Author Topic: Non-deducted Traditional to Roth IRA conversion?  (Read 1547 times)

bittheory

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Non-deducted Traditional to Roth IRA conversion?
« on: July 28, 2015, 10:53:07 PM »
So, I recently and FINALLY decided to max out my Roth IRA this and every year from now until retirement. Last week I rolled over my Roth balance from Fidelity to Vanguard, where I also noticed that I have around $14K in a traditional IRA just sitting there. Naturally, I want to convert that money to my Roth IRA, but held off when I thought about the tax hit. Then it dawned on me, I never took the deduction to my contributions to my Traditional IRA. Mostly because I was young and just wanted to get through my taxes as fast as possible and matched my employer's match and never thought about it until I started reading MMM.

So many question is simple: If I never deducted (I'm assuming I can confirm this on my tax returns), does that mean I don't have to pay anything if I convert to Roth? Or is that just never going to happen?

MDM

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Re: Non-deducted Traditional to Roth IRA conversion?
« Reply #1 on: July 28, 2015, 11:06:21 PM »
You may (if within the past ~3 years) be able to file amended returns (Form 1040X) and get the deduction for the previous years.  E.g., see http://finance.zacks.com/forgot-deduct-ira-contribution-4489.html and http://www.irs.gov/instructions/i8606/ch01.html#d0e712.

Do you know for sure that 100% Roth IRAs will be best for you, or might some traditional IRAs in the mix be worthwhile?

Cathy

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Re: Non-deducted Traditional to Roth IRA conversion?
« Reply #2 on: July 28, 2015, 11:14:15 PM »
...So many question is simple: If I never deducted (I'm assuming I can confirm this on my tax returns), does that mean I don't have to pay anything if I convert to Roth?...

Simply making contributions to an IRA does not by operation of law create a basis in the IRA. A little bit more is required. I will assume that you made no mention of the IRA contributions on your tax returns at all.

Pursuant to 26 USC 408(o)(2)(B)(ii), your limit of nondeductible contributions for the year is guaranteed to be at least as large as the amount of deductible contributions you made but did not take a deduction for. However, 26 USC 408(o)(2)(C) provides that a contribution is not a "designated nondeductible contribution" (which would create basis) unless the taxpayer designates the contribution as nondeductible in the manner as "may" be prescribed by the Secretary. The effect of this statute is that the failure to affirmatively "designate" your contributions as nondeductible means that they are not nondeductible; in fact, they were deductible contributions that you just declined to take a deduction for. They did not create basis in your IRA.

In order to create basis in your IRA, you need to amend every one of your past tax returns between the date of your first nondeductible contribution and the present in order to properly designate these contributions as nondeductible. See 26 USC 408(o)(4).

In other words, you are going to have to amend some returns regardless of whether you decide you want to take the deductions (as MDM suggests) or to create basis in your IRA (as your OP proposes). Taking the deductions may be less onerous because, for that, you only need to amend the returns in which a contribution was made; whereas for designating the contribution as nondeductible, you need to amend every return between the first contribution and the present, even years with no dealings with the IRA. However, the downside of taking the deductions is that receiving a refund is subject to a statute of limitations codified at 26 USC 6511. Marking a contribution as nondeductible may not be subject to a limitations period, but it does appear that you will be subject to a penalty of $50 for each year that you need to amend to achieve the designation: 26 USC 6693(b)(2). No similar penalty applies to taking the deduction (other than you may not be able to get a refund from it due to the limitations period). In any case, no penalty applies if the failure to designate the contributions correctly was "due to reasonable cause".
« Last Edit: July 29, 2015, 12:19:34 AM by Cathy »

bittheory

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Re: Non-deducted Traditional to Roth IRA conversion?
« Reply #3 on: July 29, 2015, 09:41:01 AM »
Thanks for the responses, everyone.

Sounds like it's probably not worth the effort, obviously, I should have deducted when I had the change. Granted, this was about 5-7 years ago, and like I said, I just kept things as simple as possible. Now I know better.

Do you think it's advantageous for me to keep that account as a traditional IRA and keep contributing to it, maybe $1k/year, with $4.5K going into my Roth? Here's my situation:

-32 years old.
-Married and in the 25% tax bracket filling jointly. 
-$28K in my Roth IRA.
-$14K in my traditional IRA.
-$10K in my employer SIMPLE IRA.