Back Door IRA with Pro-rata complication

[fjay]

Last year I contributed to my Traditional IRA and did a back door conversion.

It so happened that I had also moved quite a bit of money out of my Traditional IRA to my employer 401(k) so that i don't have any basis in the pre tax account for 2016. So by 12/31 i had zero balance in my traditional IRA.

Now my tax software - TaxAct considers that to be under the pro-rata rule and doesn't consider the pre-tax distribution as an exception to the rule.

It's using IRS Pub 590-B worksheet 1-1 to calculate this amount and it seems like this worksheet only cares about if there was a distribution from the traditional IRA and a conversion simultaneously in the same year, doesn't care for any allowable exceptions.

Can you please suggest what i should do with this?

I'm thinking of either re-characterization or return of contribution.

Greatly appreciate your immediate response.

[DMFA]

No. It's doing it wrong. You're probably counting the rollover as a distribution, which is explicitly stated to be excluded from it (see form 8606 instructions). That  or you might not have told your software that your contribution was non-deductible; it often fools people since it might pre-check the "no" box or say "this is not common."

I'm not familiar with that particular software, but on Form 8606 lines 6 (12/31/2016 value) and 7 (non-rollover, non-converted distributions) should both be zero, and since you had no prior year basis (meaning non-deducted money in it), then line 10 should be 1.000, meaning all of your conversion would be non-taxable.

A common source of this is overlooking to ensure box 2b, "taxable amount not determined," on the 1099-R is marked as being checked in the tax software (assuming it's checked on your form).

The Finance Buff has a step-by-step guide with pictures.

[fjay]

DMFA

I'm in agreement with whatever you said above and that's pretty much how I have it other than line 10 which is coming out to be zero for me. Line 6 and line 7 are zero as well. Now the only way line 10 can be a '1' is if line 8 is same as line 5 which is 5500 in my case. This is where the numbers go wrong. The tax software instead uses '*From Pub. 590-B Worksheet 1-1' to calculate line 15 and gives me a huge taxable amount based on the rollover i made to my 401(k).

Its frustrating since i am not able to fix it on the software itself.

[DMFA]

Rollovers are not taxable distributions. https://www.irs.gov/publications/p590b/ch01.html#en_US_2016_publink1000230799

I don't know why the worksheet is even relevant in this case. Are you mis-interpreting "basis" to mean all money in the accounts instead of just non-deducted contributions?

Let's go line-by-line on p590b worksheet 1-1.

1. This should be $0, unless you had non-deducted contributions sitting in there for some reason on 12/31/2015.
2. $5,500
3. $5,500 (1+2)
4. $0 (12/31/2016 value)
5. $5,500
6. $5,500 (4+5)
7. 1.000 (3÷6)
8. $5,500 (5*7, non-taxable portion)
9. $0 (5-8)
10. $0 (since 9 is $0, goes on f8606 line 18)
11. $0 (9-10, goes on f8606 line 15)

...where did that go awry?

[fjay]

It goes awry on line 5. Instead of 5500 it also adds up the rollover money which I've made sure is coded with 'G' in my entered forms. I think its a software glitch.

 

[DMFA]

fjay wrote:

It goes awry on line 5. Instead of 5500 it also adds up the rollover money which I’ve made sure is coded with ‘G’ in my entered forms. I think its a software glitch.

 

Click to expand...

I still have no idea why you even have to *do* Worksheet 1-1 in the first place.  That's for figuring out what is and isn't taxable from your distribution.  You don't need to figure this out because it's not taxable since it's a direct rollover to a qualified plan.  There shouldn't be a taxable part of an untaxable rollover.

Can you just delete Worksheet 1-1?  I still can't figure out why you need it.  Form 8606 should only be $5,500 on lines 1,3,4,8,9,11,13,14,16,17, 1.000 (nontaxable portion) on line 10, and zero everywhere else (including basis, value on 12/31/2016, and taxable amount).