The "legality" of the backdoor Roth has been debated in the past and there are multiple threads on this (some of which have been locked). But I have come across information which I have not yet seen on this forum.
Michael Kitces has tweeted that he knows of situations where the IRS has flagged the backdoor Roth process during an audit and taxpayers had to undo the process (but, can one undo a Roth conversion now?). I don't know how to link to tweets, but today he wrote:
He also advises advisors NOT to ever use the term backdoor Roth NOR put anything in writing to a client about making after tax contributions with the intent to convert:Have talked to a few advisors over the years who had clients get audited & agent called it out for that very reason. Typically it was very blatant scenarios (contribute Monday, convert Tuesday). But they were watching.
And in addition:Thus, advisors should also be cautious not to record in the advisor’s CRM [neurosphere: Client Relationship Manager software] and client file that the advisor is facilitating a backdoor Roth contribution, or risk that the advisor’s recommendation to do a “backdoor Roth contribution” is the very document used against the client to defeat the strategy!
He also (in my opinion) makes it clear that he thinks the backdoor Roth process is a process which is used to attempt/succeed to avoid IRS rules. That is, he all but writes the backdoor Roth is illegal (that word is loaded, but maybe "disallowed" is better?). So much so that he gives advisors a roadmap to hide or erase the "intent" to do something that's not allowed.But perhaps the most important to step avoid the step transaction doctrine is the simplest one: do not, in any notes or records, indicate that you are doing to do a “backdoor Roth IRA contribution” in the first place! After all, the reality is that the application of the step transaction doctrine is based on the court’s determination of intent – so when you say you are trying to do a backdoor Roth IRA to bypass the Roth contribution income limits, you are making the case for the IRS!
All the above quotes read to me as if he is saying that the backdoor Roth is not legal but if you do a few key things you can prevent getting caught.Accordingly, then, the key to avoiding the intent test of the step transaction doctrine is conceptually simple: put more time and space between the steps, to clearly establish that they were separate and independent decisions, and not part of a single whole. If there is a deliberate time gap between when the non-deductible IRA contribution is made, and when the subsequent Roth conversion occurs, it's easier to claim that the end result of dollars in the Roth wasn't part of a sole intent to circumvent the rules.
He also tweeted that he advises advisors in his seminars thusly:
So one of the most well known financial advisors is giving presentations (and writing online and tweeting) to OTHER advisors with advice to avoid any mention in their notes about the backdoor Roth so that the IRS can't find it later?Yes, which is why our presentations about this strenuously suggest advisors NOT write "backdoor Roth" in financial plan recommendations or document it that way in CRM. If you're not a CPA, your client communication is available to IRS as evidence against your client. :/
So here are my questions. My wife and I have been doing backdoor Roths for many years. Should we find a way to undo these, just to be safe? Is it LEGAL, or not. If this is a grey area, should we disclose/undo these just to be conservative and on the safe side? Should the wiki come with a giant disclaimer with a long explanation of the controversy that the process itself is not actually allowed? I guess the overall point is, I know that Kitces has always been highly conservative regarding his interpretation on the backdoor Roth. But...he now says the IRS has indeed disallowed it for at least a couple of taxpayers. I'm at a loss for how to now interpret this new information with respect to my personal situation, and as to the advice I give to others here on Bogleheads (and to others in my personal and professional life).
Neurosphere