In practice, the process of making a backdoor Roth IRA contribution is straightforward, but the documentation and reporting at tax time may be confusing. Whether you work with a professional tax preparer, use tax software such as TurboTax or complete your taxes by hand, understanding the mechanics of the money movements can help ensure you file your taxes correctly.
Let’s say you make a contribution to your Traditional IRA. If your income is too high to qualify for a deduction for the IRA contribution, the contribution is considered non-deductible. Your advisor doesn’t let the custodian (such as Charles Schwab, Fidelity or TD Ameritrade) know whether the contribution is deductible – you report it at tax time on IRS form 8606, Nondeductible IRAs. You use the form to keep track of basis in your Traditional IRA, and basis in this sense means after-tax contributions, to make sure you don’t pay tax on those exact dollars twice.
After you make the non-deductible IRA contribution, it’s converted, i.e., transferred from your Traditional IRA to your Roth IRA account. From that point on, those dollars are now Roth IRA assets and aren’t subject to future tax on earnings. If the conversion is never made, you’ll have basis, i.e., after-tax contributions in your Traditional IRA that you’ll need IRS form 8606 to keep track of. This ensures you aren’t subject to income taxes on withdrawals of that basis in the future, such as in retirement.
Around tax-time, you’ll receive a 1099-R from your custodian showing the distribution from your Traditional IRA that was converted to your Roth IRA the previous year. After tax time, closer to May, you’ll receive an information reporting Form 5498 that shows the contribution you made to the Traditional IRA, and the amount that was converted to Roth IRA for purposes of reconciliation and recordkeeping.
Let’s walk through the reporting process for a backdoor Roth IRA.
In this example, a spouse under age 50 made a $5,500 non-deductible Traditional IRA contribution prior to year-end. To keep the example simple, the individual does not have any other Traditional IRA assets in their name, as that would make part of this conversion taxable.
This next section is where the conversion portion is reported. If line 18 is 0, as it is in this example, none of the conversion ends up being taxable.
We suggest that you consult with your tax advisor with additional questions.