back door roth contribution

[Ruth1]

Good Morning itonewbie,

Your response below appears to be up my alley so to speak but I don't see the question which prompted it. I have a client who:

distributed 94K from a 401K and paid the tax.

Put the entire funds in a non-deductible IRA.

Took out the earned income and paid tax on it

 now wants to take the 94K and contribute to a Roth.

Fidelity says its taxable. I cant imagine it's not and further allowed at that large an amount.

I am perplexed by "there is no taxable income not because its not taxable but only because there is no taxable income to recognize"

I'm sort of drowning in the weeds. Taxable yea or nay?

Can you assist?  

[PhoebeRoberts]

Alternate scenario, in which the worst thing happened at every turn.

1) In 2018, client took some amount from their 401(k), and reported this as a taxable transaction on their 2018 return, and the math worked out however and now they have a big chunk of cash under a mattress.

2) In 2019, the client took their $94,000 wad of cash down to Fidelity, and said "put this in my nondeductible IRA for me," and Fidelity assumed had the client sign a paper claiming that it was a timely indirect rollover, and put it into an account where nondeductible IRA contributions had previously been made, which at the time had a basis of $100,000 and a FMV of $200,000. Total FMV is now $294,000.

3) In July 2020, the account had grown from $294,000 to $300,000. Client requests that the $6,000 growth be distributed. Custodian withholds 20% / $1,200 and sends the remaining $4,800 to the client, who goes and buys summer holiday gifts with it.

4) In July 2020, the client has $94,000 distributed to him and stuffs it under his mattress, leaving $200,000 in the IRA.

5) In December 2020, client contributes $94,000 to a Roth IRA.

Tax consequences of that mess:
2) Client has an excess contribution of $94,000 for 2019, which is subject to a 6% excise tax for each year until it comes back out.

3 & 4) I think this comes out excess contributions first, and it would take me a couple of hours to track down the code section references and manually calculate the earnings, but my eyeball guess is that all the excess would be out (with no tax because it's excess), and all of the earnings would be out (taxable + potential penalty if under 59.5), and there would be an additional amount which would run through the 8606 to determine taxability.

5) Another excess contribution.

[qbteachmt · Accepted solution]

Let me try: It helps to separate each event and go step by step.

"distributed 94K from a 401K and paid the tax"

The outflow is as distribution to the person, or as a direct transfer/rollover to an account brokerage or financial institution?

"Put the entire funds in a non-deductible IRA."

That was a conversion, if done in the required timeframe for Rollover. Or, this just happens to have made funds available to be contributed to the IRA under the new qualification, such as earnings from wages for that same tax year? Because you might be relating things that are not related nor dependent on each other.

"Took out the earned income and paid tax on it"

The taxable amount would be proportional to the basis of all Traditional IRA accounts. It isn't just the Earnings, but a ratio. Even if one entire IRA account is for Traditional pre-tax and the other is Traditional nondeductible, whichever you take from, the distribution/conversion is based on their combined total value. You cannot take one specific category of funds from a mixed account or even just the one account.

"now wants to take the 94K and contribute to a Roth."

Which is treated as a conversion, and is treated the same as the Distribution from the perspective of ratio (basis vs values in all sheltered IRA accounts).

"I am perplexed"

Here's what "backdoor Roth" typically means/requires:

You want to contribute to a Roth account, but do not qualify based on income limits.

You have no other traditional IRA accounts. You put the Nondeductible portion into a traditional IRA account and essentially immediately directly transfer to a Roth.

That's when there would be no taxable anything to report.

That may not be what you describe here, @Ruth1 

[Ruth1]

Thank you kindly

[qbteachmt]

Make sure to read this:

https://www.irs.gov/newsroom/coronavirus-related-relief-for-retirement-plans-and-iras-questions-and-...

Because the rules changed once the CARES act passed, and you need your client to give you answers, which you then apply to the new provisions. Not the provisions in the March 6 topic you originally commented in, if this is current year activity.

Also, when you mentioned, "but I don't see the question which prompted it" it isn't clear if you are looking at this from within your program or from a web browser. Come to your topic through a browser. Use the internet browser for internet-based common resources, to see all the available info.

[Ruth1]

Thank you kindly.