It’s tax filing time. I’ve been fielding a lot of questions on my two popular articles about the backdoor Roth (if you are not familiar with it please read these first):
On theme quickly emerged. All those who are confused were contributing to the traditional IRA for the previous year and then converting it to Roth. They made it too hard for themselves.
For example they contributed $5,000 to traditional IRA for 2012 in 2013 and then converted it to Roth in 2013. They are planning to contribute $5,500 for 2013, again in 2014 before April 15, before converting it to Roth. Although it’s OK to do so, it just gets very confusing at tax time when they do it this way.
The tax law requires that you report your traditional IRA contribution *for* that year and your converting to Roth *in* that year.
In the example above, the $5,000 contribution made *for* 2012 in 2013 goes on the 2012 tax return. It has to carry over $5,000 tax basis to the 2013 return. Its conversion to Roth *in* 2013 goes on the 2013 tax return. The $5,500 contribution *for* 2013 to be made in 2014 again goes on the 2013 tax return but the conversion *in* 2014 must wait for the 2014 tax return.
The 2013 tax return ends up having a $5,000 basis carried over from the previous year, a $5,000 conversion, a $5,500 contribution (to be made in 2014), and a $5,500 basis carried forward to the next year. The Form 8606 ends up looking like this (I’m assuming there was $20 in earnings by the time it was converted; click on it to see page 2):
That can be very confusing.
The easy way to do it is to contribute for the current year rather than waiting until the following year. Contribute for 2013 in 2013 and convert in 2013. Contribute for 2014 in 2014 and convert in 2014. This way will be clean and neat. Both the contribution and the conversion go on the same tax return. You don’t carry over anything from one year to the next or wait until the following year to finish it off.
Imagine if you contributed $5,000 for 2012 in 2012 and then converted it in 2012. You have $5,000 contribution and $5,000 conversion, both on the same 2012 tax return, all done. The same for 2013 tax return: if you contributed $5,500 for 2013 in 2013 and then converted it in 2013, your 2013 tax return would have both on it, with nothing carried over from 2012 and nothing to carry forward to 2014. Next year, repeat.
The Form 8606 when you are doing it the easy way looks like this:
That’s very clean (I used the same assumption for $20 in earnings by the time it was converted; click on the image to see page 2).
If you are doing backdoor Roth, please do yourself a big favor and do it the easy way. Contribute for the current year and convert it in the same year. Contribute for 2014 in 2014 and convert in 2014. Don’t wait until the following year. Otherwise you just confuse yourself at tax time.
If you must get caught up for one year, that’s fine. Contribute for 2013 in 2014, before April 15, but also contribute for 2014 in 2014, and convert both in 2014. This way you will have a clean slate come 2015, which lets you do it the easy way in 2015.
[Photo credit: Flickr user lilivanili]