now I guess I need to look at more recent year tax returns and maybe re-file to make sure I include a 8606 so this nonsense doesn't happen again next year and the year after? Ugh!
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retiredjg
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Re: IRS questioning my backdoor roth?

Post by retiredjg »

WarChest wrote:2013 and 2014
Your 2013 Form 8606 should have said you made a non-deductible contribution to IRA.

Your 2014 Form 8606 should have said you made a non-deductible contribution to IRA on the front and a conversion of the $11k to Roth on the back of the form.

Chances are, in your mind you contributed to Roth IRA. But that's not what you actually did. You really made 2 non-deductible contributions to IRA and a conversion to IRA. It must be documented that way and Form 8606 is how you do that.

You can download previous years' forms from the internet and send them in. Since you have gotten the nice notice, I guess you send them back with the notice.

Yes, if you have done this for other years, you'll have to fix those years too, but I suspect (do not know for sure) you would not send those back with the notice.
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ray.james
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Re: IRS questioning my backdoor roth?

Post by ray.james »

In my case turbotax did not report 8606 correctly. The first time I did the questions, it was very confusing.

Also, 8606 is an independent form. So you do not need to amend the entire return to file it with IRS.
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WarChest
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Re: IRS questioning my backdoor roth?

Post by WarChest »

You folks are awesome, thanks for the timely responses!
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retiredjg
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Re: IRS questioning my backdoor roth?

Post by retiredjg »

WarChest wrote:... "why would I need to tell Turbo Tax about this tIRA contribution if I am over the limits to deduct it anyways"...
So that you will fully understand, money coming out of a tIRA in retirement is taxed unless it has been taxed before. How do you and the IRS know what has been taxed before? It is the running total on your last 8606 form. :happy
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celia
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Re: IRS questioning my backdoor roth?

Post by celia »

WarChest wrote:The next day I rolled the $11k from regular IRA at Vanguard to Roth IRA at Vanguard.

For some reason the IRS thinks I took a distribution...I am writing them a letter and attaching form 5498 which shows that the $11k was rolled to the Roth IRA.
I agree with the IRS that if you rolled the money to the Roth, the money coming out of the tIRA as a distribution would be taxed (at 0% since it had been post-tax, and should have a penalty for not having been in the tIRA long enough). And dollars being contributed to the Roth would be taxed going in.

However, if you had converted the $11k from a tIRA to a Roth IRA, that conversion would have been tax-free since post-tax dollars were contributed to the tIRA.


Moral of this lesson: You need to use the correct IRS terminology when communicating with them, ESPECIALLY WHEN FILING YOUR TAXES.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Re: IRS questioning my backdoor roth?

Post by LadyGeek »

This thread is now in the Personal Finance (Not Investing) forum (taxes).
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retiredjg
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Re: IRS questioning my backdoor roth?

Post by retiredjg »

WarChest, since you didn't understand the needed paperwork, one has to wonder if you didn't understand other things as well.

Did you have any other IRAs (tIRA, rollover IRA, SEP IRA or SIMPLE IRA) in your name at the end of the year you did all this? Or the other years that you did this?

If so you have a bigger problem to work on.
cherijoh
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Re: IRS questioning my backdoor roth?

Post by cherijoh »

WarChest wrote:Also, I guess I'm focusing on Form 5498 because that is one of the forms they mention in their letter saying that if it is a rollover to please provide that form. I haven't gone back in and looked at my turbo tax return to see about the other forms you folks are mentioning.
Form 5498 is a form that your IRA custodian sends you around May of the following year. Form 8606 is one that you file with your tax return. Without a form 8606, the IRS will assume that you took a premature distribution and under-reported it. Hence the letter you received.

But it isn't clear to me whether or not the OP even reported the Income on his/her 1040. The IRA custodian should have mailed a 1099-R with the distribution amount listed. This goes on income section of the 1040 under the line for IRA distributions (space labeled a). The second part of that line (labeled b) is taxable distributions - which is calculated from the form 8606.

But if OP neglected to add the income into TurboTax, it wouldn't know to create an 8606. So there are two potential problems - OP either reported the income but entered the wrong answer to one of the "interview" questions OR OP didn't enter the income of the tax form at all.
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Re: IRS questioning my backdoor roth?

Post by curmudgeon »

My memory is that several years ago TurboTax was not at all intuitive in handling backdoor Roth. You had to do some contortions and magic incantations to get it to spit out the correct forms for filing. If you didn't work things through carefully, you could end up in this situation.

I think they've gotten better about it in recent years (which may mean that it is becoming well know enough that it will start getting attacked in politics and banned like the file-and-suspend in SS).
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WarChest
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Re: IRS questioning my backdoor roth?

Post by WarChest »

Thanks again for all the responses.

I don't think I have "bigger issues" to worry about. I've never had any pre-tax funds in tIRA accounts. I've always contributed directly to Roth IRA when under the income limit and then when I crossed the limit I have been doing backdoor Roth roll overs always starting with a $0 balance tIRA, contributing the max with after tax $$ and then within a few days rolling it all over to Roth IRA in a non-taxable event.

I've always used Turbo Tax. Yes things get complicated. My bad for not knowing about form 8606.

To wrap this thread up, I called the IRS, and was told that a 8606 should be sufficient to clear up my issue. Additionally, I plan on sending them another 8606 for year 2015 as I see I didn't file one already. No need to re-file taxes, just send them an 8606 and everything should be sorted out.

...Not sure why the code isn't just changed so we can directly contribute to Roth IRAs when above the income limit but oh well...I'll keep backdooring as long as I can.
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WarChest
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Re: IRS questioning my backdoor roth?

Post by WarChest »

Oh, and yes, I failed to report any distribution from IRA (taxable or not) on 1040. Blame me, turbo tax, etc...

Lesson learned, will be crushing my taxes come next year!
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Re: IRS questioning my backdoor roth?

Post by otinkyad »

curmudgeon wrote:My memory is that several years ago TurboTax was not at all intuitive in handling backdoor Roth.
Agreed. I don't remember the exact wording, but it was something like "Let's find out if your IRA contribution is deductible." The first year I did a backdoor Roth, I thought, "I know it's not deductible" and skipped that step in TurboTax. I happened to do that step later before filing taxes so it would quit prompting me.

OP, they aren't going to allow direct contributions with high incomes. Roth conversions are allowed without income limits as a means to pull in taxes on converted pre-tax contributions (it was a budget balancing change, IIRC). The treatment of non-deductible contributions is a sort of enticement to bring in more tax payments sooner on pre-tax tIRA contributions according to the pro rata rule. With the increasing popularity of backdoor Roths for younger people without large deductible tIRA balances, there are annual proposals to close that loophole. It's a balancing act between the loss of taxed growth on the backdoor Roths and pulling in the tax payments sooner on tax deferred tIRAs.
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Earl Lemongrab
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Re: IRS questioning my backdoor roth?

Post by Earl Lemongrab »

celia wrote:I agree with the IRS that if you rolled the money to the Roth, the money coming out of the tIRA as a distribution would be taxed (at 0% since it had been post-tax, and should have a penalty for not having been in the tIRA long enough). And dollars being contributed to the Roth would be taxed going in.

However, if you had converted the $11k from a tIRA to a Roth IRA, that conversion would have been tax-free since post-tax dollars were contributed to the tIRA.
No, there's no difference in taxation between doing a TIRA conversion via trustee transfer or 60-day rollover.

Earl
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celia
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Re: IRS questioning my backdoor roth?

Post by celia »

Earl Lemongrab wrote:
celia wrote:I agree with the IRS that if you rolled the money to the Roth, the money coming out of the tIRA as a distribution would be taxed (at 0% since it had been post-tax, and should have a penalty for not having been in the tIRA long enough). And dollars being contributed to the Roth would be taxed going in.

However, if you had converted the $11k from a tIRA to a Roth IRA, that conversion would have been tax-free since post-tax dollars were contributed to the tIRA.
No, there's no difference in taxation between doing a TIRA conversion via trustee transfer or 60-day rollover.

Earl
But the IRS can tell that OP did not do a rollover since it didn't show up on any of the 5498 forms they received that year for tIRAs. The IRS computers will be confused about the account status until the OP clears it up.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Re: IRS questioning my backdoor roth?

Post by MarkNYC »

celia wrote:
Earl Lemongrab wrote:
celia wrote:I agree with the IRS that if you rolled the money to the Roth, the money coming out of the tIRA as a distribution would be taxed (at 0% since it had been post-tax, and should have a penalty for not having been in the tIRA long enough). And dollars being contributed to the Roth would be taxed going in.

However, if you had converted the $11k from a tIRA to a Roth IRA, that conversion would have been tax-free since post-tax dollars were contributed to the tIRA.
No, there's no difference in taxation between doing a TIRA conversion via trustee transfer or 60-day rollover.

Earl
But the IRS can tell that OP did not do a rollover since it didn't show up on any of the 5498 forms they received that year for tIRAs.
No matter how the transaction is completed, a conversion is always treated as a rollover of a traditional IRA to a Roth IRA for reporting and tax purposes.

The transaction should show on Form 5498 in boxes 2 and 7 as "rollover contribution" to a Roth IRA.
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Re: IRS questioning my backdoor roth?

Post by Alan S. »

Almost all IRS issues with a back door Roth involve a mishandled former or current year 8606, so this is the place to start if you receive an IRS inquiry. Every once in awhile, the current 8606 is correct and the IRS misses it. As you know, the taxable amount on the 1099R is always reported as the full amount converted and the 8606 is needed to override the Box 2a figure if there is IRA basis.
spth
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Re: IRS questioning my backdoor roth?

Post by spth »

Turbo Tax always gets our basis wrong at first. I think it has something to do with the order of questions.
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Re: IRS questioning my backdoor roth?

Post by cherijoh »

WarChest wrote:Oh, and yes, I failed to report any distribution from IRA (taxable or not) on 1040. Blame me, turbo tax, etc...

Lesson learned, will be crushing my taxes come next year!
Never Ignore a Form 1099 - it MUST appear on your tax form or you will be hearing from the IRS sooner or later. :oops:
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Re: IRS questioning my backdoor roth?

Post by travellight »

I am having the same problem with turbotax. Have to figure out how to answer correctly to invoke 8606.
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retiredjg
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Re: IRS questioning my backdoor roth?

Post by retiredjg »

See if this 2014 blogpost is helpful. Things might look different now.

http://thefinancebuff.com/backdoor-roth ... -easy.html
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Re: IRS questioning my backdoor roth?

Post by travellight »

still showing taxation:

IRA Distributions - taxable $983
IRA Distributions - nontaxable $5,492

trying to figure it out... this time it even took me to form 8606 and asked how much I had tracked as of 12/31/14 which I answered.
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travellight
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Re: IRS questioning my backdoor roth?

Post by travellight »

IRA contributions (other than amounts in boxes 2-4 and 8-10) $0.00
2 Rollover contributions $0.00
3 Roth IRA conversion amount $6,474.88
4 Recharacterized contributions $0.00

My bank form sees it as a conversion, not a recharacterization. These terms are confusing.
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travellight
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Re: IRS questioning my backdoor roth?

Post by travellight »

It still says this:
Because you made an excess contribution of $6,500 to your Roth IRA, you will owe a 6% penalty ($390) each year that excess money remains in the IRA.
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tfb
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Re: IRS questioning my backdoor roth?

Post by tfb »

travellight wrote:It still says this:
Because you made an excess contribution of $6,500 to your Roth IRA, you will owe a 6% penalty ($390) each year that excess money remains in the IRA.
Answer 'no' under 'Did You Change Your Mind?'
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Re: IRS questioning my backdoor roth?

Post by travellight »

^I did answer no to that.
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retiredjg
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Re: IRS questioning my backdoor roth?

Post by retiredjg »

travellight wrote:It still says this:
Because you made an excess contribution of $6,500 to your Roth IRA, you will owe a 6% penalty ($390) each year that excess money remains in the IRA.
This sounds like you told TT that you made a contribution to Roth IRA. If you are talking about the back door, you made a contribution to tIRA (not Roth IRA) and did a conversion to Roth IRA.

My bank form sees it as a conversion, not a recharacterization. These terms are confusing.
Which one do you think you did? I assume you did a Roth conversion since you want to use Form 8606. I don't think this form has anything to do with documenting a recharacterization.

Seems like maybe we are getting only part of a conversation?
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Re: IRS questioning my backdoor roth?

Post by travellight »

So, to walk through the steps (hoping this exercise may be helpful to others in the same boat doing the back door roth ira and using turbotax):

Start the process by clicking on this box: (click the box for traditional and roth ira contributions)

Retirement and Investments
IRAs, investment interest expenses Visit All
Traditional and Roth IRA Contributions


1) checked contribute to traditional ira only, did not check roth ira box.

2)next box is repayment of retirement distribution: checked no.

3)Enter the total amount you put into a traditional IRA for 2015, even if you later transferred some or all of it to a Roth IRA: entered $6500.

4) How much of the $6,500 you contributed to a traditional IRA for 2015 did you switch, or "recharacterize" (this does not include conversions or rollovers), to a Roth IRA? Entered zero since I converted, not recharacterized.

5) Any excess IRA contrib before 2015? answered no.

6) Any nondeductible IRA contrib?
Yes, I made and tracked nondeductible contributions to my IRA.

7) Total Basis as of December 31, 2014 Entered my IRA basis. call it X

8)Value of your Traditional IRAs on December 31, 2015 Entered the appropriate number X plus $6500.

9)Was the contribution a repayment of money previously taken out of a retirement plan? entered no.

10)Enter your total Roth IRA contributions for 2015, even if you transferred, or "recharacterized," some or all of it to a traditional IRA.
Entered zero.

11)Tell us if you switched, or "recharacterized," any of your zero Roth IRA contribution for 2015 over to a traditional IRA. Entered no.

12)Would you like us to track your Roth IRA basis? entered yes.

13)Withdraw from Your Roth IRA Before 2015? entered no.

14) Roth IRA Contributions prior to 2015,Note: Do not include earnings and losses or amounts converted from a traditional IRA.
This was a little confusing but I entered zero.

15)Select any of the following years that you converted a traditional IRA to a Roth IRA. I checked 2013 and 2014 since that is when I started doing the back door roth ira.

16)Report net conversions to your Roth IRAs that were taxable and nontaxable in 2013. Entered X in the box for 2013 nontaxable conversions.

17)2014 Nontaxable Conversions: reported $6500

18)Adjust Roth IRA Due to Divorce? answered no.

19)Tell us if you contributed more to a Roth IRA than was allowed in 2015 or any previous year. answered no. Is this correct?

20) It then says this: "Income Too High To Deduct an IRA Contribution
Your modified adjusted gross income (MAGI) is $573,776, which puts you over the limit for IRA deductions. To deduct a contribution, you can't have a MAGI of over $71,000 while being covered by a retirement plan at work."

21) The next page says this: Your IRA Deduction Summary
Based on what you've entered you don't qualify for an IRA deduction.
You will need to complete your return before we can show you the actual results.

Watch for your actual IRA deduction results later on after Deductions & Credits.

Your IRA Deduction $0


Do any of the BH gurus on this know where in this step by step process someone doing the back door ROTH using turbotax should have answered differently to get a different outcome? Thanks.
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Duckie
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Re: IRS questioning my backdoor roth?

Post by Duckie »

travellight wrote:Do any of the BH gurus on this know where in this step by step process someone doing the back door ROTH using turbotax should have answered differently to get a different outcome?
Yes. Mainly 1) and 8) below.
1) checked contribute to traditional ira only, did not check roth ira box.
You should have also checked the Roth IRA box. It would have eventually asked you about Roth IRA conversions.
8)Value of your Traditional IRAs on December 31, 2015 Entered the appropriate number X plus $6500.
Does this mean you didn't covert all of your TIRA assets in 2015? That makes the backdoor Roth method expensive because of the pro-rata rule. Done properly this should be $0.
14) Roth IRA Contributions prior to 2015,Note: Do not include earnings and losses or amounts converted from a traditional IRA.
This was a little confusing but I entered zero.
It's asking this question because you entered "Yes" on question 12. By entering zero you are not including anything before 2015. To make it easier for now just say "No" on question 12. You can always add that information later.
19)Tell us if you contributed more to a Roth IRA than was allowed in 2015 or any previous year. answered no. Is this correct?
Probably, if you didn't contribute more than allowed to any Roth IRAs before using the backdoor method.

All of this was done in the Deductions & Credits section. Don't forget you also have to fill out the 1099-R for the conversion in the Wages & Income section.
Last edited by Duckie on Sat Jul 30, 2016 3:40 pm, edited 1 time in total.
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Re: IRS questioning my backdoor roth?

Post by travellight »

Thanks duckIe!!! I will try it with the different answer question 1. I did prior conversions cleanly and they've been reported in my past tax returns correctly. I would have not invoked the pro rata rule.

I will report back. Thanks so much for the help.
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retiredjg
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Re: IRS questioning my backdoor roth?

Post by retiredjg »

travellight wrote:1) checked contribute to traditional ira only, did not check roth ira box.
The question asks if you own or contributed, so checking the Roth IRA box seems OK to me. I didn't run the full thing so I don't know if this makes a difference.
8)Value of your Traditional IRAs on December 31, 2015 Entered the appropriate number X plus $6500.
If you did the Roth conversion in 2015, this number should be zero. I think this may be where your mistake is.
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Re: IRS questioning my backdoor roth?

Post by cheesepep »

Although legal, I do not do backdoor roths or anything similar that would cause me potential tax liability issues. I absolutely despise paperwork of any kind and getting a letter from the IRS, no matter if right or wrong, would cause me to go bonkers. I keep things simple, even if I "miss out" on potential tax benefits.
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Re: IRS questioning my backdoor roth?

Post by LadyGeek »

^^^ Excellent point. This is no different than someone choosing to stick with a Target date retirement fund vs. creating your own Lazy portfolio.

Sure, you might save a few dollars. However, if you do this wrong (or don't have the emotional fortitude to stick with individual funds when the market goes crazy), you'll probably be worse off than staying with simplicity. Especially when it comes to taxes.
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travellight
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Re: IRS questioning my backdoor roth?

Post by travellight »

Thanks retiredjg and duckie .... I tried it as suggested with the inputs below, checking both boxes (tira and roth ira):

How much of the $6,500 you contributed to a traditional IRA for 2015 did you switch, or "recharacterize" (this does not include conversions or rollovers), to a Roth IRA?
Note: Do not include earnings such as interest or losses.
Amount Switched from a Traditional IRA Contribution To a Roth IRA Contribution: I put zero

Enter Your Roth IRA Contributions
Enter your total Roth IRA contributions for 2015, even if you transferred, or "recharacterized," some or all of it to a traditional IRA. I put zero.

Amount in my traditional ira at the end of 2015: I put zero.

It still leads to the same result.
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Duckie
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Re: IRS questioning my backdoor roth?

Post by Duckie »

travellight wrote:It still leads to the same result.
What are the results? When you look in Forms mode exactly what is on the lines of Form 8606?

Under Wages & Income >> Retirement Plans and Social Security >> IRA, 401(k), Pension Plan Withdrawals (1099-R), when you input the information from your 1099-R one of the continuing questions is "What Did You Do With The Money From This Payer?" You check "I moved the money to another retirement account..." and then check "I converted all of this money to a Roth IRA account."

It then asks about non-deductible contributions, your basis, and the value of your IRA. Once all that is filled in, in Forms mode you should see the conversion on Part II of Form 8606 which then flows to lines 15a and 15b on Form 1040.
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Re: IRS questioning my backdoor roth?

Post by travellight »

thanks Duckie....I couldn't find the forms mode and I had checked all those things appropriately as you had outlined. I think I solved it though.

I went to the 1099r again and rechecked everything. I changed one item which is again when they asked how much was in my traditional ira; I changed this to zero. Previously, I had put in the entire amount in my roth ira. Changing this to zero seems to have fixed it because my fed tax refund went up by about $281 which is the amount of taxes I would have owed if they didn't acknowledge the back door roth and I had to pay taxes on the maneuver. I'll see if i find or come across form 8606 later as I go through the process. Thanks!!!
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retiredjg
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Re: IRS questioning my backdoor roth?

Post by retiredjg »

travellight wrote:thanks Duckie....I couldn't find the forms mode...
If you are using the downloaded version, look in the upper left corner. If you see "easy step" then click on it and it switches to "forms". If you see "forms", then click on it to get to "easy step"
travellight
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Location: San Diego

Re: IRS questioning my backdoor roth?

Post by travellight »

Ah, that may be why, retiredjg..... I got the online version, not the downloaded one.
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travellight
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Location: San Diego

Re: IRS questioning my backdoor roth?

Post by travellight »

I want to state for anyone reading this later that I don't think my problems are due to doing the backdoor roth ira.... I have done the backdoor roth ira since 2013 and filed taxes for two years now with no issues from the IRS regarding the backdoor roth. My current problems are due to trying to learn how to use turbotax to do the backdoor roth. I had previously had professional tax preparation and form 8606 was submitted for every year for me.
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