Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

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Topic Author
ljwobker
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Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by ljwobker »

I've done the mega-backdoor conversion in years past, then did a stint at a non-mega-corp that didn't allow after-tax contributions, and now am back where they're allowed again. In previous years I always got a single check as the distribution of only after-tax contributions, but this time around the 401k custodian has sent two separate (hypothetical) checks:
check #1, for $10000 - representing the after-tax contributions.
check #2, for $200 - representing the earnings on these contributions.

Can someone help me follow the taxation and reporting under the following two scenarios:

1) I deposit both checks into my Roth IRA
2) I deposit Check 1 into my Roth IRA and check 2 into my Traditional.

I know that in case #1 I have to pay taxes on the earnings at conversion, but in my specific case I don't currently have a Traditional IRA open, and I'm trying to figure out at what point the paperwork becomes worth the tax savings. So I suppose it's more accurate to say that I know how these two cases eventually get taxed, I'm more interested in how/where they get accounted at tax time.
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retiredjg
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by retiredjg »

If you are not doing the ordinary back door contributions to Roth, there is probably no reason not to just send the "earnings" check of $200 to tIRA. No tax will be due. When you withdraw from tIRA or convert it to Roth IRA at some later date, tax will be due then.

If you are doing ordinary back door contributions to Roth IRA, that (sending the earnings check to tIRA) will cause you a problem and you'd probably just rather send both checks to Roth IRA and pay the tax (a year from now if this is happening in 2017) on the $200.
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retiredjg
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by retiredjg »

The problem in this scenario is that $200 is not enough money to open an account at most places without using ETFs. If you don't want to use ETFs, just send it to Roth IRA and pay the tax.
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ljwobker
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by ljwobker »

It's more than $200 - i was using that as a hypothetical example... ;-)

I usually do the "ordinary" backdoor contribution each year, so I'm particularly interested in what you describe as "causing a problem" with the earnings moved into a tIRA. But, as long as each year I completely convert everything to the Roth IRA, does this matter? Asked another way, what happens if I do all of these things in the same tax year? I *think* this is how it works.... ;-)

1) contribute 5500 to tIRA
2) convert that 5500 to a Roth IRA.
3) deposit(rollover) the 200 of earnings from the 401k into a tIRA (this is reportable, but not taxable)
4) convert that 200 over to Roth (how is this reported/taxed?)

I believe that you can make multiple conversions tIRA->Roth in one year, and I believe there is no current limit to the amount you can convert. So in theory the steps above would leave me with no tax liability on this?
ved
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by ved »

If you are planning to convert the $200 from tIRA to a Roth anyway, why not go with the option 1 in your original post (deposit both checks into the RothIRA) ?
That way you keep the mega backdoor conversion activity separate from the regular backdoor contribution/conversion.
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retiredjg
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by retiredjg »

If you are going to convert the $200 to Roth, you might as well just send the $200 check to Roth in the first place and not do the second conversion.

To whom is the $200 check written?

Yes, if the $200 ends up in Roth IRA, there will be a tax liability for the $200.
Topic Author
ljwobker
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by ljwobker »

Thank you for asking about the checks - one is written specifically to "<Trustee> TR IRA" and the other is written to "<Trustee> ROTH IRA".

I guess in this case I don't have all that much choice anymore, do I?
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retiredjg
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by retiredjg »

I agree, it appears there is no choice at this point. You'll have to go ahead and deposit the TR check in a Traditional IRA and convert it in a second step. Next time you do this, you can ask for just one check. Be sure the one check is for the Roth IRA, not the TR IRA. :happy

If you are not already aware, you need to be making meticulous records on how all money is getting into Roth IRA. Direct contributions and rollover contributions and conversion contributions are handled differently when it comes to removing money from Roth IRA before you are age 59.5. So start a running tally and keep these records until your middle 60's.
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ljwobker
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by ljwobker »

Does anyone happen to know how these two distributions will be reported via 1099-R's? Specifically which codes are used for these? I ask only because I'm trying to "model" my taxes for 2016 in TurboTax, but it'll be at least 6 weeks before I have all the actual paperwork... and, I guess to be perfectly honest I'm just sort of interested in how all this stuff works. ;-)

Thanks, and yes I'm keeping good records. I found this post from Alan S to be very helpful along those lines:

viewtopic.php?t=69243#p1478231
Alan S.
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by Alan S. »

ljwobker wrote:Does anyone happen to know how these two distributions will be reported via 1099-R's? Specifically which codes are used for these? I ask only because I'm trying to "model" my taxes for 2016 in TurboTax, but it'll be at least 6 weeks before I have all the actual paperwork... and, I guess to be perfectly honest I'm just sort of interested in how all this stuff works. ;-)

Thanks, and yes I'm keeping good records. I found this post from Alan S to be very helpful along those lines:

viewtopic.php?t=69243#p1478231
In this situation, you may get a 1099R for each or a combined 1099R. Separate forms are better because they cause fewer reporting problems for the taxpayer. Box 7 codes will be G, and Box 2a should be 0. Box 5 should be 10,000 if you get a combined 1099R. Either way, using your example the 10,200 would be reported on line 16a of Form 1040, 0 on 16b with "rollover" entered next to 16b.

However, for purposes of entry into a tax program, others have reported issues when they get a combined 1099R and try to enter the numbers. Box 5 is likely the problem area. Hopefully, you will get a 1099R for the 10k and another for the 200, because if you enter them separately the chance for error is much reduced. Obviously, the end result should be that nothing is added to line 16b of your return. If you get something on 16b other than 0, there is an error somewhere in the process. If you get a combined 1099R but end up with a taxable amount, re enter these as if they were separate 1099R forms with 10,000 in Box 5 for the 10,000 distribution and nothing in box 5 for the other distribution.

Probably not the simple answer you were hoping for, but at least the tax return output is simple: 10,200 on 16b and 0 on 16b.
Topic Author
ljwobker
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by ljwobker »

Well, I was hoping for any answer that was clear, and I certainly got that. Thank you again ;-)

The next question, somewhat changed because the receiving firm *did* allow me to deposit both checks directly into my Roth IRA. So in this case, is it correct that I will either get:
a single 1099-R with:
  • the sum of the after-tax contributions and earnings in box 1
  • the taxable amount (my after-tax earnings) listed in box 2a
Or... a two separate 1099-R's where one has all the taxable and one has all the non-taxable? Maybe asked another way, does the *distributing* custodian know that the earnings are taxable no matter what because they were sent to a Roth IRA?

And yet another question: the receiving firm (Betterment in this case) lists these two transactions as:
  • a "Roth 401k Rollover" for the after-tax contributions (the large portion)
  • a "direct IRA transfer" for the earnings (the small portion)
Should I be at all concerned that these don't "sound" right to me? I don't have a Roth 401k account at all, and these funds did not come from a direct IRA transfer, either. (They both came from my corporate/Fidelity 401k). I know that for this year the only reported transactions are from the sending firm and so as long as their 1099-R's are correct it's OK there... but does it matter if the receiving firm doesn't exactly call things what I think they should be called? These terms do appear to correctly align with how things are taxed, but I like to be extra cautious with this stuff...
Alan S.
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by Alan S. »

You still might get either separate or a combined 1099R from the plan as that depends on plan processing preferences. Further, the plan thinks that the 200 was rolled into your TIRA. Bettermint should NOT have allowed you to deposit the 200 into your Roth IRA when the direct rollover check was made out to your TIRA. The problem here is that the 1099R form (or forms) you will get should show 0 in Box 2a based on how the plan issued the checks, but now the 200 should be taxable in 2a because that was pre tax money you deposited in the Roth.

At this point, wait until you receive the 1099Rs before doing anything, because there might be additional issues since plans are not used to reporting these direct Roth rollovers. But you will probably have to ask them to re issue the 1099R to show 200 in 2a if they report something different. Who knows, there could be offsetting errors under which they show the 200 in 2a anyway and then their error would offset your error! If you end up having to call them, try to get a commitment that they WILL correct the 1099R because you will not want to wait for them to respond. And you should not simply report the 200 taxable amount on your return, or the IRS might notice the discrepancy with the 1099R and send you a refund. There is a solution, but that can wait until you check out the 1099R forms and post back.

As for Bettermint erring in the source of the funds (no Roth 401), that does not matter because they would be reporting this rollover on Form 5498 as a rollover contribution in either case. The 5498 is not issued until late May, and should show a rollover contribution of 10,200 to the Roth IRA. The IRS matches the 5498 with your tax return where you also report the rollover on line 16. As for tax implications for Roth IRA withdrawals you may take later on, the tracking of the various components of your Roth IRA is your responsibility, not Bettermint's. All Bettermint would do is report any Roth distributions as non qualified or eventually as qualified and early (pre 59.5) or normal. You then complete Form 8606 to determine whether a distribution comes from regular contributions, conversions or earnings. For this particular rollover, it would be tracked as a conversion for 2016, with 200 as taxable (10% penalty if not held 5 years before distribution) and 10,000 non taxable.

In summary, there is a problem because Bettermint accepted a TIRA Direct rollover check into the Roth IRA, but no problem because they internally categorize the source as Roth 401k because the IRS will not see that. Now, if they do NOT report the 200 as part of the rollover money because "IRA transfers" are not reported, that could conceivably make for a mismatch at the IRS level. You have time to call Bettermint because the 5498 forms are not prepared until about 4/20.

Probably sorry you asked now......... :)
Topic Author
ljwobker
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by ljwobker »

OK, so the 1099-R is in. It's a single 1099R, with:
  • the combined (after-tax contribs + earnings) amount in box 1,
  • $0.00 in 2a as taxable and 2b unchecked
  • box 5 is the exact amount of the after-tax contributions.
  • "G" is the only distribution code in box 7.
Is the best path here to get in touch with Fidelity and explain where the contributions went, and ask them to re-issue the 1099? If so, I want them to issue it with the earnings amount in box 2a - are there any other changes necessary?
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ljwobker
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by ljwobker »

So i called Fidelity and asked them to correct/change the 1099R, but I'm getting some resistance from them. They seem to think that having zero as the "taxable" amount in acceptable, and that the reporting burden is on the receiving firm. This doesn't sound right to me, because the receiving firm has no way of knowing the tax status of those funds -- to the receiving firm it's all just rollover dollars. Right?
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tfb
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by tfb »

ljwobker wrote:So i called Fidelity and asked them to correct/change the 1099R, but I'm getting some resistance from them. They seem to think that having zero as the "taxable" amount in acceptable, and that the reporting burden is on the receiving firm. This doesn't sound right to me, because the receiving firm has no way of knowing the tax status of those funds -- to the receiving firm it's all just rollover dollars. Right?
I agree with Fidelity. You told Fidelity the taxable mount was going to a Traditional IRA. They issued a check as such. You and the receiving firm decided to put it into a Roth. Fidelity didn't know that. Only you and the receiving firm knew. Therefore it should be between you and the receiving firm.
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Topic Author
ljwobker
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Re: Mega-backdoor conversion : accounting/reporting details for contributions vs. earnings?

Post by ljwobker »

It's not that I *disagree* with Fidelity, I'm just trying to figure out how this gets accounted. If I put this into TurboTax as it's on the 1099, and then I say "I converted all this money to a Roth IRA", it computes the difference in what appears to be the correct fashion as taxable income -- I tested this by varying the amount in Box 5 and the taxable difference always added up. Is there any reason this isn't a valid way to report things? In this mechanism I'm paying the correct amount of tax, I'm just not certain it's accounted for properly.
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