Is Backdoor Roth ever allowed with Inherited Non-Spousal IRA's

[ea_rva aka acctgtaxmatters]

Taxpayer inherited IRA from Grandmother. Her share of the IRA is in her name and name of deceased. Advisor also created a Roth IRA in the name of the taxpayer so Trustee to Trustee. DOD was Dec 2020.

$8,000 was distributed in 2021 with 1099-R:

Line 1 = $8,000   Line 2a $8,000  Line 2b Marked X for Taxable amount not determined

Withheld for Fed & State   Line 7 = 4

No contributions and only $8,000 distribution, 2021 RMD Basis Value = $50,104

Advisor also provided statement that $6,000 Roth IRA contribution was made in 2021 in taxpayer's name. Roth Account Value as of 12/31/21 - $5,978.92.

Based on these facts, is all the $8,000 taxable?

Thanks for the help in advance!

[qbteachmt]

It's not "backdoor." Backdoor is Nondeductible Contribution, and you don't have a Contribution condition.

You might have a Conversion situation. Why did they open Roth for this?

[ea_rva aka acctgtaxmatters]

Do not know for sure. Could be prior to 2021 with no activity. Do I need to find out?

[ea_rva aka acctgtaxmatters]

Oh sorry I thought you said when. She thinks/calling the distribution a "rollover".

[qbteachmt]

"She thinks/calling the distribution a "rollover""

They can call it Chickens. That doesn't mean it Clucks.

Take everything sequentially, and by Type of IRA, because the rules matter.

DOD 2020. That means inherited Traditional or Roth? And not by Spouse. And that means SECURE Act applies.

Then, what was the next event? Let's break it down:

"Her share of the IRA is in her name and name of deceased."

What "share" and how does that apply?

What is this account (existing or new, Trad or Roth) and how is it titled (owned) as Deceased and Beneficiary, or as?

"Advisor also created a Roth IRA in the name of the taxpayer so Trustee to Trustee. DOD was Dec 2020."

Created the Roth, when? The "taxpayer" is the Beneficiary you are working for? The Date of the first deposit to the Roth is when? Where did that money come from? What happened next?

"$8,000 was distributed in 2021 with 1099-R:"

Distributed from the Roth?

"Line 1 = $8,000 Line 2a $8,000 Line 2b Marked X for Taxable amount not determined"

Do you know how long the deceased's IRA account existed? If that is/was also Roth, this matters.

"Withheld for Fed & State Line 7 = 4"

4 what?

"No contributions and only $8,000 distribution, 2021 RMD Basis Value = $50,104"

"Advisor also provided statement that $6,000 Roth IRA contribution was made in 2021 in taxpayer's name."

You just stated No contributions.

From the IRS: "If the inherited traditional IRA is from anyone other than a deceased spouse, the beneficiary cannot treat it as his or her own. This means that the beneficiary cannot make any contributions to the IRA or roll over any amounts into or out of the inherited IRA."

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-beneficiary

Notice that states traditional IRA. That's why we need to know which type of IRA the deceased owned.

"Roth Account Value as of 12/31/21 - $5,978.92."

You already told us a Basis was over $50k.

Are we mixing two or more accounts into this discussion?

"Based on these facts, is all the $8,000 taxable?"

It's not clear, yet.

[rbynaker]

Sounds like you have two completely unrelated things.  An inherited IRA distribution of $8,000 (which is likely fully taxable unless grandma had some IRA basis).

And a $6K Roth IRA contribution.  Check to make sure the contribution is allowed based on the AGI and earned income.

[qbteachmt]

Okay, I think this:

"Withheld for Fed & State Line 7 = 4"

translates as:

There is Fed withholding and State withholding, as well as Code 4 in box 7. Example:

"For an inherited retirement account, a Form 1099-R will typically report a "4," in box 7. If a "4" appears, it means you took a distribution from a tax-deferred retirement account and you are exempt from the early distribution penalty as the distributions were made after the original account holder's death."

I think you are telling us about a 1099-R from the Inherited account, which is only taxable prorata to that basis you told us about. Assuming your "share" is a breakdown of inheritance, there will be Math involved, for how much is taxable.

And then this person who took the Money, used it for some purpose. If that is transfer, this has nothing to do with the way the word "transfer" applies in any IRA regulation. You have Electronic Banking, not Transfer, it seems. You have a person who was entitled to keep the net from $8k minus withholding, but instead, sent it to their own Roth as that year's contribution. That is Source of the money they used, instead of (for instance) mowing lawns or selling blood to raise money to deposit into their Roth against their own earnings. That is not Rollover.

Is that the story?

[ea_rva aka acctgtaxmatters]

"What "share" and how does that apply?"

The Traditional IRA  (Acct #1) the $8,000 was distributed from is in her name and grandmother's name + (Decd). There were no contributions to this account. Basis is $50,104

Correct. Secure Act applies. The $8,000 is an RMD.

"Withheld for Fed & State Line 7 = 4"

Line 7 = 4 = Death

The 2021 $6,000 contribution made on behalf of the taxpayer was a different account - a Roth IRA (Acct#2) only in the taxpayer's name.

"Do you know how long the deceased's IRA account existed? If that is/was also Roth, this matters."

This was a traditional IRA. Do not know how long account existed.

"Roth Account Value as of 12/31/21 - $5,978.92."

This relates to Roth - Acct #2

Thank you!

[ea_rva aka acctgtaxmatters]

Thank you both.

How does the $50k 12/31/21 basis factor into calculating what's taxable? Only moving forward? 

I thought her basis would have been the GM basis? Do I just need to confirm that with advisor?

[qbteachmt]

"The Traditional IRA (Acct #1) the $8,000 was distributed from is in her name and grandmother's name + (Decd). There were no contributions to this account. Basis is $50,104"

Then you do enter this into the 1099-R worksheet, because basis divided by total FMV is going to give prorated percentage for portion not taxable and portion taxable of the Gross distributed.

"The $8,000 is an RMD."

It falls under the 10-year rule. Not Grandma's RMD.

"The 2021 $6,000 contribution made on behalf of the taxpayer was a different account - a Roth IRA (Acct#2) only in the taxpayer's name."

Has nothing to do with the story for the inherited account. I think you confused Source of money, with IRA provisions. These provisions do not apply to anything in this scenario. There is no Relationship between Inherited IRA and your taxpayer's own IRA(s) and activities.

No rollover.

No conversion.

No Backdoor.

No transfer.

No trustee-to-trustee event.

Just a paperless movement of Distributed money to be deposited into some account your taxpayer owns.

[qbteachmt]

Yes, the basis each year will be used against the FMV each year, for computing the taxable and nontaxable portions of each distribution year. Realize it will change, as there are earnings, and every distribution reduces basis.

$100,000 account FMV, $20k basis and $20k distribution =

20% nontaxable and 80% taxable.

$4k nontaxable + $16k taxable.

And now, $20k basis - $4k = $16k basis remaining.

Every year, recompute basis, then recompute prorata.

[ea_rva aka acctgtaxmatters]

Thank you.

The Trad IRA shows 2021 RMD Basis Value of $50,104.07

Then lists assets with total FMV of $50,104.07

So I still need to ask what the beginning basis was correct or do I just back into it based on distributions of $8k and $0 contributions.

[qbteachmt]

"RMD Basis Value of $50,104.07

Then lists assets with total FMV of $50,104.07"

If they match, then that is not what we've been discussing. It helps to know the word "basis" is used in many ways. All it means, really, is "based on."

"Trad IRA Basis" is the amount in a tax-deferred or sheltered account that was already taxed, or Post-tax, because it is not taxable again coming out, if it was taxed before going in. That would be, for instance, a Nondeductible contribution that someone made and then decided not to do a Backdoor Roth. And perhaps there is no Basis (already taxed funds) in this account at all. It can be unusual.

But the word Basis, applied to RMD, would mean: Here is the RMD value to use for the RMD table, to know you are taking an appropriate RMD. The deceased, if over 70 1/2 (now, at 72) would be taking Required Minimum Distributions as computation for the life expectancy table, that person's age, and their FMV of the account per the RMD rules.

Your client has a different rule than the life expectancy rule. Your client falls under the Inherited non-spousal rule and the SECURE Act applies: "Starting with those inherited after Jan. 1, 2020, the SECURE Act requires the entire balance of the participant's inherited IRA account to be distributed or withdrawn within 10 years of the death of the original owner."

Read this:

https://www.investopedia.com/articles/personal-finance/102815/rules-rmds-ira-beneficiaries.asp

Elsewhere on this forum, there is a recent topic for the question of taking it as RMD over 10 years, or holding off and taking it all at the end, or variations, is under scrutiny by the IRS, again. They are still trying to figure out how to comply with the SECURE Act changes.

[rbynaker]

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@ea_rva aka acctgtaxmatters wrote:

Thank you both.

How does the $50k 12/31/21 basis factor into calculating what's taxable? Only moving forward? 

I thought her basis would have been the GM basis? Do I just need to confirm that with advisor?

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The $50K is not basis, it's the FMV on 12/31/21.  If there is any IRA basis the executor might be able to get the most recent Form 8606 filed by the deceased.  I've not seen any inherited IRAs with basis yet but I'm certainly tracking enough taxpayers with 8606 forms accumulating basis.  So this will be a much bigger deal going forward and there is currently no mechanism for communicating tax basis in IRAs to beneficiaries inheriting them.

The $50K is what's used to calculate next year's RMD[1].  I'll bet you a shiny new nickel that number has nothing to do with tax basis in the inherited IRA.

Rick

[1] RMDs for inherited IRAs are currently under debate, the IRS just last month released proposed regulations indicating that RMDs *do* still apply to post-SECURE Act inherited IRAs if the decedent was already taking RMDs.  Prior to this, the general sense of Congressional Intent was that the new "10-year" distribution rules supplant the RMD rules.  IRS 2021 Publications even take this approach (10 years *instead* of RMD math).  Now new IRS proposed regulations interpret the law to mean that the RMDs still apply *in addition to* the 10-year rule.  Time will tell who's correct.  In cases of my clients inheriting IRAs post-SECURE Act, they are already spreading the distributions over the 10 years to avoid a lump-sum distribution throwing them into a higher tax bracket later.  So far I haven't had to take a tax position on RMDs.

[ea_rva aka acctgtaxmatters]

Thanks for your reply.

If I was able to get the deceased last 8606 (good chance I can) I would then have to know my client's portion of that basis which wouldn't necessarily be equal to her 3% as a beneficiary i.e. she could have received her share from other assets of the same value correct.

This is all about learning for me so thank you Rick and QBteachmt

[qbteachmt]

"be equal to her 3% as a beneficiary"

What 3%?

If your client got a portion, that FMV and any Basis would carry over.

$100,000 FMV, $20,000 basis = 20% basis.

Your client gets 3% = $3,000 inherited, and the first year, assuming in this example no growth or earnings, then Basis is $600. $2,400 would be money that was never taxed. That matters when there is a distribution, to not double-tax basis.

The Broker should be able to help, and the tax software should handle the rest.

This never should have been this hard.

[qbteachmt]

Oh:

"she could have received her share from other assets of the same value correct."

No. IRA is an Account. Not "assets." Whatever the holdings in the Account, it is just an Account. That's why putting certain investment types in an IRA makes no sense. Everything that comes out of the IRA that is taxable is Ordinary Income, even if it is gain from the sale of Stocks or State Bond Interest.

It is a convoluted subject, and it is not something to try to teach yourself. It is good you asked, but use the IRS and other resources, too. I really like the Investopedia articles.

[ea_rva aka acctgtaxmatters]

Agreed, not the best time for me to be figuring this out.

I SO appreciate you both and all the others that help us newbies.

[sjrcpa]

If your client inherited 3% of the IRA I would move on.

The entire basis probably could not be more than $50K. 

[sjrcpa]

The broker would not have basis in the IRA.

[sjrcpa]

Basis in the entire IRA would be $3,000 to the client in that example. But you don't recover it on a FIFO basis when taking distributions. It is pro rata each year. That's why I said move on.

[ea_rva aka acctgtaxmatters]

Thank you for that suggestion. Completely makes sense but I also have 4 other beneficiaries of same trust as clients so will make this last effort.

[ea_rva aka acctgtaxmatters]

Gotcha. I appreciate your responses. 

[rbynaker]

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@sjrcpa wrote:

If your client inherited 3% of the IRA I would move on.

The entire basis probably could not be more than $50K. 

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I read that (incorrectly!) as 33%.  But then I realized I don't really know how you would allocate IRA basis in a complex situation.  If there's only one account with 3 beneficiaries, no problem 1/3 of the assets, 1/3 of the basis, done.  If you have multiple accounts with different beneficiaries and different investments then at what point do you allocate basis over FMV?  I couldn't find the answer with a quick google so I stuck this on my calendar to research after 4/15.  My guess is that you would take FMV of all accounts at DOD and allocate basis to each account beneficiary on that ratio.