Back-Door Roth IRAs
The Ever-Changing World of Taxes
In our October 17, 2017 post, we cautioned taxpayers who used the back door Roth (converting a traditional IRA to a Roth IRA) that the IRS could challenge the use of this strategy claiming that it violated the step transaction doctrine. For those taxpayers who are not familiar as to why a taxpayer would attempt to convert a traditional IRA to a Roth IRA using the back-door strategy, please read our October 17, 2017 post.
The good news is that the 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. The IRS position is based on 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.
However, while the back-door strategy is a viable planning strategy, taxpayers still need to understand the tax law to avoid unexpected tax consequences. Some of the tax pitfalls include:
- 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.
- IRS 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. Thus if an early distribution is made before reaching age 59 ½, early withdrawal penalties may apply.
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 you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.