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DIY Products

Whether you’re an experienced do-it-yourselfer or doing your own taxes for the first time, this is your place to learn and share. Here you’ll find information and resources for using H&R Block’s online and software DIY solutions. You’ll also find links to more information to assist you on your DIY journey.

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Council Member
Posts: 514
Registered: ‎04-06-2016

Re: Backdoor Roth Conversion


@Craqshot wrote:

Well thanks for trying to help.  I followed tried to follow the instructions here, but still wasn't successful.

 

  1. Enter the 1099R (taxes owed goes up)
  2. Enter a traditional IRA contribution (no change)
  3. Enter an IRA conversion (no change)

 

The problem here is that once I enter the 1099R I am not able to get the amount of taxes owed to come back down no matter how I play around with the IRA contributions and conversions.  This seems broken because when I enter the 1099R, the application straight up asks if I converted the distribution to a Roth IRA.  So, it knows that I've converted and it still does nothing make the distribution non-taxable.  It's probably possible to get it right, but it's not straightforward and the app isn't doing much to make the process easy especially considering that they know the intent.  Hopefully H&R Block can dedicate some design time to make this process more straightforward next year.


It seems to me that you don't really understand how IRA contributions, distributions, and conversions work.


A "Back-door Roth conversion" is really no more than a Trad-IRA contribution followed by a Roth conversion of the money from the Trad-IRA. It's two separate transactions and each is handled separately. 

 

First you'd make your Trad-IRA contribution-- this would either be deductible or non-deductible.

-  If it's non-deductible, the contribution will be taxed the year you make it, and the non-deductible amount will be added to your basis (the amount you won't have to pay taxes on when you withdraw it). 

- If it's deductible, you don't pay taxes on it, but will have to pay taxes on it and it's earnings when you withdraw it-- when you take a distribution.

- Because Trad-IRAs can contain a mix of deductible and non-deductible contributions, keeping track of your IRA basis is important since that will help you figure the amount of any distribution that will be considered taxable the year you withdraw it. (If you don't track your basis, and haven't kept good records that will let you accurately calculate it, you'll have to assume that your basis is 0.)  If a quarter of the total value of all of your IRAs were from non-deductible contributions then your basis is 25% of your IRA.  If you take a distribution then 25% will not be taxed, but 75% will be. 

- SO, when you make your $5500 non-deductible contribution to your IRA for 2017, the amount you contribute will be added to your TOTAL Trad-IRA basis. The basis Is NOT specific to the Trad-IRA account you made the non-deductible contribution to.

   -- In case 1, let's assume this is the first year you've made a non-deductible Trad-IRA contribution, your basis would now be $5500. Let's say that you had another Trad-IRA or a Rollover-IRA that had only deductible contributions in it that was worth $94,500. The TOTAL value of all of your Trad-IRAs would be $100,000.  5.5% (5,500/100,000) of the value of your Trad-IRAs would be considered your basis (or money you've already been taxed on).

   -- In case 2, let's also assume this is the first year you've made a non-deductible Trad-IRA contribution, so your basis would be $5500.  Let's say that this is the first contribution you've made and you haven't rolled over any 401k plans or other retirement plans into a Trad-IRA.  The TOTAL value of all of your Trad-IRAs would be $5500. If you immediately converted the funds (so that the value of the IRA was still $5500, 100% (5500/5500) of the a value of your Trad-IRAs would be considered your basis.

   -- In case 3, let's make the same assumptions as case 2, but in this case let's assume that it's been 6 months since you made the contribution and your investments did well and the account is now worth $8250. Your basis will be 66.6% (5500/8250) of the Total value of your Trad-IRAs.

 

Next we'll look at the conversion side. 

-- A conversion is basically a "special" distribution from a Trad-IRA and a conversion to a Roth-IRA.  (While the money is going into the Roth-IRA it's not considered a "contribution" since it's coming from another IRA.) It's a "special" distribution in that it's not subject to any early withdrawal penalties that it might be subject to if the funds weren't being converted to the Roth-IRA.

-- A back-door conversion is just a conversion that is done shortly after you make a Trad-IRA contribution to get around the fact that you weren't eligible to make a Roth contribution to start with.  It's not necessarily a conversion of the non-deductible money you just put into your Trad-iRA.  Will the conversion be taxable?  You'll want to say NO because you're thinking that you were just taxed on the money you contributed to the Trad-IRA.  You may or may not be correct. It all depends on your Trad-IRA basis.

-- While you can specify which Trad-IRA account you want to convert the money from, remember that basis isn't tracked with any specific IRA; your IRA basis is your basis for the TOTAL of all of your IRAs. 

-- Conversions are taxed in the year they are made. 

-- When calculating the taxable amount of your conversion, you need to figure out what percent of your TOTAL IRA value your basis is. (This follows from-- you can't specify which funds you want to convert.) 

-- Let's go back to our three cases above to see how a $5500 conversion will be treated in each case.

   -- In case 1, our basis is 5.5% of the total value of all of our IRAs. That means that 94.5% (100%-5.5%) of our conversion will be taxable.  So of the $5500 that we were just taxed on and then converted, 94.5% will be taxable at the time of the conversion. $5500*94.5% = $5197.50 will be the taxable amount. This is because 94.5% of your conversion will come from the taxable amount of your IRAs and 5.5% will come from your basis (the amount you've already paid taxes on).  Since you just used 5.5% of your basis, your new basis will end up being 94.5% of it's starting amount ($5197.50).   Of the $94,500 left in your Trad-iRA, you have $5197.50 basis. Still leaving your basis at 5.5% of the amount of your IRA.  This % will vary as your Trad-IRA investments gain or lose value, but at the time of the calculation/conversion it will be correct.

     If you made your Trad-IRA contribution in 2017 and did the conversion also in 2017, in 2017 you'll be taxed on $10697.50 = $5500 (original non-deductible contribution) + $5197.50 (conversion). If you did the conversion in 2018, the $5500 non-deductible Trad-IRA contribution will be taxed in 2017 and the $5197.50 taxable part of the conversion will be taxed in 2018.  This may seem wrong, but remember that now you have $5500 in the Roth, and you still have $5197.50 of basis in your Trad-IRA, so everything you've paid taxes on still has preferential tax treatment.

  -- In case 2, our basis is 100% of the total value of our IRAs. When we convert the $5500, all of it will come from our basis-- having already been taxed. So, NONE of the conversion will be taxable.  This is the case where the answer to "Will my conversion be taxable?" is actually No. Since you're removing all of the value of the Trad-IRA, there will be no basis left.

  -- In case 3, our basis is 66.6%. That means that 33.4% (100%-66.5%) of our conversion will be taxable.  So of the $5500 that we were just taxed on and then converted, 33.4% will be taxable at the time of the conversion. $5500*33.4% = $1833 will be the taxable amount. This is because 33.4% of your conversion will come from the taxable amount of your IRAs and 66.6% will come from your basis (the amount you've already paid taxes on).  Since you just used 66.6% of your basis, your new basis will end up being 33.4% of it's starting amount ($1833).   Of the $2750 ($8250-$5500) left in your Trad-iRA, you have $1833 basis. Still leaving your basis at 66.6% of the amount of your IRA. 

     Like case 1, you'll be taxed on part of your conversion in addition to the amount you contributed to your Trad-IRA. But, the full amount of your taxed amounts will be sitting in a tax-advantaged position in either your Roth or Trad-IRA.

 

So in your scenario:

  1. Enter the 1099R (taxes owed goes up) <-- This would likely be the distribution from your Trad-IRA that was converted to Roth. If your custodian reported a taxable amount, your taxes would go up.
  2. Enter a traditional IRA contribution (no change) <-- It seems like this should have increased your tax liability if it was a non-deducitble contribution.
  3. Enter an IRA conversion (no change) <-- This is not unexpected because the taxable amount of the conversion would have been accounted for in the 1099-R reporting the distribution of the funds from the Trad-IRA.

 

So, in summary, many people mistakenly think that a Back-Door Roth conversion will somehow reduce the amount they're taxed on. It won't. If anything it will increase the amount they're taxed on. While this can be painful when it's done, it does result in money sitting in a Roth IRA earning money tax-free.

Karen

Council Member
Posts: 514
Registered: ‎04-06-2016

Re: Backdoor Roth Conversion


@jmabryh wrote:

Karen, you answers were helpful. However, I also am stuck. I'm funding a traditional IRA without taking the deduction. The interview only asks me if I have recharacterized the IRA to a ROTH. It does not ask me if I have converted the IRA to a ROTH. It wants to add the penalty if I say yes. What do I do to avoid the penalty?


The tax software is handling this correctly.  I just posted a long response in this thread to try to help people understand what's really going on with a "back-door" roth conversion. I didn't address your specific issue though.  

A recharacterization and a conversion are NOT the same thing. A recharacterization is like saying "forget I originally made that contribution as a Trad-IRA, treat it as if it was made to a Roth-IRA from the start" or vice versa. If you're making a traditional IRA contribution because you weren't eligible to make a Roth contribution, and you tell the program you recharacterized your Trad-IRA contribution.  You're basically telling it to treat your contribution as a Roth. AND since you weren't eligible, it's going to calculate the penalty for contributing to a Roth when you're not allowed. Since this is NOT what you're doing, don't say Yes.

You'll report conversions in the year you make them (regardless of whether or not you're using the "back door" strategy). So if you converted the amounts in 2018, you won't do anything about it until your file your 2018 tax return in spring 2019. If you converted the funds in 2017, you should have received a 2017 1099-R. You'll report the conversion when you report the 1099-R you received from the distribution of the funds from your Trad-IRA. This 1099-R will likely have a code 2 in box 7, "Early distribution, exception applies (under age 59 1/2)", since conversions are treated as a distribution that is exempted from the early distribution penalty because the money is going into the Roth account. Any taxable amount of the distribution will have to be reported, and taxes will need to be paid, on your return.

 

If the IRA custodian has calculated your taxable amount it'll be in Box 2a and the box labeled "Taxable Amount Not Determined" in Box 2b will NOT be checked.  It's possible that the TAND box in Box 2b will be checked and the amount in Box 2a will be the same as the amount in Box 1.  This means that they didn't determine your taxable amount, but they're assuming you have no basis.  If this box in 2b is checked you should be given the opportunity to enter your basis later in the interview.  Code 2 in Box 7 will basically tell the H&R Block program that the distribution was a conversion, and you're likely to be asked the conversion questions in this interview section. 

 

Karen

Council Member
Posts: 514
Registered: ‎04-06-2016

Re: Backdoor Roth Conversion


@fixitb wrote:

My solution was to click "No" for the question "Is the IRA / SEP / Simple" box checked. Then it worked right.



This is NOT the right thing to do.

Karen

Highlighted
Valued Pioneer
Posts: 7
Registered: ‎04-11-2018

Re: Backdoor Roth Conversion

The term "backdoor" can be confusing.  It's a Roth Conversion independent of the motivation for it.

 

The distribution from the Traditional IRA is a taxable event.  On form 1040, the amount is specified on line 15a, less any basis on 15b, aggregating with various other incomes to total income on line 22. 

 

There is no Roth contribution, as contributions come from wages.  It's a conversion, with a "from" and a "to."  Dollars are just moving from one IRA container (Traditional) to another IRA container (Roth).  They are IRA dollars and that doesn't change.

 

The form 1099-R from the financial institution that handled the conversion should be correct.  This is the business they're in, so they should be "professionally correct."  The form goes to both you and the IRS, so it's suggested that the 1099-R information be portrayed to the software exactly as the boxes display. 

 

The program has worked fine in my experience.  Over the past two years I converted a Traditional IRA to a Roth IRA in two "chunks" -- half two years ago and the other half last year -- to minimize the effect of being advanced into the next tax bracket.

 

I found it useful to completely understand what a conversion is -- how it's defined and how the process works.  That was helpful when using the software.  The interview screen flow made sense and the results were as expected.

 

Hope this helps as an overview to Karen's comments above.  Smiley Happy