How to Report a Backdoor Roth Conversion
The Backdoor Roth strategy is a great way to get more savings into Roth IRAs if you are high-income and you’ve maxed out your other retirement options. If you have performed a Backdoor Roth or are considering performing one, it is important to understand the proper way to report the transaction, as it requires additional steps to ensure your money is not taxed twice and the IRS is satisfied.
The Backdoor Roth Conversion Steps
Contribute to a Traditional IRA
Convert the Traditional IRA to a Roth IRA
Report the transaction on your tax return
What Documents You'll Receive
While performing the Backdoor Roth Conversion, you will receive three tax documents from your financial custodians:
Two Form 5498’s: IRA Contribution Information
One Form 1099-R: Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
Step 1 generates a Form 5498 for the initial contribution to the Traditional IRA. Most likely, you will receive this form in May of the year following the year of the contribution. For example, if you contributed to a Traditional IRA for the tax year 2022 (January 1, 2022 to April 14, 2023), you would receive the Form 5498 in May of 2023.
Step 2 generates a Form 1099-R from the Traditional IRA to document the conversion leaving the Traditional IRA. The 1099-R is usually received by January 31st. It will also generate a Form 5498 when the conversion enters the Roth IRA.
Tax Form Guide
In order of when you’ll see them
Form 1099-R
Form 1099-R reports the distribution from the Traditional IRA. This form might cause you to double-take when you receive it. But don’t be too alarmed, it is normal, and I’ll walk through how the form will look below.
Box 1: Gross Distribution shows the total amount distributed from the Traditional IRA.
Box 2a: Taxable Amount will likely show the same as Box 1. Although the name would suggest that you need to record this as taxable income, the custodian does not actually know if it is taxable or not, so they pair Box 2a with Box 2b.
Box 2b has a check box for “Taxable amount not determined” and “Total distribution”. “Taxable amount not determined” is basically a way for the custodian to say they don’t know if it is actually taxable or not to you. That is because they don’t know your full tax situation, like what your Modified Adjusted Gross Income is, which determines many tax calculations. If “Total Distribution” is checked, it means you successfully converted the full account balance.
Box 7: Distribution Codes will be one of two numbers depending on your age. If you are under the age of 59 ½, it will be code “2”. If you are over the age of 59 ½, it will be code “7”. Box 7 also indicates if this account was an “IRA/SEP/SIMPLE” account.
Form 8606
The custodians you invest with who issue Forms 1099-R and 5498 are not responsible for reporting the taxation of the transaction you are completing. To explain the transaction to the IRS and calculate the taxation of the conversion, you need to utilize Form 8606 when you file your taxes.
Latest Version: About Form 8606, Nondeductible IRAs | Internal Revenue Service (irs.gov)
You must complete Form 8606 for each person on the tax return performing the Backdoor Roth Conversion. If you are performing the strategy for yourself and a spouse, you will file two Form 8606, not just one.
The form is broken into two parts:
- Part I of Form 8606 reports the contribution you made as non-deductible and what amount of the conversion is taxable upon leaving out the Traditional IRA.
- Part II of Form 8606 reports on the conversion upon entering the Roth IRA.
When you don’t perform the conversion in the same tax year (perhaps you contributed for a few years before converting), Form 8606 becomes a little more complicated. You will need to ensure that you have entered everything properly on the form. If the contribution and conversion are all completed within the same year, Form 8606 will look something like this:
Form 8606 - Part I
Form 8606 - Part II
Form 5498
The two Form 5498s you will receive are simply received too late to be useful in filing your taxes. However, they do provide confirmation of the transaction and document the whole procedure. You will have one Form 5498 showing a Traditional IRA contribution (Box 1) and a second showing the Roth IRA Conversion (Box 3). You will want to ensure you keep these in your tax records for the appropriate amount of time.
Form 1040 - The Tax Return
Finally, what shows up on your 1040 tax return is the final check that everything was entered correctly. What you will see are two entries: 1) showing total IRA distributions in Box 4a (2022 1040 version), and 2) an amount hopefully close to zero in Box 4b showing the taxable amount.
It is possible, and probable, that you will have a small amount of the conversion that is taxable as the contribution will at least earn a little bit of interest while in the Traditional IRA. If it was invested in the Traditional IRA for longer, the gains could be higher.
If you did not have gains on your contribution upon conversion, your 1040 would look something like this:
If you did have gains on your contribution upon conversion, your 1040 would look something like this which assumes a $400 gain on a $6,000 contribution:
And that's it! Those are the most important items to consider as you execute the strategy. Of course, a qualified tax accountant will be able to help you with these steps as well upon filing your taxes. If you file your own taxes, you will want to be extra cautious. See the tip below on how to add a double check to your entry!
Additional Considerations
Not filing Form 8606 means you have not told the IRS why the distribution from the Traditional IRA was not taxable. It could also mean you may have paid taxes on the distribution from the Traditional IRA, which means you will pay taxes on that money twice and maybe even the 10% penalty. Not good!
You can file a late Form 8606 with a $50 filing fee to correct the issue. The form does not need to accompany a tax return and can be sent to the normal tax return filing location for your location. Assuming the conversion wasn’t taxed on your original return, there would be no further consequences. If the conversion was taxed on the original return, there is a 3-Year limitation on refunds.
https://www.irs.gov/instructions/i8606
A conversion moves money from a Traditional IRA to a Roth IRA. A Recharacterization can also move money from a Traditional IRA to a Roth IRA. So what’s the difference? Recharacterization is basically an “undo” button to a contribution and allows the IRA owner to put the contribution into a different account as if it had originally been contributed there all along. The Backdoor Roth strategy is not a recharacterization.
Tax software may ask about Recharacterizations. A recharacterization is when you switch your contribution from traditional to Roth or from Roth to traditional. If you did a Backdoor Roth, the answer to this is “No”. You converted your money not recharacterized it.
One of the biggest rules to understand in performing a Roth Conversion is the Aggregation Rule. Simply put, the aggregation rule looks at all of your IRA accounts (Traditional IRA, SEP IRA, SIMPLE IRA) as a single account for determining how your distributions are characterized between pre-tax and non-deductible. This rule must be considered before engaging in the strategy.
An easy way to ensure everything has been entered correctly is to wait until you have completed your entire tax return to enter the Backdoor Roth. The reason for this is that most software programs will show you your estimated tax refund or bill. If you note what that amount is before you enter the strategy, you can see if it changed after you finish entering the Backdoor Roth. If you have a small amount of gains, your taxes will go up slightly. However, you should not see a large increase.
Disclaimer: Any information on this page does not represent specific tax advice and is meant to be informational only.