Recharacterization + Backdoor Roth Tax Question

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Topic Author
takumi87
Posts: 7
Joined: Fri Sep 15, 2017 11:08 pm

Recharacterization + Backdoor Roth Tax Question

Post by takumi87 »

Hi all,

I got married in 2020 and our combined income put us over the Roth IRA income limit. I did a Backdoor Roth in 2020 so no issues there.

However, my wife did a direct contribution to her Roth IRA in 2020. We realized this in 2021 and have since recharacterized her contribution to a traditional IRA and then converted it to Roth afterwards, essentially making it a Backdoor Roth as well.

We spoke to Vanguard and asked them if they would provide updated tax forms to capture the recharacterization and conversion, but they said they wouldn't. This data would be captured for the 2021 tax year as that's when the recharacterization and conversion occurred.

One other thing to note is that her conversion did not exceed the $6,000 maximum even if gains are counted.

The question I have is how do I handle this on our taxes? Do I treat her contributions the same way as mine since they are both essentially Backdoor Roths at this point? Or do I report it the way that it says on the tax form that we received prior to these changes? Are there other things we need to consider such as gains?

Thanks!
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FiveK
Posts: 15742
Joined: Sun Mar 16, 2014 2:43 pm

Re: Recharacterization + Backdoor Roth Tax Question

Post by FiveK »

You each need to file Form 8606 for 2020.

Yours will include both the contribution and the conversion you did in 2020. Hers will only document the non-deductible contribution made in 2020.

See IRA recharacterization - Bogleheads and Backdoor Roth - Bogleheads.

After reading those, do you know how your forms 8606 should look?

Also, what is "the tax form that we received prior to these changes" and what is on it?
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Duckie
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Joined: Thu Mar 08, 2007 1:55 pm

Re: Recharacterization + Backdoor Roth Tax Question

Post by Duckie »

takumi87 wrote: Sat Apr 17, 2021 9:16 pm The question I have is how do I handle this on our taxes? Do I treat her contributions the same way as mine since they are both essentially Backdoor Roths at this point?
No. You made a non-deductible contribution and a conversion both in and for 2020. She made a non-deductible contribution after a recharacterization for 2020 but the conversion happened in 2021. She will file a 2020 Form 8606 reporting the non-deductible contribution and add a statement detailing the recharacterization. Take a look at the 2020 Form 8606 instructions starting on page 4:
  • "You made a contribution to a Roth IRA and later recharacterized part or all of it in a trustee-to-trustee transfer to a traditional IRA. Report the nondeductible traditional IRA portion of the recharacterized contribution, if any, on Form 8606, Part I. Don’t report the Roth IRA contribution (whether or not you recharacterized all or part of it) on Form 8606. Attach a statement to your return explaining the recharacterization. If the recharacterization occurred in 2020, include the amount transferred from the Roth IRA on Form 1040, 1040-SR, or 1040-NR, line 4a. If the recharacterization occurred in 2021, report the amount transferred only in the attached statement, and not on your 2020 or 2021 tax return."
Her 2020 Form 8606 should look like this:
  • 2020 Form 8606
    Part I
    Line 1 -- 6000 (2020 non-deductible contribution)
    Line 2 -- 0 (previous basis)
    Line 3 -- 6000
    Line 14 -- 6000 (current basis, goes on line 2 next year)
Her statement will say something like this:
  • "On DATE 2020 I (Ms takumi87) contributed $6000 to a Roth IRA. On DATE 2021 I recharacterized the entire $6000 contribution plus earnings (or minus losses) of $YY totaling $ZZ to a traditional IRA in a trustee-to-trustee transfer."
The conversion will be reported on her 2021 Form 8606.
Topic Author
takumi87
Posts: 7
Joined: Fri Sep 15, 2017 11:08 pm

Re: Recharacterization + Backdoor Roth Tax Question

Post by takumi87 »

Thanks for the info! This was very helpful. I think I understand it now. Mine is pretty straightforward and I've done this before so I'm not too worried about that.

For her, these are essentially treated as two separate events:
  • The direct Roth IRA contribution and recharacterization to a non-deductible Traditional IRA contribution counts for 2020
  • The Backdoor Roth conversion counts for 2021
After looking at this closer, it doesn't appear she received any tax forms for this event for 2020. I assume this is because it was simply a Roth IRA contribution that was already taxed. 

Based on her transaction history, here are the details (rounded for simplicity):
  • 3/11/20: $1,500 Roth Contribution
  • 3/17/20: $2,000 Roth Contribution
  • 3/22/21: $5,100 Recharacterization from Roth to non-deductible Traditional
  • 4/8/21: $5,300 Roth Conversion
Based on this, I believe this is what I need to do (please correct me if I'm wrong here):

Her 2020 Form 8606
Part I
Line 1 -- 3500 (2020 non-deductible contribution)
Line 2 -- 0 (previous basis)
Line 3 -- 3500
Line 14 -- 3500 (current basis, goes on line 2 next year)

Her statement will say something like this:

"Between March 11, 2020 and March 17,2020, Ms takumi87 contributed $3500 to a Roth IRA. On March 22, 2021 I recharacterized the entire $3500 contribution plus earnings of $1600 totaling $5100 to a traditional IRA in a trustee-to-trustee transfer."

This makes sense to me. The only question I have is regarding the current basis (line 14 on the 2020 8606) which gets carried over to line 2 on the 2021 8606. How should that look for next year's return? Should this get zeroed out somehow? Will this have any impact on her ability to perform Backdoor Roth for 2021?

Edit: One more question. In terms of taxes owed for the conversion, should it be 5300-3500=1800 or 5300-5100=200? I'm thinking the former. Is that correct? And because the conversion happened on 2021, this would be calculated on the 2021 return.
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Duckie
Posts: 9777
Joined: Thu Mar 08, 2007 1:55 pm

Re: Recharacterization + Backdoor Roth Tax Question

Post by Duckie »

takumi87 wrote: Tue Apr 20, 2021 3:52 pm Based on this, I believe this is what I need to do (please correct me if I'm wrong here):

Her 2020 Form 8606
Part I
Line 1 -- 3500 (2020 non-deductible contribution)
Line 2 -- 0 (previous basis)
Line 3 -- 3500
Line 14 -- 3500 (current basis, goes on line 2 next year)

Her statement will say something like this:

"Between March 11, 2020 and March 17, 2020, Ms takumi87 contributed $3500 to a Roth IRA. On March 22, 2021 I recharacterized the entire $3500 contribution plus earnings of $1600 totaling $5100 to a traditional IRA in a trustee-to-trustee transfer."
It looks right.
The only question I have is regarding the current basis (line 14 on the 2020 8606) which gets carried over to line 2 on the 2021 8606. How should that look for next year's return?
See below.
Should this get zeroed out somehow?
It does. It all gets converted so there is no trailing basis.
Will this have any impact on her ability to perform Backdoor Roth for 2021?
No.

Her 2021 Form 8606 will have $3500 on line 2. If she makes no contributions for 2021 but just reports her $5300 conversion, the form (using your numbers) will look something like this:
  • 2021 Form 8606
    Part I
    Line 1 -- 0
    Line 2 -- 3,500 (basis from line 14 last time)
    Line 3 -- 3,500
    Line 4 -- 0 or blank
    Line 5 -- 3,500
    Line 6 -- 0 (hopefully 0)
    Line 7 -- 0 or blank
    Line 8 -- 5,300 (amount converted in 2021)
    Line 9 -- 5,300
    Line 10 -- 0.66038 (the more numbers the better)
    Line 11 -- 3,500
    Line 12 -- 0 or blank
    Line 13 -- 3,500
    Line 14 -- 0 (current basis, goes on line 2 next time)
    Line 15a -- 0 or blank
    Line 15b -- 0 or blank
    Line 15c -- 0 or blank
    Part II
    Line 16 -- 5,300
    Line 17 -- 3,500
    Line 18 -- 1,800 (taxable amount)
If she makes a $6000 non-deductible contribution for 2021 and converts with minimal earnings the form will look something like this:
  • 2021 Form 8606
    Part I
    Line 1 -- 6,000 (2021 non-deductible contribution)
    Line 2 -- 3,500 (basis from line 14 last time)
    Line 3 -- 9,500
    Line 4 -- 0 or blank
    Line 5 -- 9,500
    Line 6 -- 0 (hopefully 0)
    Line 7 -- 0 or blank
    Line 8 -- 11,300 (amount converted in 2021--5300+6000)
    Line 9 -- 11,300
    Line 10 -- 0.8407 (the more numbers the better)
    Line 11 -- 9,500
    Line 12 -- 0 or blank
    Line 13 -- 9,500
    Line 14 -- 0 (current basis, goes on line 2 next time)
    Line 15a -- 0 or blank
    Line 15b -- 0 or blank
    Line 15c -- 0 or blank
    Part II
    Line 16 -- 11,300
    Line 17 -- 9,500
    Line 18 -- 1,800 (taxable amount)
In terms of taxes owed for the conversion, should it be 5300-3500=1800 or 5300-5100=200? I'm thinking the former. Is that correct?
You'll owe taxes on $1800 of the conversion.
And because the conversion happened on 2021, this would be calculated on the 2021 return.
Correct.
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celia
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Location: SoCal

Re: Recharacterization + Backdoor Roth Tax Question

Post by celia »

takumi87 wrote: Sat Apr 17, 2021 9:16 pm One other thing to note is that her conversion did not exceed the $6,000 maximum even if gains are counted.
What does this mean? There are no limits as to how much can be converted (other than the amounts you have in tax-deferred accounts). But there **IS** a limit on how much can be contributed.

Don't you realize she can still contribute $6,000 - 3,500 = $2,500 as a non-deductible contribution to the IRA and convert it tax-free? She can still do this for the 2020 tax year until May 17, but you can't file her taxes until after the contribution is made. This would be a pretty nifty way of stuffing more money in her Roth IRA where it can continue to growth tax-free! But you'll still have to pay taxes on the converted $1,800 growth that happened last year.
Topic Author
takumi87
Posts: 7
Joined: Fri Sep 15, 2017 11:08 pm

Re: Recharacterization + Backdoor Roth Tax Question

Post by takumi87 »

Duckie wrote: Tue Apr 20, 2021 9:00 pm
takumi87 wrote: Tue Apr 20, 2021 3:52 pm Based on this, I believe this is what I need to do (please correct me if I'm wrong here):

Her 2020 Form 8606
Part I
Line 1 -- 3500 (2020 non-deductible contribution)
Line 2 -- 0 (previous basis)
Line 3 -- 3500
Line 14 -- 3500 (current basis, goes on line 2 next year)

Her statement will say something like this:

"Between March 11, 2020 and March 17, 2020, Ms takumi87 contributed $3500 to a Roth IRA. On March 22, 2021 I recharacterized the entire $3500 contribution plus earnings of $1600 totaling $5100 to a traditional IRA in a trustee-to-trustee transfer."
It looks right.
The only question I have is regarding the current basis (line 14 on the 2020 8606) which gets carried over to line 2 on the 2021 8606. How should that look for next year's return?
See below.
Should this get zeroed out somehow?
It does. It all gets converted so there is no trailing basis.
Will this have any impact on her ability to perform Backdoor Roth for 2021?
No.

Her 2021 Form 8606 will have $3500 on line 2. If she makes no contributions for 2021 but just reports her $5300 conversion, the form (using your numbers) will look something like this:
  • 2021 Form 8606
    Part I
    Line 1 -- 0
    Line 2 -- 3,500 (basis from line 14 last time)
    Line 3 -- 3,500
    Line 4 -- 0 or blank
    Line 5 -- 3,500
    Line 6 -- 0 (hopefully 0)
    Line 7 -- 0 or blank
    Line 8 -- 5,300 (amount converted in 2021)
    Line 9 -- 5,300
    Line 10 -- 0.66038 (the more numbers the better)
    Line 11 -- 3,500
    Line 12 -- 0 or blank
    Line 13 -- 3,500
    Line 14 -- 0 (current basis, goes on line 2 next time)
    Line 15a -- 0 or blank
    Line 15b -- 0 or blank
    Line 15c -- 0 or blank
    Part II
    Line 16 -- 5,300
    Line 17 -- 3,500
    Line 18 -- 1,800 (taxable amount)
If she makes a $6000 non-deductible contribution for 2021 and converts with minimal earnings the form will look something like this:
  • 2021 Form 8606
    Part I
    Line 1 -- 6,000 (2021 non-deductible contribution)
    Line 2 -- 3,500 (basis from line 14 last time)
    Line 3 -- 9,500
    Line 4 -- 0 or blank
    Line 5 -- 9,500
    Line 6 -- 0 (hopefully 0)
    Line 7 -- 0 or blank
    Line 8 -- 11,300 (amount converted in 2021--5300+6000)
    Line 9 -- 11,300
    Line 10 -- 0.8407 (the more numbers the better)
    Line 11 -- 9,500
    Line 12 -- 0 or blank
    Line 13 -- 9,500
    Line 14 -- 0 (current basis, goes on line 2 next time)
    Line 15a -- 0 or blank
    Line 15b -- 0 or blank
    Line 15c -- 0 or blank
    Part II
    Line 16 -- 11,300
    Line 17 -- 9,500
    Line 18 -- 1,800 (taxable amount)
In terms of taxes owed for the conversion, should it be 5300-3500=1800 or 5300-5100=200? I'm thinking the former. Is that correct?
You'll owe taxes on $1800 of the conversion.
And because the conversion happened on 2021, this would be calculated on the 2021 return.
Correct.
Makes total sense now. I have read some of your other posts and they were also very insightful. Really appreciate your help, Duckie!
celia wrote: Tue Apr 20, 2021 10:04 pm
takumi87 wrote: Sat Apr 17, 2021 9:16 pm One other thing to note is that her conversion did not exceed the $6,000 maximum even if gains are counted.
What does this mean? There are no limits as to how much can be converted (other than the amounts you have in tax-deferred accounts). But there **IS** a limit on how much can be contributed.

Don't you realize she can still contribute $6,000 - 3,500 = $2,500 as a non-deductible contribution to the IRA and convert it tax-free? She can still do this for the 2020 tax year until May 17, but you can't file her taxes until after the contribution is made. This would be a pretty nifty way of stuffing more money in her Roth IRA where it can continue to growth tax-free! But you'll still have to pay taxes on the converted $1,800 growth that happened last year.
Understood. That makes sense. I didn't think this would of made a difference but just wanted to include it just in case.

Definitely will see if we can stuff some more money in there. Thank you!
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