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INSIDE THIS EDITION:
What You Should Know About Tariffs and Potential Trade War
Weekly Technical Comment
IRS Finally Says Back Door Roths Are OK
401k Plan Manager
STA Wealth participates in the Ed Slott Elite IRA Advisor Program. As part of that access, we get up to date information on all updates related to market and regulatory changes. We just got word that the IRS has now formally accepted the “Back-Door Roth IRA” as an effective strategy.
The “backdoor” Roth method — which involves contributing to a traditional IRA and then converting to a Roth IRA — is allowed under the law.
– Donald Kieffer Jr., tax law specialist (employee plans rulings and agreements), IRS Tax-Exempt and Government Entities Division, said July 10 on a Tax Talk Today webcast, reported by Tax Notes.
Yes, it’s official. The long-running debate on whether a back-door Roth is legal is over. It’s legal.
Actually, it was over when the Congressional Conference Report for the Tax Cuts and Jobs Act said four times that the so called “back-door Roth” was fine by them. Here is one of those statements:
Congressional Conference Report on the law:
“Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA.”
Remember that the IRS is there to interpret the tax law as written by Congress. This was a gray area before only because it was not spelled out that the transaction was legal. That led some (not me!) to say the IRS would call this a step-transaction and thus it would be illegal. Well, now that Congress spoke back in December 2017, the IRS has officially approved the back-door Roth. They won’t challenge it, so it’s full steam ahead for those who qualify.
It turns out that IRS just didn’t like the words “back-door” or “workaround” when it comes to tax law. Those words are red flags for IRS.
“I think the IRS’s only caution would be whenever we see words like ‘back door’ or ‘workaround’ or other step transactions that are putatively enabling a way to get around limits — especially statutory contribution limits — you generally find the IRS is not happy and prepared to challenge those,” Kieffer said. “But in this one that we’re talking about, it’s allowed under the law.”
Back-Door Roth IRA Basics
To review, the reason the back-door Roth evolved was because of the income limits for making a contribution to a Roth IRA. Since there are no income limits on Roth conversions or on contributions to traditional IRAs, the strategy was to first contribute to a traditional non-deductible IRA and then convert those funds to a Roth IRA, bypassing the Roth IRA contribution limits. The funds actually go into the Roth as a Roth conversion, not as a Roth contribution.
Also, not everyone qualifies for the back-door Roth. You still have to be eligible to make a contribution to a traditional IRA, which is the first step in the back-door Roth process. Qualifying for a traditional IRA contribution means having earned income (except for a non-working spouse if filing a joint return with a spouse having the earned income) and not being over age 70½, since traditional IRA contributions cannot be made for the year one turns age 70½ or later years. In addition, keep in mind that the pro-rata rule applies, which means that part or all of the back-door Roth conversion might be taxable if there are other traditional IRA funds, including SEP and SIMPLE IRA funds. The once-per-year 60-day IRA rollover rule does not apply to Roth IRA conversions.
For more on Back-Door Roth IRAs, check out Ed Slott’s Definitive Guide to Back Door Roth IRAs.
Ed Slott, CPA, is a recognized retirement tax expert and author of many retirement focused books. For more information on Ed Slott, Ed Slott’s 2-Day IRA Workshop and Ed Slott’s Elite IRA Advisor Group, please visit www.IRAhelp.com. Mr. Slott will be a keynote speaker at Financial Advisor’s Inside Retirement conference in Las Vegas on September 27.
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