Accidental- Partial Non Deductible IRA Contribution

[PatronWizard11]

We max out our accounts every year and 2022 was the first time this has happened. I didn't realize the MAGI limit for IRA's when both spouse have work retirement accounts.
SO we maxed out 401k, Simple IRA, HSA, 2 Traditional IRA's

I was prepping this years numbers and happened to look back at 2022 tax for something and noticed form 8606 and was like what is this. Why was 12k not deducted from out taxable income. Come to find out $1600 x2=$3200 was considered Non Deductible. So we did get a partial deduction at least.

My question is, what do I do with this $3200 basis. I didn't create a separate IRA for this so It's in the same IRA pot that I put in every year. Can I convert the 1600 to a Roth? I figured if someone had some knowledge I would appreciate the advice. I'm tempted to just leave it there and pretend it never happened and not make this mistake again.

[MDM]

My question is, what do I do with this $3200 basis. I didn't create a separate IRA for this so It's in the same IRA pot that I put in every year. Can I convert the 1600 to a Roth?

Backdoor Roth - Bogleheads will cover many (all?) of your questions.  After you read that, what questions remain/popped up?

Note Line 6 of Form 8606: it wouldn't have mattered if you each had created separate IRAs, because the IRS treats all of a person's non-Roth IRAs as "one large traditional" IRA when it comes to determining how much of an IRA withdrawal/conversion is taxable vs. non-taxable.

[PatronWizard11]

Thank you for that. I will Dive right in.

[PatronWizard11]

My question is, what do I do with this $3200 basis. I didn't create a separate IRA for this so It's in the same IRA pot that I put in every year. Can I convert the 1600 to a Roth?

Backdoor Roth - Bogleheads will cover many (all?) of your questions.  After you read that, what questions remain/popped up?

Note Line 6 of Form 8606: it wouldn't have mattered if you each had created separate IRAs, because the IRS treats all of a person's non-Roth IRAs as "one large traditional" IRA when it comes to determining how much of an IRA withdrawal/conversion is taxable vs. non-taxable.

I am not sure i understand the pro-rata rules. let's say my ira is 50k but that new non deductible basis is 1600. will i be creating a taxable event if I convert the 1600 to a Roth, bringing my basis back to zero?

[MDM]

I am not sure i understand the pro-rata rules. let's say my ira is 50k but that new non deductible basis is 1600. will i be creating a taxable event if I convert the 1600 to a Roth, bringing my basis back to zero?

If you fill out a draft 2023 Form 8606 (should be the same as the 2022 version, just add 1 to any year reference), does it look like the following (assuming the values on lines 1, 2, and 6 are or will be correct)?

Code: [Select]

1 Nondeduct. Contrib. 0
2 tIRA basis 1600
3 Add lines 1 and 2 1600
4 Contributed next year 0
5 Line 3 minus Line 4 1600
6 EOY tIRA balance 50000
7 non-conversion tIRA distrib. 0
8 t->R conversion 1600
9 Add lines 6, 7, and 8 51600
10 Divide line 5 by line 9 0.0310
11 Line 8 * line 10 50
12 Line 7 * line 10 0
13 Add lines 11 and 12 50
14 Subtract line 13 from line 3 1550
15 Taxable amount 0
16 t->R conversion 1600
17 Basis in t->R conversion 50
18 Taxable amount 1550


[reeshau]

My question is, what do I do with this $3200 basis. I didn't create a separate IRA for this so It's in the same IRA pot that I put in every year. Can I convert the 1600 to a Roth?

Backdoor Roth - Bogleheads will cover many (all?) of your questions.  After you read that, what questions remain/popped up?

Note Line 6 of Form 8606: it wouldn't have mattered if you each had created separate IRAs, because the IRS treats all of a person's non-Roth IRAs as "one large traditional" IRA when it comes to determining how much of an IRA withdrawal/conversion is taxable vs. non-taxable.

I am not sure i understand the pro-rata rules. let's say my ira is 50k but that new non deductible basis is 1600. will i be creating a taxable event if I convert the 1600 to a Roth, bringing my basis back to zero?

Pro-rata means you don't get to pick and choose the pot; it's proportionately applied.  So, $1,600 converted to Roth is ((1600 / 50000) * 1600) = $51.20 post-tax, and $1,548.80 taxable.  This leaves you with $1,548.80 in non-deductible contributions left.

Yes, yuck.  And, just like the guy who always steps 1/2 of the distance never gets to the other side, that stub will always be there, unfortunately.  Be sure to keep track of it, so you at least get credit when it's due.

There is a small window of opportunity for 401k's in the same situation.  If you roll over a whole deductible 401k with nondeductible contributions to an IRA, you get the opportunity to split those contributions to a Roth IRA, thus avoiding the mess.

[PatronWizard11]

Could I just forget this ever happened and not do the conversion? Am I missing any type of penalty here by not doing anything? Since it's such a small amount of money. Or is this something I should take care of sooner rather than later?

I plan to not make any more non deductible contributions in the future.

Is turbo Tax going to continue to do form 8606 and have the same amount every year $3200 if I do nothing?

[MDM]

You are under no obligation to convert, and if you prefer traditional to Roth for now, there is no compelling reason why you should.

Don't forget about the $1600 * 2, because when you do withdraw/convert from those IRAs you won't owe any tax on that amount (unless you do forget...).

If you neither make a non-deductible contribution nor remove any money from any IRA in a given year, Form 8606 is not required for that year.  As noted under Total Basis Chart, you go back to the "last Form 8606 you filed" (TY2022 for you) when you do take money out of a traditional IRA.

[PatronWizard11]

You are under no obligation to convert, and if you prefer traditional to Roth for now, there is no compelling reason why you should.

Don't forget about the $1600 * 2, because when you do withdraw/convert from those IRAs you won't owe any tax on that amount (unless you do forget...).

If you neither make a non-deductible contribution nor remove any money from any IRA in a given year, Form 8606 is not required for that year.  As noted under Total Basis Chart, you go back to the "last Form 8606 you filed" (TY2022 for you) when you do take money out of a traditional IRA.

This will be the route I take. It seems simple enough to keep a record of my 2022 tax and form 8606 and deal with small basis when I start Roth ladders down the road. Thanks for your assistance. I have to admit, all this non deductible contribution information is very foreign to me because I never planned to do it, so reading all this information on the fly/crash course is a little bit confusing. But knowing I can just leave it alone for now is good news to me.

[secondcor521]

You can also forget about the $3200 in basis and not bother completing form 8606 when you make withdrawals or conversions.  This will result in you paying somewhat more in taxes, but will save you a lot of paperwork and math.  The IRS won't care if you overpay your taxes in this manner.

Many people say that Turbotax will carry forward the information from year to year and complete the 8606 for you - assuming you answer all of it's questions correctly, which depends on how well they write the questions and how carefully you read and answer them.  The rules for IRAs and IRA terminology are complex so this can work but can also be problematic.

For people in a similar situation who realize it soon enough, other options include recharacterizing the non-deductible portion to a Roth (assuming Roth eligibility in that tax year), or withdrawing the non-deductible contribution plus earnings.  The deadline for these two options is the tax filing deadline (plus extensions I think), so for OP it sounds like these options have been foreclosed by the deadline.