IRS Official Says Back-Door Roth Transactions are OK
By Beverly DeVeny
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For years there has been concern by some planners that a back-door Roth conversion might be considered a step transaction by IRS. Most planners, however, did not feel that a back-door Roth fit all the criteria of a step-transaction.
In the conference report for the Tax Cuts and Jobs Act, Congress weighed in and said “Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA.” Since Congress writes the tax law and congressional intent is a big part of interpreting the law, it was now pretty clear that the back-door Roth is a viable planning strategy.
IRS has now officially stated that they are ok with the back-door Roth strategy. In a Tax Talk Today webcast, Donald Kieffer Jr., tax law specialist (employee plans rulings and agreements), IRS Tax-Exempt and Government Entities Division, said the back-door Roth is allowed under the law.
While it is now clear that you can use the back-door Roth strategy, things can still go wrong. Here is what you need to know.
You must be eligible to make an IRA contribution. That means you must have earned income and the contribution must be made before the year you turn 70 ½.
The conversion will be subject to the pro-rata rule. If you have any other IRAs with pre-tax funds, including SEP and SIMPLE IRAs, a portion of your conversion will be taxable.
Form 8606 will need to be filed with your tax return. It is used to report any after-tax contributions to your IRA, it does the pro-rata calculation and determines the tax on your distributions, and it reports the Roth conversion to IRS.
The funds in the Roth IRA are converted funds, not contributions. This will make a difference when early distributions are taken from a Roth IRA.
The one-rollover-per-year rule does not apply to Roth conversions. It only applies to IRA-to-IRA or Roth IRA-to-Roth IRA distributions.
If only Congress had seen fit to increase or remove the income limits for making Roth contributions instead of saying four times that it is ok to do a back-door Roth conversion, life would be so much simpler. But at least there is a little less worry now.