It's common to see blogs and articles touting the wonders of Roth IRAs. When you understand the tax characteristics of this particular type of account, it’s easy to see why. Once the money is deposited into a Roth IRA, it is never again subject to taxes. That means all of the growth on your Roth IRA is tax-free.
The problem many doctors and high-income earners face when it comes to Roth IRAs is that once you begin earning over the IRS’ stated income limit (around $150k single and $250k married filing jointly), you are no longer permitted to make Roth IRA contributions. This is where the “backdoor” Roth IRA comes in.
The backdoor Roth IRA is not a different type of Roth IRA account. Rather, it informally refers to the method through which high-income earners can fund a Roth IRA in an IRS-sanctioned way. Instead of contributing to a Roth IRA, you convert funds from a Traditional IRA to your Roth IRA.
In this article, you will find helpful tips for reporting your backdoor Roth IRA conversions on your tax return.
But first, a disclaimer: You will likely not receive a backdoor Roth IRA tax form by the tax filing deadline if you did not complete the transaction in the calendar year of the tax return you are filing (transaction between 1/1/23-12/31/23 for 2023 taxes). However, you can still report your Roth IRA conversion without the tax forms.
Roth IRA conversions can be completed for the prior year up until the tax filing deadline — not including extensions (along with other tax items like HSA contributions). For example, if you forgot to complete your 2023 Roth IRA conversion, you may still be able to complete the transaction up until April 15, 2024.
Three different tax documents will be produced as a result of the Roth IRA conversion “transaction.” Two of the documents will be associated with the Traditional IRA that you used for the transaction (Forms 5498 and 1099-R), and the other will be associated with the Roth IRA (Form 5498).
The Traditional IRA 5498 reports the amount contributed to the Traditional IRA. It will look something like this:
Often, for doctors and high-income earners who only use their Traditional IRAs to facilitate backdoor Roth IRA conversions, their Traditional IRAs sit empty and dormant most of the year. And it will have a fair market value of $0.00 most of the time, as seen above.
The 1099-R for the Traditional IRA reports the amount that was “distributed” from the account. In this case, the funds were distributed or converted to the Roth IRA. Usually, the 1099-R will show that the amount distributed was approximately the amount that was contributed to the Traditional IRA (give or take some interest earnings). So, for instance, the 1099-R form will look something like this:
The custodian, or financial institution, has no way of knowing what type of transaction you are completing. They are simply reporting the deposits and withdrawals from the account.
You will notice that box 2a (above) shows that the entire gross distribution was a “taxable amount” because it comes from a Traditional IRA, which is usually a pre-tax account. In box 2b, the custodian admits they don’t really know the taxable amount — “taxable amount not determined.”
More on what the taxable amount should be when discussing IRS Form 8606 below.
The final tax document you should receive is another Form 5498 reporting the conversion of funds into your Roth IRA. The Roth IRA conversion amount should usually match the distributed amount from the 1099-R.
Form 8606 is the key to reporting backdoor Roth IRAs successfully. The tax form, which is filed as part of your overall return, reports to the IRS that the Traditional IRA contribution you made to start the process of the backdoor Roth IRA was not deductible. In other words, you are not taking a tax deduction for the Traditional IRA contribution.
In essence, this maintains the “after-tax” status of those dollars and allows the conversion from the Traditional IRA to the Roth IRA to be a non-taxable event. This is referred to as having basis in the Traditional IRA. For example, Form 8606 may look something like this:
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If you do not report the Traditional IRA as nondeductible, you may pay unnecessary taxes on the distribution/conversion from the Traditional IRA to the Roth IRA. This could cost you!
One way to double-check that you are reporting the backdoor Roth IRA correctly and not paying unnecessary taxes is by checking line 4 of Form 1040 (found on page 1 of your tax return). Unless you completed another IRA distribution, it should match the amount from your 1099-R, and most likely, line 4b should be $0. It may look something like this:
It should come as no surprise that there tends to be confusion about backdoor Roth IRAs. Everyone seems to have a general idea that Roth IRAs are good, but they are not clear on why and if doctors and other high-income earners are allowed to use them.
Backdoor Roth IRAs can be great for doctors and other high-income earners planning for retirement. However, they can be tricky. Therefore, it is essential to report them properly on your tax return to avoid unnecessary taxes.
Be sure to consult your CPA if you have specific questions regarding your situation.
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Will Koster is a financial planner with Spaugh Dameron Tenny. The experience of losing his father as a teenager helped Will find his calling in financial planning. He has a passion for working with dentists and physicians, helping them navigate their unique wealth creation journeys. In addition, Will has become the in-house expert on student loans after completing the Certified Student Loan Professional® training.
