Roth Conversion Pro Rata Rule/Date

Submitted by MIKE KRUCHTEN on Tue, 2018-08-21 18:32

I have a client with a TIRA valued at 100k, 25k of which are non deductible contributions. I understand the conversion value of TIRA is not based on date of conversion but year end but have questions on how this is figured. If my client converts 50k from TIRA to Roth IRA today and year end TIRA has grown to 60k, I assume the IRS assumes the TIRA FMV would be $110,000. Take year end value and add back in conversion amount??? If market drops and TIRA is valued at 40k then TIRA FMV would be $90,000. I assume this is how it’s calculated but looking for clarity or an example. Also the prorata ratio on date of conversion would have been 25% but year end value will tweak the true pro rata amount then would be slightly different again the following year end, correct?



Submitted by David Mertz on Tue, 2018-08-21 19:13

Correct.  Form 8606 adds the conversion amount (line 8) to the year-end value (line 6) and any other regular distributions that are not rolled over, QCDs or HFDs (line 7) when determining the basis ratio.  https://www.irs.gov/pub/irs-pdf/f8606.pdf

Submitted by B_Parker73 on Wed, 2018-10-17 22:41

I too was looking for an example illustrating the computations (and appropriate dates) for a Traditional IRA to Roth IRA Conversion.  DMx, thanks for highlighting ‘the year-end value (line 6)’, for the value and date question.  I was focusing on Form 8606 Part II, and didn’t notice Line 6, Part I.       I’m befuddled by the mechanics of Form 8606, Part II.  If someone could point to an illustration of how the three lines are supposed to be completed, I would be grateful.  As I read it:   Line 16 is the dollar amount of conversion from Trad IRA to Roth IRA (on the date of the conversion). Yes, seems straightforward.        QUESTION 1 Regarding Line 17.  The Form says – If you completed Part I (which I did not because Part I did not apply to my situation) enter the amount from Line 11.  Otherwise, enter your basis in the amount of Line 16.  So, I assume this is the proportion of my basis that is related to the Line 16 amount and NOT the total basis in the Traditional IRA.     This seemed correct, UNTIL I read the Form 8606 instructions. The Instructions (page 9) tell me that if I didn’t complete Line 11 (Part I), enter on Line 17 the amount from Line 2 (or the amount you would have entered on Line 2 if you had completed that line) .  On the Form, Line 2, Part I, says to enter your TOTAL basis in traditional IRAs.  So I am supposed to enter on Line 17 my total basis in traditional IRA?  This doesn’t seem logical, nor does it agree with anything I’ve learned from reading these Forum posts.  I’m not asking for justification of the IRS Form, nor am I intending to criticize it.  Obviously, I am misreading or misinterpreting the Form and / or Instructions.  Any guidence is appreciated.         QUESTION (Comment) 2 Regarding Line 17.  In determining the basis ratio, based on DMx’s excellent answer, it appears that a taxpayer will never know in advance with any certainty the amount of the conversion that is taxable.  Only at year-end when the Traditional IRA FMV is fixed, can the computation of the taxable portion of the conversion be calculated.  Do I understand that correctly?   Thanks for any thoughts or feedback.

Submitted by David Mertz on Thu, 2018-10-18 00:35

  • Q1:  If you had basis in nondeductible contributions in your traditional IRAs, made no nondeductible traditional IRA contributions for the current tax year, converted *all* of your traditional IRA money to Roth in the current year and did not recharacterize any of the conversion back to a traditional IRA (leaving a zero balance in traditional IRAs), and you made no TIRA distributions in the current year that would be reportable on line 7, you skip Form 8606 Part I and enter the conversion amount and total basis directly on lines 16 and 17 of Part II.  (Interestingly, the tax software I’m most familiar with completes Part I under these circumstances despite the Form 8606 instructions to the contrary.  The result in Part II ends up being the same as if Part I was skipped.)
  • B_Parker73, your description of the circumstances seem to imply that you did not convert all of your traditional IRA money in the current year.  If that’s correct, Part I must be completed if you have basis in nondeductible traditional IRA contributions.
  • Q2:  When all of one’s TIRA money is converted and shown on line 16, the total amount of basis goes on line 17.  Since all of the TIRA money has been converted and no additional TIRA contributions are made during the year, the year-end TIRA balance is zero and the taxable amount of the conversions is simply the converted amount minus all of the basis (but not less than zero).
  • [I replied before reading Alan’s post below where he said the same thing.]

Submitted by B_Parker73 on Wed, 2018-11-07 20:57

DMx, first I want to thank you very much for taking the time to respond to my questions.  I really appreciate it.  Your  answers were helpful and informative.   

  • I apologize for my misreading of the Form 8606 directions for completing Part I.  Indeed, you are correct in assuming the facts (wh I did not present).   I did “convert part, BUT NOT ALL, of my TIRA in 2018, AND made non-deductible contributions to a TIRA in  an EARLIER year!”   It appears I simply glossed over the “earlier year” requirement in my reading, and concluded (incorrectly) that Part I did not apply to my facts.

Sincerely,

Submitted by Alan - IRA critic on Wed, 2018-10-17 23:41

  • First of all, you need to certain that IF Part I is required you will need to complete it for Part II to be correct. In the simple case where all you did was convert your ENTIRE TIRA, with no other transactions, Part I does not apply, so you enter your total dollar of IRA basis on line 17. Subtracting that basis from your gross converted amount provides the taxable amount on line 18.
  • This total basis comes from line 14 on your last 8606, which is the amount that would have been carried to line 2 of the current form, if you had to complete Part I.
  • Q 2 – in the above situation, the taxpayer will know the taxable amount on the day that the total conversion is completed. Note that IF the taxpayer does the total conversion and later that year rolls a 401k into the TIRA, then the taxpayer’s conversion is no longer a total conversion (ie you converted “part” of the TIRA) and there will be a year end value in the TIRA, Part I will be needed, and therefore the basis will be pro rated on the conversion. That is why you need to be sure if the instructions require a Part I or not.
  • Another characteristic of Form 8606 is that Part I addresses both Roth conversions AND distributions that are not converted. Part II only addresses the portion that is actually converted. So if you converted 80% of your TIRA and distributed the other 20% to yourself, then you will need Part I to apportion your basis between the conversion and the non conversion distribution.
  • Completion of Part I is also important for another reason, since your last 8606 will not show your remaining basis on line 14 if you do not complete Part I. So if you converted your total TIRA, followed the instructions and reported it only in Part II, and you happened to have MORE basis than value in your TIRA, the remaining basis would not show up on line 14 of your last 8606. That suggests that this unused basis is erased should you have future Form 8606 activity. Since you can no longer use a misc deduction to itemize the lost basis and can no longer carry it forward for future use, it appears to be lost. If you were to find yourself in this situation (which is very rare), you would NOT convert your entire TIRA. If you left $10 in the TIRA, then your conversion would be partial and you would have to complete Part I, thus preserving your basis on line 14 for possible future use.
  • Another issue with the 8606 Inst is how to address basis if you annuitized one of your IRAs. Applying basis when you have annuitized depends on the year end value of your IRA, but you do NOT have a year end value of an annuitized IRA because you sold it to an insurance company in exchange for monthly payments. Apparently, the IRS never considered that an IRA annuity would actually be annuitized, but many have been with no forthcoming clarification on handling basis from the IRS.

Submitted by B_Parker73 on Wed, 2018-11-07 21:17

Alan-iracritic,  Thanks very much for your detailed reply to my questions.  Brilliant.  I really appreciate that you took the time to answer so thoroughly.    

  • I responded to MDx’s remarks re: my mis-reading the directions for completing Form 8606, Part I, which I now realize I need to complete. 
  • Also I appreciate your insights; I am blown away by:   (a) how much you know about Form 8606 and (b) the presentation of the issues which may result from not completing the form properly, including basis ‘evaporation’ from a miscalculation.   

 I need to go back and review more completely each of your points to ensure I fully understand each one, but in any case, thanks again for taking the time to respond and for having responded so comprehensively. Sincerely,   

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