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Is a rollover from pre tax IRA back to pre tax 401K , then back door IRA taxable?

jesdq1
Level 3

Client rolled over all pre tax traditional IRA  (previously from all,100% pre tax 401K)  back into pre tax 401K. Then made a non deductible traditional IRA  contribution and immediately converted to Roth (back door IRA). Client argues that this is not a taxable transaction since no IRAs are in existence at the time of the Roth conversion. My position is that the funds came from 100% pre tax 401k and the source for the back door IRA came from pre tax,  therefore is taxable .  If some of the 401K was post tax, then we do the math and go from there, but this was all pre tax. The fact that there is no IRAs does not tell the whole story here since the source was 401k to IRA to 401K. OR, does the IRS only look at the value of any current IRA???? 

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qbteachmt
Level 15

"The Traditional IRA was populated by the 401K"

When?

Example:

Old 401(k) rolled to Trad IRA, then rolled to new employer's 401(k), then rolled to Traditional IRA? Because that part in BOLD is where you specifically stated a nondeductible contribution was made. That contradicts that a Rollover was made.

Which was it?

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"Level Up" is a gaming function, not a real life function.

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16 Replies 16
IRonMaN
Level 15

Tell your client to quit listening to tax advice down at the barbershop.  You can't take pretax money and put it into a Roth IRA without first stopping to pay some tax on that money.

I'm keeping this job. But I am selling surplus anvils on the side. If you are interested please call 867-5309
rbynaker
Level 11

I'm having trouble reconciling these two conflicting statements:


Then made a non deductible traditional IRA  contribution 

and


the source for the back door IRA came from pre tax

Was the IRA contribution non-deductible or pre-tax?

 

jesdq1
Level 3

The IRA is non deductible due to the high income of the client (IRA limitations). The source of the IRA came from all pre tax 401k.

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qbteachmt
Level 15

"My position is that the funds came from 100% pre tax 401k and the source for the back door IRA came from pre tax, therefore is taxable"

But that's not what you stated. Let's separate out the two types of Plans:

Employer and Individual

For Employer Pan: You stated there was the Reverse Rollover. As long as all Trad IRA money is now in the Employer 401(k), and none went into Roth 401(k), there is no conversion and no taxable event; and now, the person has no tax deferred amounts in Trad IRA, SIMPLE IRA or SEP.

For Individual: Now that there is nothing tax deferred outside of the Employer plan, they put a nondeductible contribution into Trad IRA and immediately rolled it to Roth IRA. That is Backdoor Roth, and since there is only Basis, there is no taxable event.

"The IRA is non deductible due to the high income of the client (IRA limitations). The source of the IRA came from all pre tax 401k."

The way you stated it, you have two different events.

"The fact that there is no IRAs does not tell the whole story here since the source was 401k to IRA to 401K."

That is the First part = Employer. There is nothing taxable about that part.

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"Level Up" is a gaming function, not a real life function.
jesdq1
Level 3

Thank You. I guess I am not making myself clear and I am not understanding (sorry it has been a long challenging tax year).  Their were two events, one being the Reverse Rollover and the second event was the non deductible IRA back door.  I agree the first event is non taxable. I am having a hard time understanding why the second event is not taxable. Yes, the client does not have an existing Traditional  IRA, Simple IRA or SEP. But, the dollars used to fund the non deductible IRA came from a 401k that has zero basis.  Help me understand how the rollover transforms tax deferred into no tax deferred or no basis. 

If an IRA existed at the time of the back door we must use an allocation method to arrive at the taxable amount. So, why do we not have to use an allocation method for the back door from a 401k?   Your help is greatly appreciated.  

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qbteachmt
Level 15

"But, the dollars used to fund the non deductible IRA came from a 401k that has zero basis."

You didn't describe this at all. You stated the funds for the 401(k) came as a rollover from a Trad IRA, which itself was a rollover from a 401(k). If all of that is true, then the funds stayed tax sheltered the entire time. The Backdoor Roth had nothing to do with the Employer-related activities. Perhaps you stated it incorrectly, or perhaps what you are thinking of really has no impact on anything.

You never stated he held back some of the funds in between any of the rollover steps. If he did, that would be a Distribution. Once you have these funds in your possession and have paid taxes and any penalties on them, they are just Your Money, at that point. There is no further examination needed for the Source. It's the same as any other money available to you and on hand. Take a vacation. Make an investment.

Next, when you fund your Nondeductible IRA, that's from money on hand. Employment takehome, Car wash, selling drugs, selling eggs, or a prior retirement distribution...Source or why you have these funds on hand, has no bearing on the use of the funds. The use of the funds has no bearing on the source of the funds. It's your money to do with what you want to.

Is there something you need to restate for understanding the path of the Roth Conversion, working backwards step by step, from Roth conversion to Nondeductible IRA to ????

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"Level Up" is a gaming function, not a real life function.
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qbteachmt
Level 15

This also is not in any of your descriptions: "So, why do we not have to use an allocation method for the back door from a 401k?"

How and where in these steps did the money move out of 401(k) and then into Roth IRA?

*******************************
"Level Up" is a gaming function, not a real life function.
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rbynaker
Level 11

I feel like we're just talking in circles at this point.  Perhaps it would be helpful if we had a timeline with dates, amounts and sources of funds.

 

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jesdq1
Level 3

I did not ask this question very clearly. Let me try again.  Client rolled over all of his Traditional IRAs into Employer 401K.  Then, opened a Non Deductible Traditional IRA, and immediately converted to a Roth IRA from the 401K. Conversion did not come from "new" money. The 401k contains all pre tax dollars with no basis. It is my understanding that the pro-rata rules (and Notice 2014-54) also apply to the 401k with a slightly different allocation method.  Since there is no basis in the 401k, the converted amount is taxable. The rollover of the IRA (done to try to escape the pro rata rules) did not help save any tax in this situation. If the client had for example $5,000 of post tax in the 401K, $5,000 escapes tax.   Am I correct?  Thank you for your help and patience. 

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qbteachmt
Level 15

Great; let's take it one step at a time.

"Client rolled over all of his Traditional IRAs into Employer 401K."

That means tax deferred amounts are still tax deferred.

"Then, opened a Non Deductible Traditional IRA, and immediately converted to a Roth IRA from the 401K."

But again, that sentence is two Different Things. What you stated here is the same as: I opened a can of Tuna and made a Ham Sandwich. I seem to have skipped over what happened to the Tuna and you don't know where the Ham came from.

Step 1: Opening an Account is what you do for investing.

Step 2: You designate it as your regular savings or investment account or a Traditional IRA (personal retirement account) or a Roth account or a 529 account.

Step 3: You Deposit to that account. The Contribution you then put into that account is either Pre-tax or post-tax or from a rollover and is either trustee-transfer or goes through you or is directly from your funds on hand; and had withholding or not.

You describe the person put personal, post-tax (nondeductible) funds into their Trad IRA account. Everything here, for the Traditional IRA, has no bearing on the 401(k) and is not impacted by having an employer plan.

"Conversion did not come from "new" money."

You have to tell us:

The money that went into the Traditional IRA account came from where?

The money that went into the Roth IRA account came from where?

Once he put money into the new employer plan (the 401(k) account) is that money still there or did he direct them to do something with it?

"It is my understanding that the pro-rata rules (and Notice 2014-54) also apply to the 401k with a slightly different allocation method."

This point is moot if he rolled/converted all of the money in the Trad IRA to the Roth. You told us it was right away and all of it is Basis.

Don't mix the 401(k) into this, unless that applies. And if it applies, how does it fit into the movement of funds?

"Since there is no basis in the 401k, the converted amount is taxable."

A Roth conversion from a Trad IRA is based on Trad IRA, SEP and SIMPLE IRA. Having a 401(k) has no bearing on Traditional to Roth conversions.

I still can't tell where money started, where it went Next, and where it ended.

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"Level Up" is a gaming function, not a real life function.
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qbteachmt
Level 15

Let me try another idea:

First 401(k) rollover to Trad IRA = if it was all pre-tax, it still is pre-taxed, and tax deferred.

Second 401(k) = if a new employer has a plan that accepts a rollover "into" it, the person rolled the Trad IRA to their Employer, and that would continue tax deferral.

Now we have No Trad IRA account. No SEP. No SIMPLE IRA.

Open a new Trad IRA account. Populate it with which funds, from where?

Backdoor Roth that Trad IRA account <== always taxable unless only Basis exists in the Trad IRA. Assuming the New Trad IRA account has only an amount recently deposited as Nondeductible, then that makes it all Basis (not time for earnings, even). Therefore, not a taxable event as long as there was no withholding, no earnings, and no amount held back by the owner, and it meets the timeliness rules for rollover/conversion.

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"Level Up" is a gaming function, not a real life function.
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jesdq1
Level 3

The Traditional IRA was populated by the 401K

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qbteachmt
Level 15

"The Traditional IRA was populated by the 401K"

When?

Example:

Old 401(k) rolled to Trad IRA, then rolled to new employer's 401(k), then rolled to Traditional IRA? Because that part in BOLD is where you specifically stated a nondeductible contribution was made. That contradicts that a Rollover was made.

Which was it?

*******************************
"Level Up" is a gaming function, not a real life function.

View solution in original post

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jesdq1
Level 3

Ok, Bingo! The light went on, I finally understand what both of you have been asking me (for the past two days)!  I did some further investigating with the client.  There WAS a distribution from the 401k in which a 1099R was issued which I do not have in my possession  yet.  Then that distribution was used to fund the Traditional IRA which was immediately converted to Roth IRA. So you are correct, no taxable event regarding the back door, pro rata calculation is moot, not relevant.  The distribution from the 401K will be taxed. And it does not matter that the traditional IRA was funded by dollars from the 401k disbursement, he could have used any of his "already been taxed" dollars to fund it. So, yes the non deductible IRA  certainly  has full basis. I thank you for taking the time and asking me the same question in so many different ways, but the ham sandwich analogy made me a bit hungry.  

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qbteachmt
Level 15

Okay, great! So this part applies: "Next, when you fund your Nondeductible IRA, that's from money on hand. Employment takehome, Car wash, selling drugs, selling eggs, or a prior retirement distribution..."

Glad to help.

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"Level Up" is a gaming function, not a real life function.
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jesdq1
Level 3

Yes. I was erroneously assuming the 401K was "magically" funding the Traditional IRA , skipping an important  sequence of these transactions.    

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