Illinois State Tax Loophole? What am I missing?

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IowaFarmBoy
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Re: Illinois State Tax Loophole? What am I missing?

Post by IowaFarmBoy »

I've been doing this for several years and it is quite simple. I think you pretty much have it figured out.

I make a contribution to a traditional IRA and just put the money in a money market sweep account. As soon as it shows up, I initiate the conversion on the Vanguard website. I think your description of how to do it is right but I don't remember exactly what I need to do. After it is in the Roth, I allocate it to the fund(s) that I want for the long term.

I also use H&R Block and between retrieving the 1099s from Vanguard and the software, I really haven't had to think about it much. For your Federal return, you get to take a deduction for the IRA but then have to add back the income for the conversion. So it ends up being a wash for your taxable income on your Federal return. I don't remember exactly what happens when you do your state return- I think maybe you are pulling your Federal adjusted gross and then you get to exclude retirement income (like the conversion).

All in all, it couldn't be much simpler for a nice benefit.
Topic Author
redbird24
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Re: Illinois State Tax Loophole? What am I missing?

Post by redbird24 »

IowaFarmBoy wrote: Sat Jun 29, 2019 5:40 pm I've been doing this for several years and it is quite simple. I think you pretty much have it figured out.

I make a contribution to a traditional IRA and just put the money in a money market sweep account. As soon as it shows up, I initiate the conversion on the Vanguard website. I think your description of how to do it is right but I don't remember exactly what I need to do. After it is in the Roth, I allocate it to the fund(s) that I want for the long term.

I also use H&R Block and between retrieving the 1099s from Vanguard and the software, I really haven't had to think about it much. For your Federal return, you get to take a deduction for the IRA but then have to add back the income for the conversion. So it ends up being a wash for your taxable income on your Federal return. I don't remember exactly what happens when you do your state return- I think maybe you are pulling your Federal adjusted gross and then you get to exclude retirement income (like the conversion).

All in all, it couldn't be much simpler for a nice benefit.
I have done exactly that, but haven't been a full year, so I'm assuming I will get a 1099-R. If you look at a previous post of mine, it should clarify how I think it will work tax wise. It will be a wash for the Feds, but your federal AGI is what you use for the state minus anything that comes off a 1099-R. So your federal AGI is the same as it would be minus what comes off the 1099-R, meaning you don't pay tax on your conversion. Then it grows in your Roth tax free
lstone19
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Re: Illinois State Tax Loophole? What am I missing?

Post by lstone19 »

IowaFarmBoy wrote: Sat Jun 29, 2019 5:40 pm I also use H&R Block and between retrieving the 1099s from Vanguard and the software, I really haven't had to think about it much. For your Federal return, you get to take a deduction for the IRA but then have to add back the income for the conversion. So it ends up being a wash for your taxable income on your Federal return. I don't remember exactly what happens when you do your state return- I think maybe you are pulling your Federal adjusted gross and then you get to exclude retirement income (like the conversion).
Correct. Regarding fed payments, if you were paying enough through withholding, then you're still paying enough as the IRA deduction will exactly balance the conversion income. Keep in mind that estimated payments are simply payments - you do not designate what income they're for. So long as enough was paid, the IRS will not care that you did a conversion but did not make an estimated payment.

As for the state return, it starts on line 1 with Fed AGI from your fed 1040. IL-1040 line 7 then deducts "Social Security benefits and certain retirement plan income received if included in Line 1" (yes, your Roth conversion qualifies as "certain retirement plan income" and it will be included on line 1). Any good software (I use TurboTax) will do this for you automatically.
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Artful Dodger
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Re: Illinois State Tax Loophole? What am I missing?

Post by Artful Dodger »

Hopalong wrote: Sat Jun 29, 2019 11:20 am I've been making Roth IRA contributions for many years as an Illinois resident, and didn't think of this loophole. I'm a low earner by Bogleheads standards, so I'm well within the income limits for Roth and I have never done any conversions.

As far as the actual conversion process, do I basically make a traditional IRA contribution (my accounts are with Vanguard), then when I see that the transaction has been processed and the money is in my traditionaal account, log in and use the "exchange" funds options under "transactions" to move the money from the traditional account to my Roth account? Is it as simple as that? Does Vanguard generate a 1099R for a distribution from the traditional?

On to taxes - how does this get recorded on my taxes at the end of the year? Do I claim the traditional IRA contribution amount to get the deductions on my Federal and State (Illinois) returns. How do I pay the federal tax on the conversion...is it by claiming the amount that I exchange from the traditional to the Roth as an IRA withdrawal which gets considered as additional income by the Feds, but not by Illinois.

I use H&R Block software to do my taxes, so hopefully this process can still be handled by their program.

Sorry for all the simple questions. I've read this thread and the BH wiki page on roth conversions, but want to make sure I do it properly to take advantage of this and not cause any unnecessary problems.
I noted above, I've been doing this for a number of years. Yes, you could certainly make a traditional IRA contribution, then do a ROTH conversion. Or, if you have funds already in a traditional IRA, you can convert whatever amount you would like, at anytime. I've been increasing my more recent conversions to benefit from the recently lowered tax rates. But, my spouse is already 65, so I have to watch the IRMAA limits. I don't have Vanguard, we have Fidelity, so I can't answer your specific question on the exchange feature. I usually call Fidelity, and have them handle it. They're familiar with the rules, tax withholding, etc., and all has worked fine since I've begun doing this.

As far as handling the taxes, the federal return will be the same. Vanguard should supply the 1099R. When you file your Illinois return, you deduct any distributions from qualified retirement accounts (social security, pensions, IRAs, 401ks, etc). It is one line on the return. Take a look at your last years Illinois return, and you should see it.
dalbright
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Re: Illinois State Tax Loophole? What am I missing?

Post by dalbright »

I wanted to bump this post up for the new year for IL residents as I just learned about it from bh last year and gave it a shot for our IRAs for 2020. I will presumably do it again in 2021 as well.
mschurner
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Re: Illinois State Tax Loophole? What am I missing?

Post by mschurner »

auv-ee wrote: Sun Mar 24, 2019 8:11 pm
redbird24 wrote: Sat Mar 23, 2019 7:37 pm In order for it to reduce your state income it has to be taxed at the federal level (line 4b). In order to get a state tax advantage you have to have a low enough MAGI to be able to deduct it and then pay the tax on it.

In your case it's probably a nondeductible contribution that is then not taxed upon conversion, netting no money on line 4b, which is deductible on line 5 of IL-1040.

That's at least the way I'm understanding it
As noted by redbird24, in all cases you only get an Illinois deduction from income to the extent that you had Federal taxable income due to a retirement source. We're not Illinois residents, but we may become so in a few years, so I've been following this thread carefully. At redbird's prompting, I've studied the new Fed 1040 and IL-1040 forms, and see the situation this way:

If a conversion is made of an IRA contribution that was not Federally tax deductible when made (because of high AGI), then there will be no "benefit" in Illinois. This occurs because the 1099-R withdrawal amount is not Federally taxable (a conversion of already taxed dollars as computed on 8606), and so is never added to Fed 1040 line 7, and so never appears in IL-1040 line 4 as taxable income. IL-1040 line 5 only allows the deduction of retirement income that is included in IL-1040 line 4 (i.e.none, in this case).

I really think that calling any "tax reduction" from the Roth conversion of a deductible IRA contribution a "loophole" is really a misnomer. Evidently, Illinois does not tax retirement income, period. (maybe there are some odd exceptions, but certainly Social Security, pensions, IRA withdrawals, etc. are to be excluded form IL income.)

Any tax deduction for traditional IRA withdrawals is not so much a loop hole, as an intentional outcome of Illinois' policy that retirement income will not be taxed at the state level. IRA withdrawals would neither be taxed by Illinois when taken from a traditional IRA, nor from a Roth IRA, and thus not from the conversion between them, either. While the Illinois "loophole" allows a deduction for a federally taxable conversion, which seems like a reduction in Illinois taxable income, all that's really happening is that the Feds tax now your (previously deferred) conversion from a traditional IRA to a Roth (and never again), or would otherwise tax later withdrawals from the traditional IRA, while Illinois never taxes either. Whether you choose to contribute to a traditional IRA and leave it there, or to then do a Roth conversion, is only a question of whether to pay Federal tax now (if the contribution was fully or partially deductible) or whether to pay it later. It really has nothing to do with Illinois tax, unless you forget to use IL line 5 to deduct any Federally taxable retirement income that was included on IL line 4.

Edit 2019/3/25:

I now see that because IL follows Federal rules on the deductibility of a tIRA contribution, and because IL does not tax IRA withdrawals, there is something of a loophole:

A deductible contribution to a tIRA is from income that has no Fed or IL tax, and only Fed tax applies to a later withdrawal.

A non-deductible contribution to a tIRA is from income that has been taxed by both Fed and IL.

There is Fed tax once on money that flows through a tIRA, either at time of contribution or withdrawal, while IL misses taxing this money if the original contribution was deductible.

I have gone through this thread. I also looked at the other thread.

viewtopic.php?f=10&t=86262&hilit=ILLINOIS&start=100

I can see some ambiguity about deducting IRA distribution in IL return.
For someone who is above the AGI limit, this loophole doesn't work as the IRA withdrawal amount is not taxable/negligible as it was converted to Roth IRA. Is that right? Otherwise I have been leaving quite a bit on the table.
lakpr
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Re: Illinois State Tax Loophole? What am I missing?

Post by lakpr »

mschurner wrote: Sat Apr 03, 2021 4:43 pm I have gone through this thread. I also looked at the other thread.

viewtopic.php?f=10&t=86262&hilit=ILLINOIS&start=100

I can see some ambiguity about deducting IRA distribution in IL return.
For someone who is above the AGI limit, this loophole doesn't work as the IRA withdrawal amount is not taxable/negligible as it was converted to Roth IRA. Is that right? Otherwise I have been leaving quite a bit on the table.
Before I proceed, a disclaimer: I am NOT a resident of Illinois.

I do notice that the IL state return begins with the AGI that's reported on the Federal tax return, which does NOT include any IRA deductions at that point, so yes what you say is true.

But in a situation where you contribute to a 401k at a job, then roll that 401k to a Rollover IRA after leaving the job ... the AGI does not include the 401k contributions so you would have gotten tax breaks on both Federal and IL; then when you convert portions of the Rollover IRA to Roth you get taxed only on Federal tax return and not on IL tax return. Net result: for Roth conversion purposes it's the same as if you were relocated to a no-income-tax state such as FL, NV, TX. You were not taxed on the 401k contributions, nor are you taxed on the subsequent Roth conversions.
csmath
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Re: Illinois State Tax Loophole? What am I missing?

Post by csmath »

mschurner wrote: Sat Apr 03, 2021 4:43 pm I have gone through this thread. I also looked at the other thread.

viewtopic.php?f=10&t=86262&hilit=ILLINOIS&start=100

I can see some ambiguity about deducting IRA distribution in IL return.
For someone who is above the AGI limit, this loophole doesn't work as the IRA withdrawal amount is not taxable/negligible as it was converted to Roth IRA. Is that right? Otherwise I have been leaving quite a bit on the table.
lakpr wrote: Sat Apr 03, 2021 6:14 pm Before I proceed, a disclaimer: I am NOT a resident of Illinois.

I do notice that the IL state return begins with the AGI that's reported on the Federal tax return, which does NOT include any IRA deductions at that point, so yes what you say is true.
The two of you are making statements based on the initial condition that the TIRA contributions are non-deductible correct? If that is what you are saying, then yes I believe you are correct that there is not a benefit in IL of doing the TIRA to ROTH contribution/conversion to avoid the 4.95% State tax unless the original TIRA contribute is deductible.

As lakpr points out, the traditional 401k, 403b, 457b conversions still result in a savings.
mschurner
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Re: Illinois State Tax Loophole? What am I missing?

Post by mschurner »

lakpr wrote: Sat Apr 03, 2021 6:14 pm
mschurner wrote: Sat Apr 03, 2021 4:43 pm I have gone through this thread. I also looked at the other thread.

viewtopic.php?f=10&t=86262&hilit=ILLINOIS&start=100

I can see some ambiguity about deducting IRA distribution in IL return.
For someone who is above the AGI limit, this loophole doesn't work as the IRA withdrawal amount is not taxable/negligible as it was converted to Roth IRA. Is that right? Otherwise I have been leaving quite a bit on the table.
Before I proceed, a disclaimer: I am NOT a resident of Illinois.

I do notice that the IL state return begins with the AGI that's reported on the Federal tax return, which does NOT include any IRA deductions at that point, so yes what you say is true.

But in a situation where you contribute to a 401k at a job, then roll that 401k to a Rollover IRA after leaving the job ... the AGI does not include the 401k contributions so you would have gotten tax breaks on both Federal and IL; then when you convert portions of the Rollover IRA to Roth you get taxed only on Federal tax return and not on IL tax return. Net result: for Roth conversion purposes it's the same as if you were relocated to a no-income-tax state such as FL, NV, TX. You were not taxed on the 401k contributions, nor are you taxed on the subsequent Roth conversions.

This is my understanding. There is no deduction for IRA contribution for high AGI. Distribution is not taxable at the IL state level from 401k,IRA and IRA conversion to Roth.
Lets say someone do backdoor Roth, ( contributes $6000 to tIRA and then converts the entire amount, $6000 to Roth IRA ), taxable amount is 0. So the whole contribution and deduction/conversion makes no change with your AGI. If it is not counted as income at the federal level, you cant deduct it for IL
I'm not sure how its different for someone who is eligible for the deductible contribution. I assume they would also have IRA distribution of $6000 in 1040 4a and taxable amount would be 0 in 1040 4b. ( As per OP, he would see taxable amount in 4b, I'm lost here) What am I missing?


Illinois does not tax distributions received from:

qualified employee benefit plans, including 401(K) plans;
an Individual Retirement Account, (IRA) or a self-employed retirement plan;
a traditional IRA that has been converted to a Roth IRA;

if the income is included in your federal adjusted gross income on Form IL-1040, Line 1.


https://www2.illinois.gov/rev/questions ... es/99.aspx
csmath
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Re: Illinois State Tax Loophole? What am I missing?

Post by csmath »

Line 4b is what matters for IL, not 4a.
mschurner wrote: Sat Apr 03, 2021 10:25 pm Lets say someone do backdoor Roth, ( contributes $6000 to tIRA and then converts the entire amount, $6000 to Roth IRA ), taxable amount is 0.
What do you mean the taxable amount is 0? It is definitely taxed Federally and can be taxed in IL also if any portion of the original TIRA contribution was non-deductible. On Federal 1040 the conversion is a distribution that goes on line 4a. So that would have $6,000 on it. Line 4b is where things change depending on your AGI.
  • If TIRA contributions were fully deductible, 4b will have the full $6,000 on it = $297 IL tax savings
  • If TIRA contributions were fully non-deductible, 4b will have $0 on it = $0 IL tax savings
  • If TIRA contributions were partially non-deductible, 4b will have only the deductible portion on it = 4.95% of line 4b IL tax savings
mschurner wrote: Sat Apr 03, 2021 10:25 pm I'm not sure how its different for someone who is eligible for the deductible contribution. I assume they would also have IRA distribution of $6000 in 1040 4a and taxable amount would be 0 in 1040 4b. ( As per OP, he would see taxable amount in 4b, I'm lost here) What am I missing?
The highlighted portion above is false. It is my understanding that IL generally uses the amount on 4b to determine what portion of the IRA distribution not to tax, even though it is included on Federal 1040 lines 9 and 11 for "total income" and "AGI" respectively. So if you look at the three cases I listed above, IL reduces your taxable income by that amount.
mschurner wrote: Sat Apr 03, 2021 10:25 pm Illinois does not tax distributions received from:

a traditional IRA that has been converted to a Roth IRA;

if the income is included in your federal adjusted gross income on Form IL-1040, Line 1.


https://www2.illinois.gov/rev/questions ... es/99.aspx
Yeah this part is a bit weird because if it was fully deductible you would have $6,000 on 4a, $6,000 on 4b and your total income is then increased by $6,000. However, on Schedule 1 you would have the $6,000 IRA contribution which is part of the income adjustments on line 10a and gets removed again before arriving on line 11 where your AGI is found and then used on line 1 of IL 1040

I think this is how it works. Say you have income 0f 100k and do the IL backdoor Roth IRA.
Line 1: $100,000 (earned income)
Line4b: $6,000 (retirement income from conversion)
Line9: $106,000 (total income)
Line10c: $6,000 (TIRA contribution removed AFTER the income was added from conversion in Line4b)
Line11: $100,000 (AGI - It has the original earned $6,000 still in it)

Federal uses line11 to get to taxable income.
IL uses line11 to get taxable income but also uses line4b from Fed 1040 on line5 of IL 1040 to reduce taxable income. This is where the conversion saves IL taxes if it was deductible in the first place.
mschurner
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Re: Illinois State Tax Loophole? What am I missing?

Post by mschurner »

csmath wrote: Sat Apr 03, 2021 11:35 pm Line 4b is what matters for IL, not 4a.
mschurner wrote: Sat Apr 03, 2021 10:25 pm Lets say someone do backdoor Roth, ( contributes $6000 to tIRA and then converts the entire amount, $6000 to Roth IRA ), taxable amount is 0.
What do you mean the taxable amount is 0? It is definitely taxed Federally and can be taxed in IL also if any portion of the original TIRA contribution was non-deductible. On Federal 1040 the conversion is a distribution that goes on line 4a. So that would have $6,000 on it. Line 4b is where things change depending on your AGI.
  • If TIRA contributions were fully deductible, 4b will have the full $6,000 on it = $297 IL tax savings
  • If TIRA contributions were fully non-deductible, 4b will have $0 on it = $0 IL tax savings
  • If TIRA contributions were partially non-deductible, 4b will have only the deductible portion on it = 4.95% of line 4b IL tax savings
mschurner wrote: Sat Apr 03, 2021 10:25 pm I'm not sure how its different for someone who is eligible for the deductible contribution. I assume they would also have IRA distribution of $6000 in 1040 4a and taxable amount would be 0 in 1040 4b. ( As per OP, he would see taxable amount in 4b, I'm lost here) What am I missing?
The highlighted portion above is false. It is my understanding that IL generally uses the amount on 4b to determine what portion of the IRA distribution not to tax, even though it is included on Federal 1040 lines 9 and 11 for "total income" and "AGI" respectively. So if you look at the three cases I listed above, IL reduces your taxable income by that amount.
mschurner wrote: Sat Apr 03, 2021 10:25 pm Illinois does not tax distributions received from:

a traditional IRA that has been converted to a Roth IRA;

if the income is included in your federal adjusted gross income on Form IL-1040, Line 1.


https://www2.illinois.gov/rev/questions ... es/99.aspx
Yeah this part is a bit weird because if it was fully deductible you would have $6,000 on 4a, $6,000 on 4b and your total income is then increased by $6,000. However, on Schedule 1 you would have the $6,000 IRA contribution which is part of the income adjustments on line 10a and gets removed again before arriving on line 11 where your AGI is found and then used on line 1 of IL 1040

I think this is how it works. Say you have income 0f 100k and do the IL backdoor Roth IRA.
Line 1: $100,000 (earned income)
Line4b: $6,000 (retirement income from conversion)
Line9: $106,000 (total income)
Line10c: $6,000 (TIRA contribution removed AFTER the income was added from conversion in Line4b)
Line11: $100,000 (AGI - It has the original earned $6,000 still in it)

Federal uses line11 to get to taxable income.
IL uses line11 to get taxable income but also uses line4b from Fed 1040 on line5 of IL 1040 to reduce taxable income. This is where the conversion saves IL taxes if it was deductible in the first place.

Thank you for the response and numbers. I get this part now. For someone who is eligible for the IRA deduction, they will have 6000 in 4b after Roth conversion.  I didn't know this.  As I have a high AGI, I have 0 in 4b.
As per IL, IRA distribution is not taxable if it is included in the AGI - line 11 in 2020., 8b in 2019 form.  But schedule 1 deduction kicks in BEFORE calculating AGI.  Low AGI filers are not paying tax either at the federal level or IL level already.  Getting another deduction in IL level for the same amount is an error/ false. Software is taking the 4b amount for IL calculation by mistake.
As high AGI filers, IRA distribution $$ is just not taxable at line 4b to avoid double tax as this $ already included in AGI as they cant get to have deduct.  IL tax rule states nothing about 4a/4b. They should be able to deduct IRA distribution as they are paying federal tax for this, but not at the line 4b.  What am I missing? I'm going to look into this more.


Illinois does not tax distributions received from:

an Individual Retirement Account, (IRA) or a self-employed retirement plan;
a traditional IRA that has been converted to a Roth IRA;

if the income is included in your federal adjusted gross income on Form IL-1040, Line 1.
Topic Author
redbird24
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Re: Illinois State Tax Loophole? What am I missing?

Post by redbird24 »

mschurner wrote: Sun Apr 04, 2021 8:53 pm
csmath wrote: Sat Apr 03, 2021 11:35 pm Line 4b is what matters for IL, not 4a.
mschurner wrote: Sat Apr 03, 2021 10:25 pm Lets say someone do backdoor Roth, ( contributes $6000 to tIRA and then converts the entire amount, $6000 to Roth IRA ), taxable amount is 0.
What do you mean the taxable amount is 0? It is definitely taxed Federally and can be taxed in IL also if any portion of the original TIRA contribution was non-deductible. On Federal 1040 the conversion is a distribution that goes on line 4a. So that would have $6,000 on it. Line 4b is where things change depending on your AGI.
  • If TIRA contributions were fully deductible, 4b will have the full $6,000 on it = $297 IL tax savings
  • If TIRA contributions were fully non-deductible, 4b will have $0 on it = $0 IL tax savings
  • If TIRA contributions were partially non-deductible, 4b will have only the deductible portion on it = 4.95% of line 4b IL tax savings
mschurner wrote: Sat Apr 03, 2021 10:25 pm I'm not sure how its different for someone who is eligible for the deductible contribution. I assume they would also have IRA distribution of $6000 in 1040 4a and taxable amount would be 0 in 1040 4b. ( As per OP, he would see taxable amount in 4b, I'm lost here) What am I missing?
The highlighted portion above is false. It is my understanding that IL generally uses the amount on 4b to determine what portion of the IRA distribution not to tax, even though it is included on Federal 1040 lines 9 and 11 for "total income" and "AGI" respectively. So if you look at the three cases I listed above, IL reduces your taxable income by that amount.
mschurner wrote: Sat Apr 03, 2021 10:25 pm Illinois does not tax distributions received from:

a traditional IRA that has been converted to a Roth IRA;

if the income is included in your federal adjusted gross income on Form IL-1040, Line 1.


https://www2.illinois.gov/rev/questions ... es/99.aspx
Yeah this part is a bit weird because if it was fully deductible you would have $6,000 on 4a, $6,000 on 4b and your total income is then increased by $6,000. However, on Schedule 1 you would have the $6,000 IRA contribution which is part of the income adjustments on line 10a and gets removed again before arriving on line 11 where your AGI is found and then used on line 1 of IL 1040

I think this is how it works. Say you have income 0f 100k and do the IL backdoor Roth IRA.
Line 1: $100,000 (earned income)
Line4b: $6,000 (retirement income from conversion)
Line9: $106,000 (total income)
Line10c: $6,000 (TIRA contribution removed AFTER the income was added from conversion in Line4b)
Line11: $100,000 (AGI - It has the original earned $6,000 still in it)

Federal uses line11 to get to taxable income.
IL uses line11 to get taxable income but also uses line4b from Fed 1040 on line5 of IL 1040 to reduce taxable income. This is where the conversion saves IL taxes if it was deductible in the first place.

Thank you for the response and numbers. I get this part now. For someone who is eligible for the IRA deduction, they will have 6000 in 4b after Roth conversion.  I didn't know this.  As I have a high AGI, I have 0 in 4b.
As per IL, IRA distribution is not taxable if it is included in the AGI - line 11 in 2020., 8b in 2019 form.  But schedule 1 deduction kicks in BEFORE calculating AGI.  Low AGI filers are not paying tax either at the federal level or IL level already.  Getting another deduction in IL level for the same amount is an error/ false. Software is taking the 4b amount for IL calculation by mistake.
As high AGI filers, IRA distribution $$ is just not taxable at line 4b to avoid double tax as this $ already included in AGI as they cant get to have deduct.  IL tax rule states nothing about 4a/4b. They should be able to deduct IRA distribution as they are paying federal tax for this, but not at the line 4b.  What am I missing?


Illinois does not tax distributions received from:

an Individual Retirement Account, (IRA) or a self-employed retirement plan;
a traditional IRA that has been converted to a Roth IRA;

if the income is included in your federal adjusted gross income on Form IL-1040, Line 1.
Low AGI filer here: I'm taking earned income (already taxed), putting it in my tIRA, rolling over to Roth. On the federal level I'm paying tax on it. Let's say it's the max contribution. I'm taxed on the $6,000 from my paycheck/w2/line 1 of federal return. I add $6,000 to my income and adjust $6,000 from my income, meaning I'm still paying federal tax on my $6,000.

As far as the state goes, Publication 120 (https://www2.illinois.gov/rev/research/ ... ub-120.pdf) states on page 2:
What retirement income may I subtract on Form IL-1040, Line 5, and where is it reported on my federal return?
-an Individual Retirement Account (IRA) (including amounts rolled over to a Roth IRA) or a self-employed retirement (SEP) plan reported on your U.S. 1040 or 1040-SR, Line 4b

I understand what you are saying about federal AGI. I could take a deduction now and then in retirement age take the distribution. I would still not pay IL income tax on that money. I could really make the contribution in December and convert the following January and they wouldn't then be on the same tax return.
mschurner
Posts: 122
Joined: Sun Sep 23, 2018 11:33 pm

Re: Illinois State Tax Loophole? What am I missing?

Post by mschurner »

Low AGI filer here: I'm taking earned income (already taxed), putting it in my tIRA, rolling over to Roth. On the federal level I'm paying tax on it. Let's say it's the max contribution. I'm taxed on the $6,000 from my paycheck/w2/line 1 of federal return. I add $6,000 to my income and adjust $6,000 from my income, meaning I'm still paying federal tax on my $6,000.

We are all paying federal taxes on the taxable income (AGI - deductions). W 2 line 1 is just wages. You are contributing to tIRA and then converting to Roth and getting $6000 in 4b. You are deducting that 6000 already on schedule 1 which goes to 10a in 1040. You are not paying the federal taxes on this $6000. Correct me if I'm wrong.
As this $6000 is not taxable at the federal AGI, this should not get the IL deduction.

I did go through pub 120. Yes, you are correct about 4b.
It also states If your U.S. 1040 or 1040-SR Lines 4b, 5b, and
6b do not clearly identify the Social Security benefits and
retirement income you are reporting on Line 5, you must
attach a copy of Form 1099-R or Form SSA-1099, Social
Security Benefit Statement, as applicable.
My 1099-R from Vanguard clearly states $6000 is taxable distributions, but not taxed at federal level - 4b as it was already taxed to start with while contributing to IRA ( I could say it is not deductible contribution). I could file IL return by deducting $6000 with 1099R. I dont know whether I'll end up in trouble. I'm not sure its worth to go that route.
csmath
Posts: 826
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Re: Illinois State Tax Loophole? What am I missing?

Post by csmath »

redbird24 wrote: Sun Apr 04, 2021 9:15 pm I understand what you are saying about federal AGI. I could take a deduction now and then in retirement age take the distribution. I would still not pay IL income tax on that money. I could really make the contribution in December and convert the following January and they wouldn't then be on the same tax return.
This is true that taking the distribution in the future still results in no IL tax if tax laws stay the same. However, I was unaware that people stay in IL by choice once retired? :twisted:
csmath
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Re: Illinois State Tax Loophole? What am I missing?

Post by csmath »

mschurner wrote: Sun Apr 04, 2021 10:01 pm As per IL, IRA distribution is not taxable if it is included in the AGI - line 11 in 2020., 8b in 2019 form. But schedule 1 deduction kicks in BEFORE calculating AGI.
Yes, but what is the deduction removing from the AGI? The $6,000 TIRA contribution or the $6,000 retirement income? The answer is that it is removing the contribution. The retirement income created in the conversion is still included in the AGI.
mschurner wrote: Sun Apr 04, 2021 10:01 pm Low AGI filers are not paying tax either at the federal level or IL level already.
Not taxed at the federal or IL level for the original contribution, true. But the retirement income created during the conversion is still part of AGI and will get taxed by both parties, except that IL asks for how much of the AGI was taxable retirement income on line5 of IL 1040 so that it removes it before calculating IL tax owed. You don't get taxed on the retirement income/Roth conversion.

All of this is of course is if the original TIRA contribution was deductible (low AGI as you say)
mschurner wrote: Sun Apr 04, 2021 10:01 pm Getting another deduction in IL level for the same amount is an error/ false. Software is taking the 4b amount for IL calculation by mistake.
Nope. This is where the magic happens and is actually the entire point of the Illinois Backdoor Roth. You are not getting taxed on the contribution or the distribution and now the money is in a Roth which has locked in no State taxes, which you can take with you when you leave IL in retirement, if you wish.
csmath
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Re: Illinois State Tax Loophole? What am I missing?

Post by csmath »

mschurner wrote: Sun Apr 04, 2021 10:01 pm My 1099-R from Vanguard clearly states $6000 is taxable distributions, but not taxed at federal level - 4b as it was already taxed to start with while contributing to IRA ( I could say it is not deductible contribution). I could file IL return by deducting $6000 with 1099R. I dont know whether I'll end up in trouble. I'm not sure its worth to go that route.
Yes, your Vanguard 1099-R should list the $6,000 conversion as taxable in 1099-R 2a.

If your AGI is too high and the entire TIRA contribution was non-deductible, then your 4b needs to be $0 because none of the distribution is taxable since you already have to pay taxes on the original TIRA contribution due to high AGI.

In this case, you wouldn't get the IL deduction for the TIRA contribution and since IL 1040 line4b is $0 you still don't get to deduct anything from the conversion. Putting $6,000 on IL 1040 line5 would be incorrect.

Just to make sure we are clear, I am not a tax professional. I am however familiar with this specific "feature" in IL and it is not the only state that has this sort of tax laws with the retirement income. I have also seen TurboTax put a full $6,000 on IL 1040 line5 when the original TIRA contribution was only partially deductible. The result was that IL made an adjustment and only reduced the AGI by the portion of the conversion that was deductible in the TIRA contribution.
mschurner
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Re: Illinois State Tax Loophole? What am I missing?

Post by mschurner »

Yes, but what is the deduction removing from the AGI? The $6,000 TIRA contribution or the $6,000 retirement income? The answer is that it is removing the contribution. The retirement income created in the conversion is still included in the AGI.
Beautiful! You are awesome!!
Nope. This is where the magic happens and is actually the entire point of the Illinois Backdoor Roth. You are not getting taxed on the contribution or the distribution and now the money is in a Roth which has locked in no State taxes, which you can take with you when you leave IL in retirement, if you wish.
Basically you get the $6000 IRA distribution that is taxed at the federal level. You could get deduct this IL line 5. IRA contribution and deduction has nothing to do with IL. Got it! Much appreciated!!
csmath
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Re: Illinois State Tax Loophole? What am I missing?

Post by csmath »

mschurner wrote: Sun Apr 04, 2021 11:19 pm
Yes, but what is the deduction removing from the AGI? The $6,000 TIRA contribution or the $6,000 retirement income? The answer is that it is removing the contribution. The retirement income created in the conversion is still included in the AGI.
Beautiful! You are awesome!!
Nope. This is where the magic happens and is actually the entire point of the Illinois Backdoor Roth. You are not getting taxed on the contribution or the distribution and now the money is in a Roth which has locked in no State taxes, which you can take with you when you leave IL in retirement, if you wish.
Basically you get the $6000 IRA distribution that is taxed at the federal level. You could get deduct this IL line 5. IRA contribution and deduction has nothing to do with IL. Got it! Much appreciated!!
:sharebeer
mschurner
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Re: Illinois State Tax Loophole? What am I missing?

Post by mschurner »

Yes, your Vanguard 1099-R should list the $6,000 conversion as taxable in 1099-R 2a.

If your AGI is too high and the entire TIRA contribution was non-deductible, then your 4b needs to be $0 because none of the distribution is taxable since you already have to pay taxes on the original TIRA contribution due to high AGI.
Got it. Its clear at the federal level.
In this case, you wouldn't get the IL deduction for the TIRA contribution and since IL 1040 line4b is $0 you still don't get to deduct anything from the conversion. Putting $6,000 on IL 1040 line5 would be incorrect.
We get the IL deduction for the IRA distribution, not contribution, right? Is that what you meant?
As per IL Publication 120, its Its pretty straight forward as long as we have something at line4b of 1040, we can deduct at IL line 5.
For high AGI, IRA distribution is not taxed at 4b as its already taxed/nondeductible contribution to start with as you stated. However this amount is included in AGI for the year.
If we get the IRA distribution and that amount is included in AGI, can we deduct it IL return and submit 1099R and Form 1040 page 1 and Form 8606 along with IL return?
lstone19
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Re: Illinois State Tax Loophole? What am I missing?

Post by lstone19 »

I am gobsmacked by how confused this topic has become. First off, keep in mind that we call the "backdoor Roth" (or anything else involving an IRA contribution and a conversion) is really two independent transactions as far as tax codes are concerned. When you start trying to look at them as one atomic transaction, certain aspects of it don't seem right and yet because the tax code thinks they are independent, we need to be looking at them as independent.

Contribution to an IRA:
Federal: Deducted (if deducted) on Federal Schedule 1 Line 19 which flows to 1040 Line 10a.
Illinois: IL-1040 comes from 1040 Line 11 so if the contribution was deducted for federal, it's deducted for Illinois

Distribution from an IRA:
Federal: Full amount of distribution is reported on 1040 Line 4a with taxable portion on 1040 Line 4b. Since this is above Line 11, the taxable portion is included in AGI on Line 11
Illinois: The portion not taxable by Illinois is reported on IL-1040 Line 5 and subtracted from IL-1040 Line 4 (Total Income which was Line 1 plus Illinois income additions) to give IL-1040 Line 9 (Illinois Base Income).

Illinois tax code does not go into how long a period must pass between the contribution and the distribution (conversion) so even if it was only a day (or even seconds if your financial institution could do it that fast) does not change the tax handling of the distribution. Was it an unintended consequence? Perhaps. But like anything else in the tax code, it is our job as taxpayers to legally minimize what we pay by using aspects of the tax code that can save us on what we pay.
mschurner
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Re: Illinois State Tax Loophole? What am I missing?

Post by mschurner »

Thanks for pitching in.
Illinois: The portion not taxable by Illinois is reported on IL-1040 Line 5 and subtracted from IL-1040 Line 4 (Total Income which was Line 1 plus Illinois income additions) to give IL-1040 Line 9 (Illinois Base Income).
The portion not taxable in IL is from federal line 4b. It's pretty clear. 4a which ( IRA distribution) is not taxed at 4b for high AGI as it is a nondeductible contribution. I do think this 4a IRA distribution is included in federal AGI. That's why I'm bringing up whether high AGI filers should deduct IRA distribution ( 4a) in IL 5 by attaching 1099-R. Hope I'm clear. I'm not optimistic though. 
lstone19
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Re: Illinois State Tax Loophole? What am I missing?

Post by lstone19 »

mschurner wrote: Mon Apr 05, 2021 8:29 am Thanks for pitching in.
Illinois: The portion not taxable by Illinois is reported on IL-1040 Line 5 and subtracted from IL-1040 Line 4 (Total Income which was Line 1 plus Illinois income additions) to give IL-1040 Line 9 (Illinois Base Income).
The portion not taxable in IL is from federal line 4b. It's pretty clear. 4a which ( IRA distribution) is not taxed at 4b for high AGI as it is a nondeductible contribution. I do think this 4a IRA distribution is included in federal AGI. That's why I'm bringing up whether high AGI filers should deduct IRA distribution ( 4a) in IL 5 by attaching 1099-R. Hope I'm clear. I'm not optimistic though. 
No, no, no. You are conflating deductibility of contributions with taxability of distributions. They are independent taxable events in the eyes of the tax code.

A high AGI restricts the deductibility of the contribution. A high AGI has nothing to do with taxability of the distribution other than what tax rate applies to it.

For most IRA situations, the difference between 4a (gross distributions and NOT included in AGI) and 4b is the basis in the IRA applicable to the distribution. That basis came about when the contribution was made and would be based on the taxpayers AGI in that year, not the current year (unless the contribution and distribution were in the same year which is not something you can assume for the general case).

For IRA distributions (including conversions) coded in 1099-R box 7 with 2 (early distribution, exception applies) and 7 (normal distribution) (I have no idea how other codes might factor into it), the distribution is not taxable by Illinois and is therefore deducted on IL-1040 Line 5. And that is all that goes into it (how long ago the contribution was made, what your AGI is, nor anything else is a factor in the taxability).
mschurner
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Re: Illinois State Tax Loophole? What am I missing?

Post by mschurner »

No, no, no. You are conflating deductibility of contributions with taxability of distributions. They are independent taxable events in the eyes of the tax code.
Got it. Thanks.
For most IRA situations, the difference between 4a (gross distributions and NOT included in AGI) and 4b is the basis in the IRA applicable to the distribution. That basis came about when the contribution was made and would be based on the taxpayers AGI in that year, not the current year (unless the contribution and distribution were in the same year which is not something you can assume for the general case).
Regarding the basis for the contribution, why its based on AGI for that year. I'm not understanding this.
For IRA distributions (including conversions) coded in 1099-R box 7 with 2 (early distribution, exception applies) and 7 (normal distribution) (I have no idea how other codes might factor into it), the distribution is not taxable by Illinois and is therefore deducted on IL-1040 Line 5.
As high AGI filer, I do have code 2 in 1099-R. However its not taxable for me because of the timing when I contributed (same year) and cost basis. So I CAN'T deduct in IL line-5. Am I correct?
lstone19
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Re: Illinois State Tax Loophole? What am I missing?

Post by lstone19 »

mschurner wrote: Mon Apr 05, 2021 9:06 am
For IRA distributions (including conversions) coded in 1099-R box 7 with 2 (early distribution, exception applies) and 7 (normal distribution) (I have no idea how other codes might factor into it), the distribution is not taxable by Illinois and is therefore deducted on IL-1040 Line 5.
As high AGI filer, I do have code 2 in 1099-R. However its not taxable for me because of the timing when I contributed (same year) and cost basis. So I CAN'T deduct in IL line-5. Am I correct?
You can only deduct the distribution to the extent it was federally taxable on 1040 line 4b and therefore included in your Federal AGI which flows to IL-1040 Line 1. If it's not in IL-1040 Line 1, there is nothing to deduct.

Keep in mind that the Federal backdoor Roth and what I'm calling the Illinois backdoor Roth are very much opposites. The federal backdoor Roth lets you essentially make a Roth contribution when you don't qualify to do so directly. OTOH, the Illinois backdoor Roth lets you essentially make a Roth contribution yet get a state tax deduction for it that you would not get if you contributed directly to the Roth but you must be eligible to make a deductible IRA contribution.

Federal back door Roth:
- Make a non-deductible contribution to a Traditional IRA so no federal or Illinois tax deduction generated
- Covert to Roth and since the basis is (almost) equal to the amount converted, no federal or Illinois taxable income generated

Illinois back door Roth:
- Make a deductible contribution to a Traditional IRA generating a federal and Illinois tax deduction (the Illinois tax deduction is implicit in that the deduction is already included in the AGI amount that flows from your 1040 to your IL-1040)
- Convert to Roth and since the basis is zero, it generated federally taxable income (almost) equal to what you deducted right above so an (almost) net zero for federal purposes just as if you had directly contributed to the Roth
- But then you deduct the conversion on your Illinois return on IL-1040 line 5 netting a deduction for Illinois purposes equal to what you converted (for Illinois purposes, you have deducted the contribution but then recognized no income when converting).

The (almost) in various spots above recognizes that there may have been some income for the period between contribution to the traditional and conversion to the Roth.
mschurner
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Re: Illinois State Tax Loophole? What am I missing?

Post by mschurner »

Got it. Thank you.
I'm doing backdoor Roth. Usually I contribute and convert them to Roth very next business day after the settlement.
I cant deduct IRA distribution in IL line 5 PERIOD.
bidd24
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Re: Illinois State Tax Loophole? What am I missing?

Post by bidd24 »

I have already maxed my Roth this year the traditional way. What is best way for next year? Should I contribute to Traditional IRA in Dec and convert to Roth in Jan.

TIA
lstone19
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Re: Illinois State Tax Loophole? What am I missing?

Post by lstone19 »

bidd24 wrote: Tue Aug 03, 2021 11:43 am I have already maxed my Roth this year the traditional way. What is best way for next year? Should I contribute to Traditional IRA in Dec and convert to Roth in Jan.
If you've already maxed your Roth contribution this year, you cannot contribute to a traditional IRA in December. The annual limit for traditional and Roth IRAs is a combined limit - the total of your contributions to both types.

But also note that conversions are not contributions. You can convert an unlimited amount from traditional to Roth each year and it has not effect on the contribution limit.

Since you're asking, I am assuming you are eligible to make deductible traditional IRA (if you aren't, then this discussion does not apply to your situation). If so, you may want to consider recharacterizing this year's contribution to traditional so you can then convert it and get the Illinois tax deduction.
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