How do I make sure my IRA-to-Roth conversion is taxed correctly?

[Fru-Gal]

I converted a small amount last year, around 6.5k, to Roth. Where on the tax form will I see that it’s correctly taxed with no penalty for withdrawal? I’m using Free Tax USA, and did indicate that it was a direct conversion from IRA to Roth.

[secondcor521]

The conversion amount should show up on line 4b and flow from there into your taxable income on line 15.

If there were a 10% early withdrawal penalty, it would show up on Form 5329.  You should confirm that Form 5329 is missing from your tax return (unless you need to complete it for some other reason, which is unlikely).

If you're planning on doing a Roth conversion ladder and removing any converted amounts before age 59.5, you should also complete a Form 8606, with the conversion amount on line 8, 9, 16, and 18.

There are other complications that could arise that would make things different, but the above is the basics.

[Sandi_k]

You also need to fill out Form 8606.

[lhamo]

Pro tip:  KEEP COPIES OF THE 8606 forms in a single, easy to find folder for future reference!

I only learned this year, after many years of doing conversions, that Vanguard doesn't bother to keep track of your converted amounts.  Thankfully I still had copies of all my tax forms and was able to pull the 8606s out to confirm my contribution amounts (except for 2012, which has mysteriously gone missing).  In my case that would have potentially been a nearly 200k pot of contributions I would have potentially been taxed on if it turns out I need to tap them in the next 4 years.  I had a Roth 403b for several years so I have a LOT of contributions.

[Fru-Gal]

Thanks for the replies everyone. I find reading my tax statements from Vanguard and Fidelity totally confusing but I will keep trying.

[MDM]

Where on the tax form will I see that it’s correctly taxed with no penalty for withdrawal?

What was the box 7 code on the 1099-R?

You may not see a "this isn't penalized statement" but rather you'll not see anything that says "this is penalized".

[evanc]

Pro tip:  KEEP COPIES OF THE 8606 forms in a single, easy to find folder for future reference!

I only learned this year, after many years of doing conversions, that Vanguard doesn't bother to keep track of your converted amounts.  Thankfully I still had copies of all my tax forms and was able to pull the 8606s out to confirm my contribution amounts (except for 2012, which has mysteriously gone missing).  In my case that would have potentially been a nearly 200k pot of contributions I would have potentially been taxed on if it turns out I need to tap them in the next 4 years.  I had a Roth 403b for several years so I have a LOT of contributions.

Apologies if this is a stupid question, but why would you need tax records from 2012? The IRS has a 3 year statute of limitations to "disagree" with the tax returns you filed in past years, so I'm thinking there is no need to be able to prove conversion amounts that far back. What am I missing?

[MDM]

Apologies if this is a stupid question, but why would you need tax records from 2012? The IRS has a 3 year statute of limitations to "disagree" with the tax returns you filed in past years, so I'm thinking there is no need to be able to prove conversion amounts that far back. What am I missing?

If you withdraw from a Roth prior to reaching age 59.5, the taxability of that distribution will depend on how much you contributed (vs. earnings on those contributions) as outlined in Treatment of distributions.

[Reynold]

Apologies if this is a stupid question, but why would you need tax records from 2012? The IRS has a 3 year statute of limitations to "disagree" with the tax returns you filed in past years, so I'm thinking there is no need to be able to prove conversion amounts that far back. What am I missing?

Sort of like records for cost basis, if you buy a stock in 1980 for $100/share and sell it in 2024 for $120/share, you don't HAVE to have a record of your purchase price in 1980, the IRS would be happy to assume you bought it for $0 (the default IRS position without your records) and so the entire $120/share is taxable.  Or you can have records from 44 years ago showing you paid $100 for it so only $20/share is taxable, your choice. . .

[Fru-Gal]

If there were a 10% early withdrawal penalty, it would show up on Form 5329.  You should confirm that Form 5329 is missing from your tax return (unless you need to complete it for some other reason, which is unlikely).

If you're planning on doing a Roth conversion ladder and removing any converted amounts before age 59.5, you should also complete a Form 8606, with the conversion amount on line 8, 9, 16, and 18.

OK, there is no penalty (no form 5329).

However the auto-generated form 8606 does not show conversion amounts on those lines. It shows the entire amount as taxable.

Being that this is a conversion from an IRA started nearly 30 years ago where most of the gains are via compounding rather than contributions (there was a 10 year period with no contributions, for example), is it plausible that none of this amount would be taxable because it is all gains? If so how do I figure that basis out?

[secondcor521]

OK, there is no penalty (no form 5329).

Good.  There should be no penalty because there is no early withdrawal penalty associated with a Roth conversion.

However the auto-generated form 8606 does not show conversion amounts on those lines. It shows the entire amount as taxable.

The entire amount is taxable, generally, so that's correct.  But Roth conversion amounts can be withdrawn five tax years later without penalty, even before age 59.5.  That's why they should be documented on the 8606 (particularly lines 16 and 18).  It may be helpful for you later in certain circumstances.

Being that this is a conversion from an IRA started nearly 30 years ago where most of the gains are via compounding rather than contributions (there was a 10 year period with no contributions, for example), is it plausible that none of this amount would be taxable because it is all gains? If so how do I figure that basis out?

No.  Unless you made non-deductible contributions (which is uncommon and hopefully you would know if you had), all distributions from a traditional IRA are treated as ordinary income.  The age of the account, the contribution history, compounding, and gains are generally entirely irrelevant.

(In the uncommon case where you did make non-deductible contributions, you would/should have documented that on your tax return in Part I of Form 8606 and would track that contribution basis via the 8606 (and any related Form 5498s).  Then any Roth conversions would be taxed on a pro-rata basis based on the ratio of your remaining basis and the value of your account.  The ratio is calculated on line 10 of Form 8606.)

[Fru-Gal]

Awesome!! I was coming to that conclusion, remembering that all the IRA tax-deferred savings were eventually taxed, gains and all. Thanks for the quick reply!

[SeattleCPA]

Awesome!! I was coming to that conclusion, remembering that all the IRA tax-deferred savings were eventually taxed, gains and all. Thanks for the quick reply!

If you're converting tax-deferred IRA money to a Roth IRA, I would be very surprised that that works. Even getting a nondeductible IRA balances into a Roth IRA seems to me to be a low impact tax plan. Most people, i'll bet never save much or any tax with a backdoor Roth.

How I see the tax accounting work: https://evergreensmallbusiness.com/backdoor-roth-iras-and-401ks-really-a-smart-idea/