Backdoor Roth Cont. & Step Transaction

Submitted by Keith Peterson on Thu, 2020-04-16 21:15

I know Slott had a post about this back in 2018 after the tax relief package was passed, that included wording that essentially “blessed” backdoor Roth IRA contributions and that they don’t violate the step transaction rule. I just wanted to to make sure that in practice, it’s still okay to essentially do your pre-tax contribution to the IRA, and then convert to the Roth IRA on the same day, or consecutive days. I used to follow the Slott advice of waiting a month, but it sounds like that’s not necessary any more, and it’s certainly much easier and cleaner to just get it all done on the same day. Thanks for the help!

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Permalink Submitted by Alan - IRA critic on Thu, 2020-04-16 23:29

Yes, there is no need to wait before converting. However, a back door Roth is executed by making non deductible TIRA contribution (post tax not pre tax), and converting tax free. You could make a deductible contribution and then do a taxable conversion and the deduction and conversion tax would offset each other. However, most people cannot deduct the TIRA contribution when their income is also too high for a Roth contribution.

Permalink Submitted by Keith Peterson on Fri, 2020-04-17 14:25

Yes, apologies, I didn’t mean pre-tax contribution. Non-deductible IRA contribution, and then conversion. I gather from the comments that there is no real need to wait, which is the answer I was hoping for, so thanks all!

Permalink Submitted by William Tuttle on Thu, 2020-04-16 23:58

There was no change any tax law. There was only a mention of the Backdoor Roth process in the conference committee report, which does not confer any “substantial authority”.
The subsequent IRS comments were from a spokesperson, which here again does not confer any “substantial authority”.
The whole “wait a while” was never probative. There is ample precedence that delay does NOT cure a step transaction if it indeed ocurrs.
Not to mention that an IRS spokesman told the Wall Street Journal and Financial Planning magazine way back in 2012 and I quote verbatim; “There is no caveat about waiting”. Which yet again does not confer any “substantial authority”.
However, don’t panic if you get a CP2000 notice. Counterintuitively, it was rare to get a CP2000 Notice on a legitimate Backdoor before the TCJA, but there is strong anecdotal evidence that while still uncommon the IRS appears to be sending far more CP2000 Noties for legitimate Backdoors after the TCJA.
I leave it to Alan on how to dot your ‘I’s and cross your ‘T’s to miniminze the chance that happens.

Permalink Submitted by Keith Peterson on Tue, 2020-06-02 20:16

I saw over the weekend on twitter Michael Kitces is still recommending people wait a year to convert the money from the Non-Deductable IRA to the Roth. It appears the Slott team used to advise waiting for the next statement (i.e. about a month) to convert, but the comments above seem to indicate that’s no longer the train of thought. I trust the advive of Ed Slott and Michael Kitces about equally, and they rarely disagree on things like this, so i’d be curious to get some clarity. Don’t wait at all vs. wait a year is a bit of a disconnect. Thanks!

Permalink Submitted by William Tuttle on Tue, 2020-06-02 21:16

Michael Kites used to be Mr. Chicken Little on this issue. Now he is just a self-righteous stubborn laughing stock.

He is almost entirely responsible for this histerical step-transaction doctrine application. Not to mention, there is ample precedent that time does not cure a step transaction anyway.
The IRS refuted him in Financial Planning Magazine in 2011 and the Wall Street Journal in 2012. In Both cases they said there was no caveat about waiting to do a Roth conversion after doing a traditional IRA non-deductible contribution.
He had the unmitigated gall to continue to say he was right and knew better than the IRS, because no tax court decision had been rendered on this issue.
In a related 2017 case “Summa Holdings v. Comm’r of Internal Revenue”, the U.S. 6th Court of Appleals ruled that:

“Even if we were willing to endorse the Commissioner’s recharacterization power in its full flowering form—disregarding transactions based solely on an individual’s tax-minimizing motive—he could not use it here. No court has used this power to override statutory provisions whose only function is to enable tax savings.“
The Commissioner persists that Congress intended Roth IRAs to be used only by medianincome and low-income taxpayers, as evidenced by the contribution and income limits. We have our doubts. When pressed, the Commissioner knew of no empirical data to support the point. At any rate, Congress’s decision in 2005 to allow owners of traditional IRAs, who can make contributions regardless of income, to roll them over into Roth IRAs no matter how many assets the accounts hold or how high the owners’ incomes, see 26 U.S.C. § 408A(d)(3), undercuts this contention. Those rollovers permit high-income taxpayers to avoid the income limits on Roth IRA contributions, just as the DISC permitted Summa Holdings to avoid the contribution limits. The Commissioner cannot fault taxpayers for making the most of the tax-minimizing opportunities Congress created.“

You can choose to believe the IRS (twice), a U.S. Appeals Court, Congress and the IRS again. Or you can choose to support a legend in his own mind. A man who refuses to accept that he has been completely and unmistakenly wrong, when presented with overwhelming evidence for almost a decade, exhibits a serious character flaw.

Permalink Submitted by Alan - IRA critic on Tue, 2020-06-02 21:28

If correct, it is very surprising that Michael is doubling down on his pre TCJA step transaction warnings, even after Footnote 269 in the House TCJA Conference Report stated that the back door Roth was allowable. Back door Roth conversions have been going on several years now and to my knowledge the IRS has never challenged even one of them. No reason not to make the ND contribution and convert the next day.

Permalink Submitted by Keith Peterson on Wed, 2020-06-03 16:53

That’s perfect, thanks for the help! Here’s a link to the twitter thread if you’re interested. https://twitter.com/michaelkitces/status/1266746603479711745?s=21

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