Tag Archives: Backdoor Roth IRA

IRA Basis Isolation Revisited

Basis in IRAs is a funny thing. It necessitates the Pro-Rata Rule, one of the least understood tax rules affecting financial planning. IRA basis creates all sorts of confusion, making traditional IRAs less user friendly. 

Further, the value of basis in a traditional IRA is whittled away by inflation. Basis is generally the undistributed prior after-tax (or nondeductible) contributions in the IRA. Since basis might be distributed or converted years, perhaps decades, after the contribution, and is not increased for inflation, its value diminishes the longer it exists. 

Thus, basis isolation techniques gain attention. The idea is to use the basis in an advantageous way to (1) harvest it prior to its value being eroded away by inflation and (2) move basis amounts into Roth IRAs relatively tax free. 

Basis Isolation Techniques

The most basic basis isolation technique is a properly done Backdoor Roth IRA. IRA basis is created and quickly used to move money into Roth IRAs. The basis is fully used before inflation can erode its value.

The Backdoor Roth IRA is a simple tactic that, employed over many years, can be tremendously beneficial. It has very little downside risk and is relatively simple to implement. 

Another basis isolation tactic is the qualified charitable distribution (“QCD”). This one is even easier than the Backdoor Roth IRA. QCDs do not take IRA basis when transferred to a charity. Thus, distributions the taxpayer receives and/or Roth conversions attract more of the available IRA basis to reduce the taxable amount. A small IRA basis benefit, but still helpful. 

What about situations where someone has (1) significant basis in an IRA and (2) significant pretax amounts in an IRA? Now we have complexity, risk, and opportunity. The tactic I wrote about which could be useful in this situation is the Basis Isolation Backdoor Roth IRA.

The Basis Isolation Backdoor Roth IRA does the following:

  1. Cleans up IRA basis and uses it before inflation reduces its value. 
  2. Creates a Roth IRA the owner can use for tax free withdrawals in retirement. 
  3. Reduces future required minimum distributions (“RMDs”) by reducing the size of a traditional IRA. 

I believe advisors and IRA owners need to proceed with caution when it comes to the Basis Isolation Backdoor Roth IRA. What initially looks incredibly attractive may turn out to be an unattractive planning technique.

Note that some 401(k) and other qualified plans do not accept roll-ins of IRAs. Some other plans only accept roll-ins of a certain type of IRA, a “conduit IRA.” A conduit IRA is an IRA comprised only of old 401(k)s, 403(b)s, governmental 457s, and other qualified plans and the growth thereon. Thus, plans requiring that the rolled-in IRA be a conduit IRA cannot be used to facilitate isolation of IRA basis created by old nondeductible traditional IRA annual contributions, since the growth on nondeductible traditional IRA contributions is not eligible to be moved over to such plans. 

Basis Isolation Backdoor Roth IRA Examples

To analyze whether employing a sophisticated IRA basis isolation technique is advisable, I’m going to present two examples. These examples will illustrate when I favor and when I disfavor using the Basis Isolation Backdoor Roth IRA. 

Example 1: Basis Isolation Backdoor Roth IRA into a Large Employer 401(k)

April, age 48 in 2026, works for Apple Inc. She is a participant in their 401(k) plan. In 2022 through 2026 her adjusted gross income was such that she qualified for neither a deductible annual contribution to a traditional IRA nor an annual contribution to a Roth IRA. In 2022 she contributed $6,000 to a traditional IRA. In 2023 she contributed $6,500 to a traditional IRA. In 2024 she contributed $7,000 to a traditional IRA.

All of these contributions were nondeductible. In 2025 April learned about the Backdoor Roth IRA and the Pro-Rata Rule. Thus, she did not make any contributions to a traditional IRA for 2025. 

April is planning on retiring in five years. She has a sizable balance in her 401(k). Her taxable brokerage account is worth $100,000, and her traditional IRA is worth $100,000, consisting of (1) the three nondeductible contributions ($19,500 total), (2) a $20,000 401(k) rollover from a former employer plan and (3) investment growth on both 1 and 2. April has no Roth IRAs or health savings accounts.

Only for sake of this analysis, assume Apple’s 401(k) both accepts all IRA roll-ins (other than IRA basis) and offers satisfactory low-cost investment options. 

April proceeds as follows:

Step 1: In May 2026, April contacts her IRA custodian and splits her $100,000 traditional IRA into two IRAs. The first is $19,700 invested in a money market account (her basis amount of $19,500 plus a small $200 round up). This IRA is the Leave Behind IRA. The second IRA (IRA 2) is worth $80,300 and can be invested in whatever April desires.

Step 2: April works with the Apple 401(k) plan and her IRA custodian to arrange a direct trustee-to-trustee transfer of IRA 2 from the traditional IRA to April’s Apple 401(k) account. 

Step 3: After the completion of Step 2, April converts the entire Leave Behind IRA (now worth $19,900 due to interest accruing on the money market fund) to a Roth IRA. Due to IRA basis isolation, only $400 of the $19,900 is taxable to April on her 2026 federal income tax return. 

Steps 1 through 3 are the Basis Isolation Backdoor Roth IRA. 

Step 4: April executes the two steps of a 2026 Backdoor Roth IRA, getting another $7,500 (plus a small amount of interest) into her Roth IRA.

Step 5: April ensures that as of December 31, 2026, she has $0 balances in all traditional IRAs, traditional SEP IRAs, and traditional SIMPLE IRAs. 

I’m drafting this at the end of the Winter Olympics. Recall that many of the figure skaters make the “heart sign” gesture after their skates. You can feel free to picture me making the heart sign gesture when thinking about April’s Basis Isolation Backdoor Roth IRA. 

Why do I like this basis isolation play for April? Let me list the reasons.

Reason One: Helpful to April in early retirement. Recall that April intends to retire at age 53. Recall further that April has just $100,000 in a taxable brokerage account and no Roth IRA or HSA. Steps 1 through 4 create approximately $27,500 in Roth IRA basis that April can access in early retirement prior to age 59 ½ without tax or penalty. Further, the Basis Isolation Backdoor Roth IRA opens up the Backdoor Roth IRA for the last five years of her career, allowing her to create even more Roth IRA basis that can help fund early retirement advantageously from a Premium Tax Credit perspective and an income tax perspective.

Reason Two: Relatively modest IRA transfer. April moves approximately $80,000 of pretax IRA money. Any movement of pretax IRA money involves, however small, an element of risk. While $80,000 is not a tiny sum, it is also not a huge sum. It’s not the lion’s share of April’s wealth. Execution risk is mitigated in April’s case by the modesty of the sum moving into the Apple 401(k).

Reason Three: Using a large employer 401(k). Unless you work at Apple, you, like me, have little insight as to the contours and compliance record of Apple’s 401(k). Regardless, we would be absolutely shocked if we woke up tomorrow morning and read that the IRS and/or the Department of Labor challenged Apple’s 401(k) plan qualification. 

Why? Disqualifying Apple’s 401(k) plan would create problems for thousands of voters. Congressmen from multiple Congressional districts, and perhaps even Senators, would strongly question the IRS and/or the Department of Labor about the issue. We know the motivations of the IRS and Department of Labor in this regard. They have every incentive to avoid significant headaches and work with Apple to get to a place where Apple’s 401(k) qualifies as a 401(k). 

None of this is to cast aspersions at IRS and/or Department of Labor personnel. It’s simply acknowledging reality. How often do you look to stir up a hornet’s nest at your place of work? 

As discussed above, I have absolutely no knowledge or opinion about the qualification of Apple’s 401(k) and/or the quality of the investments in it. I simply raise possibilities and discuss pivotal actors’ motivations to explore planning where one uses a workplace 401(k) to facilitate an IRA basis isolation transaction. 

Helping fund early retirement. Relatively low risk of transferring pretax amounts. Parking assets in a stable, established, large employer 401(k) to achieve the objective.

April’s Basis Isolation Backdoor Roth IRA is quite attractive, in my opinion. 

Example 2: Basis Isolation Backdoor Roth IRA into a Solo 401(k)

Jack, age 66 in 2026, and his wife, Becky, also age 66 in 2026, retired two years ago. Jack made $80,000 of nondeductible traditional IRA contributions over the years. With rollovers of prior large employer 401(k)s, today Jack’s traditional IRA is worth $2 million. Jack is very happy with the financial institution holding the traditional IRA and the investments offered by that institution. 

Jack and Becky currently live off taxable brokerage accounts, currently worth $1 million. Becky also has $500,000 in a traditional IRA with no basis. Neither Jack nor Becky has a Roth IRA or an HSA. 

Jack is interested in isolating his $80,000 traditional IRA basis and getting it into a Roth IRA. He’s heard about the Solo 401(k) and is intrigued. He concocts an idea. He will drive for Lyft part time for three months. Doing so brings in $3,000 of revenue. After expenses and a deduction for half of his self-employment taxes, he has $2,000 of net profit.

Jack proceeds as follows:

Step 1: Jack takes the position that he has self-employment income in 2026 and thus opens a Solo 401(k). He makes a maximum $2,000 employee deferral contribution for 2026.

Step 2: In August 2026, Jack contacts his IRA custodian and splits his $2 million traditional IRA into two IRAs. The first is $80,200 invested in a money market account (his basis amount of $80,000 plus a small $200 round up). This IRA is the Leave Behind IRA. The second IRA (IRA 2) is worth $1,920,000 and can be invested in whatever Jack desires.

Step 3: Jack works with the Solo 401(k) plan custodian and his IRA custodian to arrange a direct trustee-to-trustee transfer of IRA 2 from the traditional IRA to Jack’s Solo 401(k) account. 

Step 4: After the completion of Step 3, Jack converts the entire Leave Behind IRA (now worth $80,500 due to interest accruing on the money market fund) to a Roth IRA. Due to IRA basis isolation, Jack takes the position that only $500 of the $80,500 is taxable to him on his 2026 federal income tax return. 

Steps 2 through 4 are the Basis Isolation Backdoor Roth IRA. 

Step 5: Jack ensures that as of December 31, 2026, he has $0 balances in all traditional IRAs, traditional SEP IRAs, and traditional SIMPLE IRAs. 

Jack’s Basis Isolation Backdoor Roth IRA makes me feel the way my New York Jets fandom has in recent years. For those unaware, the Jets currently have the longest streak of missing the playoffs in North American major sports. 

Why do I disfavor this basis isolation play for Jack? Let me list the reasons.

Reason One: No help solving retirement funding issues. Jack and Becky’s retirement is well funded. Unlike April, they do not need to control income for Premium Tax Credit purposes. Jack and Becky are currently living off taxable accounts. As I have previously discussed, they may pay practically no federal income tax doing so. 

Why are Jack and Becky moving a large account and doing sophisticated distribution planning when they already have years of paying hardly any federal income tax?

Reason Two: Large IRA transfer. Jack moves approximately $1.92M of pretax IRA money. Any movement of pretax IRA money involves, however small, an element of risk. $1.92 million is the lion’s share of Jack and Becky’s financial wealth. Execution risk on a $1.92 million transfer of assets already in a satisfactory location, a traditional IRA with a liked institution, is not something I favor successful retirees affirmatively planning into. 

Reason Three: Using a Solo 401(k). Compare the IRS disqualifying Jack’s Solo 401(k) with disqualifying Apple’s Solo 401(k). No Congressman is reaching out to the IRS if they disqualify Jack’s Solo 401(k). Further, the success of Jack’s strategy depends on him successfully maintaining his Solo 401(k) in the future. Rocket science? No. But guaranteed? Also, no. 

Is Jack’s Solo 401(k) Valid? 

Contributions of Self-Employment Income

I strongly question whether Jack would have a valid Solo 401(k) in this fact pattern. Consider the Congressional intent behind Solo 401(k)s. Solo 401(k)s allow the self-employed to make significant contributions of self-employment income to retirement accounts. Solo 401(k)s solve for the problem of the self-employed not having access to large employer 401(k) plans. 

Jack’s use of a Solo 401(k) is hardly reflective of the intent behind the Solo 401(k). Jack accumulated years of retirement account contributions in a traditional IRA. He had no need for the Solo 401(k) to accumulate and maintain retirement savings. Further, about a tenth of a percent of the Solo 401(k) balance is funded by “self-employment income.” About 99.9 percent of the balance of Jack’s Solo 401(k) has nothing to do with self-employment. 

These numbers indicate that Jack’s Solo 401(k) has little to do with contributions of self-employment income to save for retirement. 

Is Jack Self-Employed?

As I discussed on page 24 of this article, one needs self-employment to have a Solo 401(k). I strongly question whether Jack’s Lyft driving qualifies as self-employment allowing him to open a Solo 401(k). 

Consider making the case to respect Jack’s Lyft activities as “self-employment.” How is a retired person self-employed? What do Jack and Becky live off of? Accumulated retirement assets or Lyft income? That Jack and Becky live off their retirement savings and not off Jack’s Lyft income is instructive in determining whether that income comes from an activity sufficient to be considered a business to allow Jack to have a Solo 401(k). 

IRA Basis Isolation and Solo 401(k) Stuffing

I’m not shy when I see the IRS in a weak position. In this article, I strongly argue the IRS has a very weak position if they attempt to enforce the literal terms of Notice 2022-6 governing 72(t) payment plans. 

I’m also not shy in acknowledging situations where the IRS may have a strong position. When it comes to stuffing Solo 401(k)s for distribution motivated reasons, I believe the IRS has a strong position. I previously wrote about this when it comes to stuffing a Solo 401(k) for Rule of 55 planning. See pages 24 through 26 of this article. 

I believe the IRS would have a high likelihood of success were they to challenge the validity of Jack’s Solo 401(k). Can you imagine taxing a $2 million traditional IRA through an attempted rollover into an invalid Solo 401(k) just to get $80,000 into a Roth IRA?

After considering Solo 401(k) stuffing in the contexts of both the Rule of 55 and the Basis Isolation Backdoor Roth IRA, I’ve come up with Mullaney’s Solo 401(k) Distribution Planning Principle: 

Do not use a Solo 401(k) for distribution planning. 

Solo 401(k)s can be distributed out of (as I argue in this article), but I disfavor using them to facilitate sophisticated distribution planning such as a Basis Isolation Backdoor Roth IRA. 

Fortunately, Solo 401(k)s remain a great option for accumulation planning for the fully self-employed. 

Tax Planning and New Businesses

I disfavor tax planning that necessitates the starting of a business to achieve retirement tax benefits. 

Picture a financial planner, Jill, recommending to Jane, a self-employed lawyer, that she opens a Solo 401(k). Jill’s recommendation does not necessitate Jane starting a business. Jill simply is recommending a potentially advantageous tactic that Jane’s preexisting business opens the door to. 

Contrast Jane’s preexisting business with Jack’s new “business” of Lyft driving. There are legitimate Lyft businesses operated by thousands of Americans. But in Jack’s case, his Lyft activity does not strike me as likely to be considered a trade or business sufficient to open a Solo 401(k). 

Even if the Lyft activity is a sufficient trade or business, why do tax planning that requires changes in lived experience when the retiree is already financially successful? 

Basis Isolation Backdoor Roth IRA Planning

Factors I view as favorable indicators that the Basis Isolation Backdoor Roth IRA may be a good planning tactic:

  • Need for Roth basis in early retirement
  • Relatively modest pretax amounts in traditional IRAs
  • Possibility of opening up several years worth of Backdoor Roth IRAs
  • Rolling pretax amounts into a large employer 401(k) with good investment selections

Factors I view as indicative that the Basis Isolation Backdoor Roth IRA should be disfavored:

  • No compelling need for Roth basis in early retirement
  • Significant pretax amounts in traditional IRAs
  • No ability to do future Backdoor Roth IRAs
  • Rolling pretax amounts into a Solo 401(k)
  • The necessity to start a business to achieve a tax benefit in retirement
  • Confusion surrounding the actual amount of IRA basis, since IRA basis cannot be rolled into a 401(k) or other workplace retirement plan

The above are my opinions. None of this should be read as advice for you or anyone else. Further, none of this should be read as to say any previously implemented planning in this regard is “wrong.” Rather, all this is intended to provide is my views as to what is desirable and what is not desirable from a planning perspective. 

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn: @SeanWMullaney

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

The Spousal IRA

Is earned income required to contribute to an individual retirement account (an “IRA”)? If you’re married, it may not be, thanks to the Spousal IRA. 

The Spousal IRA is a great opportunity for families to build financial stability, and perhaps get a juicy tax deduction, even if only one of the spouses work outside of the home. It can help families save for the future, qualify for Premium Tax Credits, and prioritize important goals such as raising children.

IRA Basics

There are two types of IRAs that most working Americans can consider. I did a primer about them here.

A traditional IRA offers tax-deferred growth and the possibility of a tax deduction for contributions. While distributions from a traditional IRA in retirement are taxable, many will find that traditional IRA distributions in retirement are only lightly taxed. 

A Roth IRA offers no tax deduction on the way in, but features tax-free growth and tax-free withdrawals in retirement. 

Both can be a great way to build up tax-advantaged wealth for retirement.

IRA Contribution Limits

The limit on IRA contributions for 2025 is the lesser of $7,000 or earned income ($8,000 or earned income if you are age 50 or older in 2025). The limit on IRA contributions for 2026 is the lesser of $7,500 or earned income ($8,600 or earned income if you are age 50 or older in 2026). Remember that traditional IRAs and Roth IRAs share that contribution limit, so a dollar contributed to a traditional IRA is a dollar that cannot be contributed to a Roth IRA and vice-versa. 

IRA Contribution Deadlines

Generally speaking, the deadline to contribute to either a traditional IRA or a Roth IRA is April 15th of the following year. The deadline cannot be extended even if the taxpayer files for an extension to file their own tax return. On rare occasions the IRS may provide a very limited exception to the April 15th IRA contribution deadline. 

The Spousal IRA

For purposes of having earned income allowing one to make an IRA contribution (tradition and/or Roth), a non-working spouse can use their spouse’s earned income for purposes of making either (or both) a traditional IRA or a Roth IRA contribution.

Here is an example:

Joe and Mary are married. Joe has a W-2 job and Mary does not. Mary can make an IRA contribution (a Spousal IRA) based on Joe’s W-2 earned income. 

The Spousal IRA can be used to increase tax-advantaged retirement savings. It can also be used to strategically optimize tax deductions. Many W-2 workers are covered by a workplace 401(k) plan. Thus, based on low income limits, it is difficult for them to deduct a traditional IRA contribution. 

However, when one is not covered by a workplace retirement plan, it is much easier to qualify to deduct a traditional IRA contribution. It is often the case that a Spousal IRA will offer a potential tax deduction when the working spouse is not able to deduct a traditional IRA contribution. 

IRA Contributions to Increase Premium Tax Credits

For early retirees, planning for the Premium Tax Credit in order to save thousands of dollars on ACA medical insurance premiums can be a challenge. This is particularly true in 2026 with the return of the 400 percent of federal poverty level cliff. A dollar of income over the 400 percent of federal poverty level cliff could cause a married couple $10,000 of Premium Tax Credits.

One tool in the tool box of those with side hustles or part time jobs in early retirement is the deductible traditional IRA contribution. An example can illustrate how a married couple could use deductible traditional IRA contributions, including a deductible spousal IRA contribution, to qualify for thousands of dollars of Premium Tax Credits. 

Larry and Cheryl, both age 55, are retired in 2026. They have capital gains, interest, and dividends in 2026 of $80,000. Cheryl works part time and earns $20,000 in W-2 income. She is not covered by a workplace retirement plan. 

Larry and Cheryl’s $100,000 of adjusted gross income puts them above 400% of the 2025 federal poverty level ($84,600). However, they can each make a deductible $8,600 traditional IRA contribution. Larry’s deductible traditional IRA contribution is a Spousal IRA. 

Those deductible contributions lower Larry and Cheryl’s adjusted gross income to $82,800, allowing them to qualify for thousands of dollars of Premium Tax Credits for 2026. 

Split-Year Spousal IRA Contribution Example

As I write this, the 2026 tax return season (for 2025 tax returns) is about to get started. Now’s the time to be thinking about 2025 IRA contributions if you have not yet made one!

There’s still plenty of time to contribute to an IRA (traditional or Roth) for the year 2025. Some of that planning might involve strategically employing a Spousal IRA. Here’s an example:

Mark and Theresa, both age 41, are married and have three children. They live in California. Mark works a W-2 job and Theresa does not have earned income. Mark is covered by a 401(k) at work. Their modified adjusted gross income (“MAGI”) for 2025 is $200,000. This puts them in the 22% marginal federal income tax bracket and the 9.3% marginal California income tax bracket. They have made no IRA contributions for either of them for 2025 going into tax season. 

It is early April 2026 and Mark and Theresa are about to file their tax returns. They see they have $9,000 in cash available to use to make 2025 IRA contributions. What they might want to do is contribute $7,000 to a 2025 deductible traditional IRA for Theresa (a Spousal IRA) and the remaining $2,000 to a 2025 Roth IRA for Mark, since he cannot deduct a traditional IRA contribution. By prioritizing a tax deduction, Mark and Theresa save $2,191 on their 2025 income taxes. 

The Spousal IRA as a Backdoor Roth IRA

The Spousal IRA can be executed as a Backdoor Roth IRA. Here is an example:

Jack and Betty, both age 42, are married. Jack works a W-2 job and Betty does not have earned income. Jack is covered by a 401(k) at work. Their MAGI for 2026 is $265,000 and thus neither of them qualify to make a regular annual contribution to a Roth IRA. 

Assuming Betty has no balances in traditional IRAs, SEP IRAs, and SIMPLE IRAs (and thus does not have a Pro-Rata Rule problem), Betty can contribute $7,500 to a nondeductible traditional IRA and then convert that amount (plus any growth) to a Roth IRA. Doing so uses a Spousal IRA to implement a Backdoor Roth IRA. 

Spousal IRA Tax Return Reporting

To report a deductible traditional Spousal IRA contribution, the amount of the contribution must be reported on Schedule 1, line 20, filed with the couple’s annual federal income tax return. 

To report a nondeductible traditional Spousal IRA contribution, the amount of the contribution must be reported on Part I of the Form 8606.

There is no required federal income tax return reporting for a Roth Spousal IRA contribution. However, such contributions should be entered into the tax return software to help determine the potential eligibility for a retirement savers’ credit. 

Conclusion

The Spousal IRA creates a great opportunity for married couples to save for retirement and possibly gain access to valuable tax deductions. It can help married couples focus on important priorities such as child rearing and still make significant contributions to retirement accounts. For the early retired with small amounts of earned income, it can help reduce income in order to qualify for a Premium Tax Credit or increase the amount of a Premium Tax Credit. 

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn at @SeanWMullaney

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

2026 Backdoor Roth IRA Timing

Merry Christmas and Happy New Year!

The Christmas season (ending January 11th this year) coincides with the beginning of personal finance’s Backdoor Roth IRA season. 

Many readers look forward to New Year’s Day not to watch the Rose Bowl but rather to contribute to a traditional IRA, the first step of the Backdoor Roth IRA. 

The question then becomes: how long should I wait to do the second step of the Backdoor Roth IRA, the conversion of the traditional IRA contribution and any small growth to a Roth IRA?

Below I discuss my views on the matter as they apply to 2026 Backdoor Roth IRAs. 

Backdoor Roth IRA Timing Concerns

The Backdoor Roth IRA involves three accounts and two steps. First, the investor transfers money from a bank account (A) to a traditional IRA (B) as a regular annual contribution to the traditional IRA. Second, the investor converts the entire traditional IRA balance to a Roth IRA (C).

Written out logically, the Backdoor Roth IRA sequence is as follows:

A→B→C

The question is “do we respect the transfer to B or do we disregard the transfer to B and say, instead, that there was a single transfer from A to C?

Michael Kitces, in 2015, wrote an article stating that he was, at that time, concerned that, if the Roth conversion step was done close in time to the traditional IRA contribution, the transfer to the traditional IRA would be disregarded. For high income individuals, this would create an excess contribution to a Roth IRA subject to a 6% annual penalty.

I do not share his concern. My perception is that most financial planners, financial advisors, and tax return preparers also do not share his concern. 

My Approach

I wrote a detailed blog post stating that I do not believe the step transaction doctrine invalidates the Backdoor Roth IRA. Of particular note is Section 408(d)(2)(B), which provides that all IRA distributions (including Roth conversions) during the year are aggregated into a single distribution. 

This rule tells us that timing within the year is irrelevant for determining tax treatment. Why would a judicial doctrine change the Backdoor Roth IRA’s tax treatment based on a timing concern when the Code itself says timing is irrelevant? 

Favored Backdoor Roth IRA Timing

Here is my favored approach: Make the traditional IRA contribution at any time during a particular month and then wait until the following calendar month to do the Roth conversion step. Usually the traditional IRA is invested in a low yielding stable cash or cash equivalent type of asset, creating a small bit of income in between the two steps. 

Here is how that plays out with an example:

Keith, age 47, wakes up on New Year’s Day 2026 and contributes $7,500 to a traditional IRA invested in a money market fund. On February 2, 2026, when the traditional IRA has grown to $7,525, he converts all of it to a Roth IRA. 

Yes, Keith could have converted the $7,500 to a traditional IRA on January 2, 2026. I would strongly argue that he has a good Backdoor Roth IRA in that scenario.

But my favored approach is for him to wait until February. Why not? What’s the downside to my favored approach? Practically none. My favored approach increases Keith’s taxable income by $25, which is obviously no big deal. It also buys Keith a bit more protection against the step transaction doctrine concern (which, admittedly, I believe to be a minimal concern). 

Backdoor Roth IRA Diligence

Allow me to touch on two important diligence points when doing the Backdoor Roth IRA.

The first is to ensure that as of December 31st of the year of any Roth conversion step (so 2026 in Keith’s example), it is important to have $0 (or close to $0) in all traditional IRAs, SEP IRAs, and SIMPLE IRAs. For more discussion as to why that’s important, see this post. 

Second, it is important to properly complete the Form 8606 and file it with the annual federal income tax return. This post has an example of how a Form 8606 is completed to reflect a Backdoor Roth IRA. 

Further Reading

In early 2026 many Americans will find they made too much to have made their 2025 Roth IRA contribution. Having contributed in 2025, they now need to remedy the overcontribution. Further, they may still want to do a Backdoor Roth IRA for 2025 in 2026, what I refer to as a Split-Year Backdoor Roth IRA. 

Read here to find out my favored approach when facing this situation. 

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn at @SeanWMullaney

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, medical, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, medical, and tax matters. Please also refer to the Disclaimer & Warning section found here.

The Backdoor Roth IRA After an Excess Contribution to a Roth IRA

It happens all the time. People contribute to a Roth IRA only to find out at tax time they made too much income to have made the Roth IRA contribution. 

There are two primary ways to correct this situation. They are a recharacterization and a corrective distribution. Both are entirely valid remedial paths when it turns out that one contributed to a Roth IRA and their income was too high to have done so. 

But which remedial path makes the most sense if the investor wants to also do a Backdoor Roth IRA for the year in question?

As I am posting this in late 2025, this is about to become very relevant as applied to excess Roth IRA contributions occurring in 2025. Many will find out in early 2026 as they work through their 2025 tax return that they did not qualify for a previously made 2025 Roth IRA contribution. 

Below I explore this topic with two examples. 

Recharacterization

Let’s consider Rich and Rebecca, married and both age 48 in 2025. At least one of them was covered by a workplace retirement plan in 2025. Rich and Rebecca each contributed $7,000 to a Roth IRA on January 2, 2025 anticipating their 2025 modified adjusted gross income would be approximately $225,000. Due to a year-end bonus and unexpected capital gains distributions, their 2025 MAGI turned out to be $250,000, which they discovered after talking to their income tax return preparer in February 2026. 

Having exceeded the 2025 Roth IRA MAGI contribution limit of $246,000, they need to remedy the situation. Since neither of them has any balance in a traditional IRA, SEP IRA, and/or SIMPLE IRA, they are also interested in doing a Backdoor Roth IRA for 2025 (what I refer to as a Split-Year Backdoor Roth IRA). 

They proceed as follows. First, they ask their financial institution to recharacterize their 2025 Roth IRA contributions and related earnings ($550 in Rich’s case, $600 in Rebecca’s case) as traditional IRAs in late February 2026. This event does not create any 2025 or 2026 taxable income. 

Second, in early March 2026, Rich converts the balance in his traditional IRA, now $7,560, from his traditional IRA to a Roth IRA. Likewise, Rebecca converts the balance in her traditional IRA, now $7,612 from her traditional IRA to a Roth IRA. This creates $560 of 2026 taxable income for Rich and $612 of 2026 taxable income for Rebecca. 

Both Rich and Rebecca have $0 balances in all traditional IRAs, SEP IRAs, and SIMPLE IRAs as of December 31, 2026. 

I believe that it’s helpful to illustrate the sequence logically using letters. A is a checking account, B is a traditional IRA, and C is a Roth IRA.

Here is how the entire sequence looks when Rich and Rebecca first contribute to a Roth IRA, correct it through a recharacterization, and then do the Split-Year Backdoor Roth IRA. 

A→C→B→C

Corrective Distribution

Let’s consider Carl and Debbie, married and both age 47 in 2025. At least one of them was covered by a workplace retirement plan in 2025. Carl and Debbie each contributed $7,000 to a Roth IRA on January 2, 2025 anticipating their 2025 modified adjusted gross income would be approximately $225,000. Due to a year-end bonus and unexpected capital gains distributions, their 2025 MAGI turned out to be $255,000, which they discovered after talking to their income tax return preparer in February 2026. 

Having exceeded the 2025 Roth IRA MAGI contribution limit of $246,000, they need to remedy the situation. Since neither of them has any balance in a traditional IRA, SEP IRA, and/or SIMPLE IRA, they are also interested in doing a Backdoor Roth IRA for 2025. 

They proceed as follows. First, they ask their financial institution to send them a corrective distribution of their 2025 Roth IRA contributions and related earnings ($650 in Carl’s case, $700 in Debbie’s case) in late February 2026. 

The February 2026 corrective distribution of the excess Roth IRA contributions and related net income attributable to the returned contributions creates taxable income of $650 to Carl and $700 to Debbie in 2025 to be reported on their soon-to-be-filed 2025 federal income tax returns. See Section 408(d)(4)(C), Treas. Reg. Sec. 1.408A-6 Q&A 1(d), and this Vorris J. Blankenship article. 

Second, in late February 2026, both Carl and Debbie make a $7,000 contribution to their traditional IRAs and code the contribution as being for 2025. 

Third, Carl converts the balance in his traditional IRA, now $7,010, from his traditional IRA to a Roth IRA. Likewise, Debbie converts the balance in her traditional IRA, now $7,010, from her traditional IRA to a Roth IRA. This creates $10 of 2026 taxable income for Carl and $10 of 2026 taxable income for Debbie. 

Both Carl and Debbie have $0 balances in all traditional IRAs, SEP IRAs, and SIMPLE IRAs as of December 31, 2026. 

Here is how the entire sequence looks when Carl and Debbie first contribute to a Roth IRA, correct it through a corrective distribution, and then do the Split-Year Backdoor Roth IRA. 

A→C→A→B→C

Critical Assessment

Let’s step back. Logically, what is the Backdoor Roth IRA? It boils down to the following formulation:

A→B→C

I and others have argued that “B” should be respected. I’m unaware that the IRS disagrees with this view. At this point, after a decade and a half of Backdoor Roth IRAs, it would be exceedingly odd for the IRS to start aggressively challenging the transaction. 

Assessing the Corrective Distribution Remedial Path

Viewed logically, the “corrective distribution followed by the Split-Year Backdoor Roth IRA” is just as strong as the Backdoor Roth IRA itself. It simply appends two additional transactions, an (ultimately excess) Roth IRA annual contribution followed by a corrective distribution. If one can defend the Backdoor Roth IRA, one should be able to defend the corrective distribution followed by the Split-Year Backdoor Roth IRA.

You might argue that the money was in a Roth IRA and ultimately ends up back in a Roth IRA. That can be true, though the investor need not use the exact same dollars received in the corrective distribution to initiate the later Split-Year Backdoor Roth IRA. 

Regardless, in order to “collapse” steps, the IRS would need to successfully defeat not one, but two, steps. First the IRS would need to successfully disregard the corrective distribution on which the investor most likely reports taxable income. Second, the IRS would need to disregard the transfer to the traditional IRA. 

The IRS has not aggressively tried to disregard a single step (the traditional IRA contribution) when it comes to the Backdoor Roth IRA transaction for the past 15 years. It’s difficult to imagine the IRS would try to aggressively disregard two distinct steps, which is what it would take to defeat the “corrective distribution followed by the Split-Year Backdoor Roth IRA” path. 

Assessing the Recharacterization Remedial Path

Where I get much more concerned is the “recharacterization followed by the Backdoor Roth IRA” path. 

In all of these analyses, the key issue is “do we respect “B”?” Recall the recharacterization followed by the Backdoor Roth IRA formulation:

A→C→B→C

Notice what’s on both sides of B? 

C!

We have a case where funds are in a Roth IRA, temporarily rest in a traditional IRA, and then end up right back in a Roth IRA. 

Yes, the Internal Revenue Code allows recharacterizations. But could the IRS successfully disregard a recharacterization into a traditional IRA when both immediately before and immediately after those funds are in a Roth IRA?

I believe that a recharacterization followed by a Split-Year Backdoor Roth IRA dramatically increases the risk to the investor. The risk is that the recharacterization would be disregarded, exposing the investor to the annual 6% excess Roth IRA contribution penalty. 

Favored Approach

I strongly favor the corrective distribution remedial path if one is looking to do a Backdoor Roth IRA after having made an excess contribution to the Roth IRA for the year.

What are the drawbacks to my favored approach? It requires three steps instead of two, since the investor must initiate the corrective distribution, contribute to a traditional IRA, and then convert the traditional IRA. 

Further, my favored approach generally accelerates the tax on the “net income attributable” to the excess contribution. Recall Rich and Rebecca pay that tax in 2026 while Carl and Debbie pay practically all of that tax with their 2025 federal income tax returns. 

My favored approach generally does not increase the small tax created by the combination of the remediation and the Split-Year Backdoor Roth IRA. It simply accelerates it by one year. In a low yield world, that is a tiny drawback. 

I believe that the corrective distribution remedial path is very strong. I do not believe that the IRS would stand a very good chance of disregarding two steps to create an excess contribution to a Roth IRA. Further, I believe that respecting time spent in a traditional IRA is much more challenging when that money is in a Roth IRA immediately before and immediately after being in the traditional IRA. 

When both corrective distributions and recharacterizations are available to those looking to ultimately do a Backdoor Roth IRA, why not choose the corrective distribution path? 

Finally, note that this blog post is not advice for you or anyone else. I am not writing that the recharacterization remedial path cannot work. Rather, I am, in an academic sense, simply stating two things.

First, the recharacterization followed by a Split-Year Backdoor Roth IRA path increases the risk to the investor.

Second, the corrective distribution path appears to be preferable to the recharacterization path if one is looking to do the Split-Year Backdoor Roth IRA after an excess contribution to the Roth IRA for the same year. 

The Real Answer

Congratulations on reading a blog post that should not exist! The real answer to this issue isn’t my analysis. Rather, it is for Congress to eliminate the MAGI restriction on the ability to make an annual Roth IRA contribution. This would align American rules with Canadian rules. 

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn at @SeanWMullaney

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, medical, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, medical, and tax matters. Please also refer to the Disclaimer & Warning section found here.

2025 Year-End Tax Planning

It’s that time of year again. The air is cool and the New York Jets season is over. That can only mean one thing when it comes to personal finance: time to start thinking about year-end tax planning.

I’ll provide some commentary about year-end tax planning to consider, with headings corresponding to the timeframe required to execute. 

As always, none of this is advice for your particular situation but rather it is educational information. 

Urgent

By urgent, I mean those items that (i) need to happen before year-end and (ii) may not happen if taxpayers delay and try to accomplish them late in the year. 

Taxable Roth Conversions

Before we talk about taxable Roth conversion timing, we must talk about taxable Roth conversion desirability. Taxable Roth conversion desirability has significantly declined in recent years. Many commentators have not caught up to the new reality.

Fortunately, Mike Piper knows what time it is. At the 2024 Bogleheads conference, he said “[Roth conversions] don’t usually improve financial security in retirement.” Cody Garrett and I also acknowledge and tackle the changed landscape in our new book Tax Planning To and Through Early Retirement. 

Yes, there can be some taxable Roth conversions that are highly advantageous. But they tend to be much more limited in scope and scale than most commentators acknowledge. In our book, Cody and I detail the sorts of taxable Roth conversions that tend to be beneficial.  

Back to timing. For a Roth conversion to count as being for 2025, it must be done before January 1, 2026. That means New Year’s Eve is the deadline. However, taxable Roth conversions should be done well before New Year’s Eve because 

  1. It requires analysis (hopefully done with up-to-date thinking) to determine if a taxable Roth conversion is advantageous, 
  2. If advantageous, the proper amount to convert must be estimated, and 
  3. The financial institution needs time to execute the Roth conversion so it counts as having occurred in 2025. 

For those age 65 or older by year-end, the Roth conversion calculus should consider the new senior deduction.

Generally speaking it is not good to have federal and/or state income taxes withheld when doing Roth conversions!

Donor Advised Fund Contributions

The donor advised fund is a great way to contribute to charity and accelerate a tax deduction. My favorite way to use the donor advised fund is to contribute appreciated stock directly to the donor advised fund. This gets the donor three tax benefits: 1) a potential upfront itemized tax deduction, 2) removing the unrealized capital gain from future income tax, and 3) removing the income produced by the assets inside the donor advised fund from the donor’s tax return. 

In order to get the first benefit in 2025, the appreciated stock must be received by the donor advised fund prior to January 1, 2026. This deadline is no different than the normal charitable contribution deadline.

2025 is a great time to make a donor advised fund contribution. Why? Because of the new 0.5% of income haircut on itemized charitable deductions starting in 2026. Assuming one has high income in both years, 2025 might be more desirable than 2026. I walked through an example of how the new haircut reduces itemized charitable deductions with Brad Barrett on the ChooseFI podcast. 

Due to much year end interest in donor advised fund contributions and processing time, different financial institutions will have different deadlines on when transfers must be initiated in order to count for 2025. Donor advised fund planning should be attended to sooner rather than later. 

Adjust Withholding

This varies, but it is a good idea to look at how much tax you owed last year. If you are on pace to get 100% (110% if 2024 AGI is $150K or greater) or slightly more of that amount paid into Uncle Sam by the end of the year (take a look at your most recent pay stub), there’s likely no need for action. But what if you are likely to have much more or much less than 100%/110%? It may be that you want to reduce or increase your workplace withholdings for the rest of 2025. If you do, don’t forget to reassess your workplace withholdings for 2026 early in the year.

One great way to make up for underwithholding, particularly for retirees, is through an IRA withdrawal mostly directed to the IRS and/or a state taxing agency. Just note that for those under age 59 ½, this tactic may require special planning.  

Backdoor Roth IRA Diligence

The deadline for the Backdoor Roth IRA for 2025 is not December 31st, as I will discuss below. But if you have already completed a Backdoor Roth IRA for 2025, the deadline to get to a zero balance in all traditional IRAs, SEP IRAs, and SIMPLE IRAs is December 31, 2025. 

Year-End Deadline

These items can wait till close to year-end, though you don’t want to find yourself doing them on New Year’s Eve.

Tax Gain Harvesting

For those finding themselves in the federal 0% long-term capital gains tax bracket and with an asset in a taxable account with a built-in gain, tax gain harvesting prior to December 31, 2025 may be a good tax tactic to increase basis without incurring additional federal income tax. Remember, though, the gain itself increases one’s taxable income, making it harder to stay within the federal 0% long-term capital gains tax bracket. 

I’m also quite fond of tax gain harvesting that reallocates one’s portfolio in a tax efficient manner. 

Tax Loss Harvesting

The deadline for tax loss harvesting for 2025 is December 31, 2025. Just remember to navigate the wash sale rule. 

RMDs from Your Own Retirement Account

The deadline to take any required minimum distributions from one’s own retirement account is December 31, 2025. Remember, the rules can get a bit confusing. Generally, IRAs can be aggregated for RMD purposes, but 401(k)s cannot. 

RMDs from Inherited Accounts

The deadline to take any RMDs from inherited retirement accounts is December 31st. 

Can Wait Till Next Year

Traditional IRA and Roth IRA Contribution Deadline

The deadline for funding either or both a traditional IRA and a Roth IRA for 2025 is April 15, 2026. 

Backdoor Roth IRA Deadline

There’s no law saying “the deadline for the Backdoor Roth IRA is DATE X.” However, the deadline to make a nondeductible traditional IRA contribution for the 2025 tax year is April 15, 2026. Those doing the Backdoor Roth IRA for 2025 and doing the Roth conversion step in 2026 may want to consider the unique tax filing when that happens (what I refer to as a “Split-Year Backdoor Roth IRA”). 

HSA Funding Deadline

The deadline to fund an HSA for 2025 is April 15, 2026. Those who have not maximized their HSA through payroll deductions during the year may want to look into establishing payroll withholding for their HSA so as to take advantage of the payroll tax break available when HSAs are funded through payroll. 

The deadline for those age 55 and older to fund a Baby HSA for 2025 is April 16, 2026. 

2026 Tax Planning at the End of 2025

ACA, HDHP, and HSA Open Enrollment

It’s open enrollment season at work and November 1st starts ACA medical insurance open enrollment for 2026. Now is a great time to assess whether a high deductible health plan (a HDHP) is a good medical insurance plan for you. One of the benefits of the HDHP is the health savings account (an HSA).

New for 2026! All Bronze and Catastrophic ACA plans will qualify as HDHPs! This opens the door for many self-employed and early retired individuals covered by these plans to make deductible HSA contributions. These deductible contributions can increase Premium Tax Credits and lower income taxes. 

As I write this in mid-October 2025, the Premium Tax Credit is in flux. I do think many early retirees and self-employed individuals will benefit from considering a Bronze or Catastrophic plan. As I’ve said before, Bronze is Gold!

For those who already have a HDHP, now is a good time to review payroll withholding into the HSA. Many HSA owners will want to max this out through payroll deductions so as to qualify to reduce both income taxes and payroll taxes.

Self-Employment Tax Planning

Year-end is a great time for solopreneurs, particularly newer solopreneurs, to assess their business structure and retirement plans. Perhaps 2025 is the year to open a Solo 401(k). Often this type of analysis benefits from professional consultations.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn at @SeanWMullaney

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, medical, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, medical, and tax matters. Please also refer to the Disclaimer & Warning section found here.

2024 Backdoor Roth IRA in 2025

Did you know that if you’re reading this before April 16, 2025 (before October 16, 2025 if you live in Los Angeles), it’s still possible to do a 2024 Backdoor Roth IRA?

Yes, it is absolutely possible. I refer to it as a Split-Year Backdoor Roth IRA.

Below I go through an example with a theoretical step plan to do two Backdoor Roth IRAs in 2025!

Everything below is academic information and opinion provided for your education and entertainment. It is not individualized tax, legal, or investment advice for you or anyone else. 

2024 and 2025 Backdoor Roth IRA Example

Brad is 38. In early 2025, he learned about the Backdoor Roth IRA. He makes approximately $300,000 of adjusted gross income in each of 2024 and 2025, so he does not qualify for an annual Roth IRA contribution. Brad has no traditional IRAs, SEP IRAs, and/or SIMPLE IRAs.

Brad takes the following steps to implement two Backdoor Roth IRAs in 2025.

Step 1: Brad contributes $7,000 to a traditional IRA in February 2025. He codes the contribution as being for 2024. Brad invests it in a money market fund.  

Step 2: In March 2025, Brad converted the entire traditional IRA balance, now $7,020, to a Roth IRA.

I have some thoughts on the timing between Steps 1 and 2 if you’re interested. 

Step 3: In April 2025, Brad files his 2024 federal income tax return with a Form 8606 reporting the $7,000 2024 nondeductible traditional IRA contribution. 

The 2024 Form 8606 looks like this.

Step 4: In April 2025, Brad contributed $7,000 to a traditional IRA for 2025. He invests it in a money market fund. 

Step 5: In May 2025, Brad converted the entire traditional IRA balance, now $7,020, to a Roth IRA.

Step 6: Brad ensures that as of December 31, 2025, he has $0 balances in all traditional IRAs, SEP IRAs, and/or SIMPLE IRAs.

Step 7: Brad files a Form 8606 with his 2025 federal income tax return. It reports (1) the 2025 nondeductible traditional IRA contribution and (2) both Roth conversions.

It’s almost too easy 😉 . . . 

Here is what Brad’s 2025 Form 8606 looks like (pardon the use of the 2024 version of the form, as I cannot currently access the 2025 version without a DeLeorean, a flux-capacitor, and 1.21 gigawatts of electricity). 

What Has Brad Accomplished?

I believe this planning can be quite beneficial for Brad’s financial future. He just got $14,000 out of taxable accounts and into a tax free account for the rest of his life. Further, that $14,000 now enjoys a significant degree of creditor protection (note this does vary state to state).

Two years of a Backdoor Roth IRA don’t make that much of a difference. But what about 5 years? 10 years? 20 years? Now we are talking about significant numbers that can help Brad accomplish his financial goals.

Conclusion

In early 2025 it is not too late to do a Backdoor Roth IRA for 2024. I refer to this as the Split-Year Backdoor Roth IRA. It can be combined with a current year Backdoor Roth IRA.The taxpayer has to have the right profile, including no balances in traditional IRAs, SEP IRA, and/or SIMPLE IRAs. 

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on X: @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Los Angeles Tax Delay

The 2025 fires in Los Angeles have been devastating. My heart goes out to all those affected, and you are in my prayers.  

Los Angeles County now has a deadline delay for their 2024 tax returns, 2024 and 2025 tax payments, and IRA contributions. 

Los Angeles County Tax Deadline Delay

The IRS announced that because of the January 2025 fires in Los Angeles, Angelenos have an extended deadline, October 15, 2025, to perform most 2024 tax acts that otherwise would have been due early in 2025. The Franchise Tax Board has followed suit and also issued their own delay announcement with respect to California state income tax returns and payments. 

2024 Traditional and Roth IRA Contributions

The deadline for Los Angeles County residents to make 2024 contributions to traditional and/or Roth IRAs has been extended to October 15, 2025. As a practical matter, I wouldn’t encourage reliance on this particular deadline delay. Financial institutions may find it difficult to allow “late but timely” 2024 IRA contributions on their platform when it is available only to residents of a single county. 

If you are an Angeleno reading this after April 15, 2025 and want to make an IRA contribution for 2024, I recommend initiating the process by calling the financial institution rather than using the financial institution’s website.  

2024 Backdoor Roth IRAs

Los Angeles County residents now have until October 15, 2025 to execute the first step of a 2024 Backdoor Roth IRA, the nondeductible contribution to a traditional IRA for 2024. This would be a Split-Year Backdoor Roth IRA. 

2024 HSA Contributions

The deadline for making 2024 HSA contributions is October 15, 2025.  

2024 Tax Returns and Payments and 2025 Q1 Through Q3 Estimated Tax Payments

Los Angeles County residents now have until October 15, 2025 to (i) file their 2024 federal and California income tax returns, (ii) pay the amount due with their 2024 federal and California income tax returns, (iii) make fourth quarter 2024 estimated tax payments, and (iv) make 2025 first through third quarter estimated tax payments. 

Who Benefits?

Residents of Los Angeles County qualify for the extended deadline. Note (1) there’s no need to have suffered any loss or damage due to the fires and (2) the extensions apply to the entirety of Los Angeles County. It is not just limited to residents of the City of Los Angeles. 

Taxpayers with records in Los Angeles County can also benefit. 

Resources

IRS Los Angeles County Announcement and Additional IRS Announcement

Franchise Tax Board Los Angeles County Announcement

Treasury Regulation Section 301.7508A-1

Revenue Procedure 2018-58

Follow me on X: @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Backdoor Roth IRA Timing

Happy New Year! It’s Backdoor Roth IRA season, so let’s talk about the issue that refuses to go away . . . the timing of the two steps of the Backdoor Roth IRA. 

Recall that the Backdoor Roth IRA is a two-step transaction. First, there is a nondeductible contribution to a traditional IRA. The second step is a relatively close-in-time conversion of the nondeductible traditional IRA contribution and any minor growth to a Roth IRA. Assuming the correct profile, this can move money into a Roth IRA for a year the person exceeds the Roth IRA contribution MAGI limits. 

If there are two steps of the Backdoor Roth IRA, that begs a question: Just how long do I have to wait between the two steps, i.e., how long does the nondeductible traditional IRA contribution have to sit in the traditional IRA prior to the Roth conversion step? A minute? A day? A month? A year?

In some, but not all, cases there may have to be a few days or even a few weeks between the two steps of the Backdoor Roth IRA. Dr. Jim Dahle discussed this on a recent episode of The White Coat Investor podcast. 

The Backdoor Roth IRA and the Step Transaction Doctrine

There has been a concern with the Backdoor Roth IRA: the step transaction doctrine, which can collapse steps into a single step. In theory, the two steps of the Backdoor Roth IRA can be viewed as a single step (a direct contribution to a Roth IRA), which creates an excess contribution (subject to a potential 6 percent penalty). Michael Kitces has written that he is concerned that, because the Roth conversion step might occur so soon after the nondeductible traditional IRA contribution, the step transaction doctrine can apply to the Backdoor Roth IRA. Kitces generally advocates waiting a year between the steps based on his step transaction doctrine concern. To my knowledge he has never changed his view on the issue. 

I believe Mr. Kitces is a bit of a lone voice on the issue these days. In fact, Kitces’ own colleague Jeffrey Levine disagrees with him on the issue. 

Two late 2010’s developments moved the needle in the practitioner community towards Mr. Levine’s view. First, the IRS, in informal comments, indicated they were not too concerned with the Backdoor Roth IRA. Second, the legislative history to 2017’s Tax Cuts and Jobs Act indicated that Congressional staffers believed the Backdoor Roth IRA was valid. I believe this second development was overblown, as legislative history, to the extent relevant, is relevant to the legislation then being passed. It is not relevant, to my mind, to prior legislation (the Backdoor Roth IRA enabling legislation passed in 2006 – see Section 512). That said, both developments were informative, though certainly not binding. 

Sean’s Take

I have never been too concerned with the Step Transaction Doctrine and the Backdoor Roth IRA. In 2019, I co-wrote a Tax Notes article (available behind a paywall) about the issue with Ben Willis, my former PwC colleague. We concluded that it is not appropriate to apply the step transaction doctrine to a taxpayer’s use of the explicit, taxpayer favorable IRA rules. I believe we made a good case that the step transaction should not apply to the Backdoor Roth IRA based on the contours of the doctrine.

The Backdoor Roth IRA and Section 408(d)(2)(B)

Since 2019, I have further developed my thinking. I now believe a little commented-on rule in the IRA statute is very instructive: Section 408(d)(2)(B).

Section 408(d)(2)(B) provides that all IRA distributions during the year are treated as a single distribution. As a result, the timing of IRA distributions is irrelevant. A January 1st distribution is treated the same as a March 29th distribution, which is treated the same as a December 31st distribution. Roth conversions are distributions from an IRA. 

By grouping all IRA distributions into a single distribution, the Internal Revenue Code tells us the timing of IRA distributions, including Roth conversions, during the year is irrelevant. 

It would be exceedingly odd to apply a judicial doctrine (the step transaction doctrine) to give that timing relevance when the Code strips away that relevance. Anyone arguing the step transaction doctrine applies to a Backdoor Roth IRA is saying that the step transaction doctrine should override the specific rule of Section 408(d)(2)(B) in determining the degree of relevance afforded to the timing of the Roth conversion step. 

I strongly believe it is not appropriate to apply the step transaction doctrine when the Internal Revenue Code itself gives us a rule telling us the timing of the Roth conversion is irrelevant. 

Backdoor Roth IRA Favored Timing

I have two beliefs. First, timing is irrelevant when doing the Backdoor Roth IRA. Second, my views are not guaranteed to yield a 9-0 Supreme Court decision 😉

Based on those two beliefs, I have a third. The most desirable Backdoor Roth IRA path is to wait until the end of a month passes and then do the Roth conversion step of the Backdoor Roth IRA. This is the old Ed Slott tactic and locks in an end-of-month statement showing some interest or dividends in the traditional IRA. 

It could look something like this:

Roger contributes $7,000 to his traditional nondeductible IRA on January 2, 2025 for 2025 and invests it in a money market fund. On February 1, 2025, he converts the entire amount, now $7,027, to a Roth IRA. He has no other IRA transactions during the year and on December 31, 2025 he has $0 balances in any and all traditional IRAs, SEP IRAs, and SIMPLE IRAs.

Oh no, Roger created $27 of taxable income on his Backdoor Roth IRA. We’ve finally found something worse than IRMAA!

All kidding aside, here’s what Roger’s 2025 Form 8606 could look like (pardon the use of the 2023 form, the latest version available as of this writing): 8606 Page 1 8606 Page 2 And, yes, Roger should convert the entire traditional IRA balance, not just the $7,000 originally contributed to the traditional IRA.

To my mind, this works as a good Backdoor Roth IRA. So now you say, But Sean, what about your first belief? I thought timing was irrelevant!

I respond, (A) see my second belief and (B) what’s the downside of my desired approach? 

$27 of taxable income creates $10 of federal income tax if Roger is in the highest federal tax bracket, and Roger will have $27 more protected from future tax by the Roth IRA. 

The Backdoor Roth IRA Should Not Exist

That the Backdoor Roth IRA exists is ridiculous. It is obnoxious that our tax laws are so complicated that one of the most prominent financial planners, Michael Kitces, could plausibly claim the step transaction doctrine adversely impacts the Backdoor Roth IRA.

Let’s end all of this and adopt a rule that notorious tax haven, Canada, has adopted: Eliminate the income limit on the ability to make an annual Roth IRA contribution! Canada’s Tax-Free Savings Account (their version of a Roth IRA) has absolutely no income limit on the ability to make a contribution. America should adopt that rule as a small part of what hopefully will be a dramatic simplification of American income tax laws in 2025.

Conclusion

I do not believe that the step transaction doctrine should apply to the Backdoor Roth IRA. I do not believe that the timing of the two steps is relevant for determining their ultimate federal income taxation. That said, I like waiting until the following month to do the Roth conversion step. 

Of course, the entirety of this article is simply academic commentary. It is not tax, legal, or investment advice for you or anyone else.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on X: @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

2024 Year-End Tax Planning

It’s that time of year again. The air is cool and the Election is in the rear-view mirror. That can only mean one thing when it comes to personal finance: time to start thinking about year-end tax planning.

I’ll provide some commentary about year-end tax planning to consider, with headings corresponding to the timeframe required to execute. 

As always, none of this is advice for your particular situation but rather it is educational information. 

Urgent

By urgent, I mean those items that (i) need to happen before year-end and (ii) may not happen if taxpayers delay and try to accomplish them late in the year. 

Donor Advised Fund Contributions

The donor advised fund is a great way to contribute to charity and accelerate a tax deduction. My favorite way to use the donor advised fund is to contribute appreciated stock directly to the donor advised fund. This gets the donor three tax benefits: 1) a potential upfront itemized tax deduction, 2) removing the unrealized capital gain from future income tax, and 3) removing the income produced by the assets inside the donor advised fund from the donor’s tax return. 

In order to get the first benefit in 2024, the appreciated stock must be received by the donor advised fund prior to January 1, 2025. This deadline is no different than the normal charitable contribution deadline.

However, due to much year end interest in donor advised fund contributions and processing time, different financial institutions will have different deadlines on when transfers must be initiated in order to count for 2024. Donor advised fund planning should be attended to sooner rather than later. 

Taxable Roth Conversions

For a Roth conversion to count as being for 2024, it must be done before January 1, 2025. That means New Year’s Eve is the deadline. However, taxable Roth conversions should be done well before New Year’s Eve because 

  1. It requires analysis to determine if a taxable Roth conversion is advantageous, 
  2. If advantageous, the proper amount to convert must be estimated, and 
  3. The financial institution needs time to execute the Roth conversion so it counts as having occurred in 2024. 

Remember, generally speaking it is not good to have federal and/or state income taxes withheld when doing Roth conversions!

Gotta Happen Before 2026!!!

Before the Election, many commentators said “you’ve gotta get your Roth conversions done before tax rates go up in 2026!” If this were X (the artist formerly known as Twitter), the assertion would likely be accompanied by a hair-on-fire GIF. 😉

I have disagreed with the assertion. As I have stated before, there’s nothing more permanent than a temporary tax cut! Now with a second Trump presidency and a Republican Congress, it is likely that the higher standard deduction and rate cuts of the Tax Cuts and Jobs Act will be extended. 

Regardless of the particulars of 2025 tax changes, I recommend that you make your own personal taxable Roth conversion decisions based on your own personal situation and analysis of the landscape and not a fear of future tax hikes.

Adjust Withholding

This varies, but it is a good idea to look at how much tax you owed last year. If you are on pace to get 100% (110% if 2023 AGI is $150K or greater) or slightly more of that amount paid into Uncle Sam by the end of the year (take a look at your most recent pay stub), there’s likely no need for action. But what if you are likely to have much more or much less than 100%/110%? It may be that you want to reduce or increase your workplace withholdings for the rest of 2024. If you do, don’t forget to reassess your workplace withholdings for 2024 early in the year.

One great way to make up for underwithholding is through an IRA withdrawal mostly directed to the IRS and/or a state taxing agency. Just note that for those under age 59 ½, this tactic may require special planning.  

Backdoor Roth IRA Diligence

The deadline for the Backdoor Roth IRA for 2024 is not December 31st, as I will discuss below. But if you have already completed a Backdoor Roth IRA for 2023, the deadline to get to a zero balance in all traditional IRAs, SEP IRAs, and SIMPLE IRAs is December 31, 2024. 

Solo 401(k) Planning

There’s plenty of planning that needs to be done for solopreneurs in terms of retirement account contributions. 

The Solo 401(k) can get complicated. That’s why I wrote a book about them and post an annual update on Solo 401(k)s here on the blog. 

Year-End Deadline

These items can wait till close to year-end, though you don’t want to find yourself doing them on New Year’s Eve.

Tax Gain Harvesting

For those finding themselves in the 12% or lower federal marginal income tax bracket and with an asset in a taxable account with a built-in gain, tax gain harvesting prior to December 31, 2024 may be a good tax tactic to increase basis without incurring additional federal income tax. Remember, though, the gain itself increases one’s taxable income, making it harder to stay within the 12% or lower marginal income tax bracket. 

I’m also quite fond of tax gain harvesting that reallocates one’s portfolio in a tax efficient manner. 

Tax Loss Harvesting

The deadline for tax loss harvesting for 2024 is December 31, 2024. Just remember to navigate the wash sale rule. 

RMDs from Your Own Retirement Account

The deadline to take any required minimum distributions from one’s own retirement account is December 31, 2024. Remember, the rules can get a bit confusing. Generally, IRAs can be aggregated for RMD purposes, but 401(k)s cannot. 

RMDs from Inherited Accounts

The deadline to take any RMDs from inherited retirement accounts is December 31st. For some beneficiaries of retirement accounts inherited during 2020, 2021, 2022, and 2023, the IRS has waived 2024 RMDs. That said, all beneficiaries of inherited retirement accounts may want to consider affirmatively taking distributions (in addition to RMDs, if any) before the end of 2024 to put the income into a lower tax year, if 2024 happens to be a lower taxable income year vis-a-vis future tax years. 

Can Wait Till Next Year

Traditional IRA and Roth IRA Contribution Deadline

The deadline for funding either or both a traditional IRA and a Roth IRA for 2024 is April 15, 2025. 

Backdoor Roth IRA Deadline

There’s no law saying “the deadline for the Backdoor Roth IRA is DATE X.” However, the deadline to make a nondeductible traditional IRA contribution for the 2024 tax year is April 15, 2025. Those doing the Backdoor Roth IRA for 2024 and doing the Roth conversion step in 2025 may want to consider the unique tax filing when that happens (what I refer to as a “Split-Year Backdoor Roth IRA”). 

HSA Funding Deadline

The deadline to fund an HSA for 2024 is April 15, 2025. Those who have not maximized their HSA through payroll deductions during the year may want to look into establishing payroll withholding for their HSA so as to take advantage of the payroll tax break available when HSAs are funded through payroll. 

The deadline for those age 55 and older to fund a Baby HSA for 2024 is April 15, 2025. 

2025 Tax Planning at the End of 2024

HDHP and HSA Open Enrollment

It’s open enrollment season. Now is a great time to assess whether a high deductible health plan (a HDHP) is a good medical insurance plan for you. One of the benefits of the HDHP is the health savings account (an HSA).

For those who already have a HDHP, now is a good time to review payroll withholding into the HSA. Many HSA owners will want to max this out through payroll deductions so as to qualify to reduce both income taxes and payroll taxes.

Self-Employment Tax Planning

Year-end is a great time for solopreneurs, particularly newer solopreneurs, to assess their business structure and retirement plans. Perhaps 2024 is the year to open a Solo 401(k). Often this type of analysis benefits from professional consultations.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on Twitter at @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Thoughts on Trump and Taxes

It happened. The frontrunner for the Presidency said “Sure, . . . why not?” when asked if he would eliminate the income tax on the Joe Rogan podcast. Whoa!!!

Okay, let’s calm down. Let’s not plan on never filing a tax return again just yet.

Tax planning is all about probabilities. Over the 2024 presidential campaign, probabilities have shifted. Below I’ll discuss the changing landscape, what it means for how Americans should approach their own planning (at year-end in 2024 and beyond), and a few thoughts on the future of American taxation.

Trump Tax Promises and Trend

Trump has been quite explicit with three individual income tax cut promises during the campaign:

  • No tax on tips
  • No tax on Social Security
  • No tax on overtime

Trump and his campaign have frequently mentioned these. It’s more than fair for the electorate to hold Trump to these promises.

Separately, Trump has been speaking quite fondly of tariffs. He did so during an interview with Dave Ramsey, which caught my attention.

I saw then what has become even clearer thanks to Donald Trump’s answer Joe Rogan’s question: the Trump Era would, to at least some degree, shift America away from income taxes and towards tariffs. 

I do not view Trump’s answer to Rogan as a promise. It was one line during a 3 hour interview. It should be taken seriously, not literally. Trump briefly stated it in response to Rogan’s question. Importantly, Trump then went into detail not on eliminating income taxes but rather on his fondness of tariffs.  

The above caveats aside, trend here is obvious. Much like with polling, trends matter much more than the top line. I have previously stated that tariffs might become very popular with politicians after Trump’s retirement. Voters don’t file tariff tax returns! That alone indicates future politicians might be more than happy to adopt pro-tariff positions, which could mean less in the way of income taxes. 

What this Means for Americans

Does a Joe Rogan episode radically change financial planning for most Americans? No. But considering the odds, I think it, combined with Trump’s other promises, gives us two insights to consider.

2024 Year-End Roth Conversions

First, there is little reason to rush year-end 2024 Roth conversions, particularly before Election Day. The conventional wisdom had been “better do those Roth conversions before taxes go up in 2026!” That conventional wisdom is now out the window. 

I generally recommend Roth conversions when they make sense for the individual based on the individual’s circumstances. I don’t recommend Roth conversions based on “conventional wisdom” about tax changes in 2026.

Question Paying Tax to Get Into Roth

I have been fond of traditional retirement account contributions. I didn’t think I would get evidence supporting that view from a Joe Rogan episode, but that’s where we are.

If future income taxes are trending down, why not take the deduction while it is valuable? That’s where we are going into the 2024 Election.

Does this mean we should never go Roth? No! But now we must start to question paying tax to get into Roth. 

Please don’t read this to say “oh wow, FI Tax Guy is against Roth.” Far from it! But I must question paying federal income tax in 2024 to get into Roth.

There are times we pay tax to get into a Roth. Contributing to a Roth 401(k) instead of to a traditional 401(k) is paying tax to get into Roth, because we have foregone the tax deduction that we could have received for a traditional 401(k) contribution. Taxable Roth conversions are another time we pay tax to get into a Roth.

There are times we don’t pay tax to get into a Roth. For most people, an annual Roth IRA contribution involves no additional tax, since most Americans do not qualify to deduct contributions to traditional IRAs. Backdoor Roth IRA contributions are the same – there’s no forgone tax deduction. “Taxable” Roth conversions against the standard deduction are another example where there’s no additional federal income tax incurred to get money into a Roth. 

To my mind, these “tax free” ways are the best way to get money into Roth accounts, and in this environment should be favored. 

My Proposal

Many questions and challenges remain regardless of the outcome of the Election. It remains to be seen how much revenue can be raised by tariffs. The 47th President must prioritize significant cuts to federal spending, particularly foreign military spending. Oh, and the federal government has over $35 trillion of accumulated debt.

We are a long way away from axing the individual income tax. But, perhaps a relatively modest measure could get many Americans there. I propose doubling the standard deduction. The IRS just announced the 2025 standard deduction will be $15,000 for singles and $30,000 for married filing joint couples. Why not double it to $30K for singles and $60K for marrieds?

My proposal achieves some great outcomes. Combined with no taxes on Social Security, a doubled standard deduction would eliminate income taxes for most retired Americans. Trump could say he eliminated millions of tax returns with this one change.

Doubling the standard deduction would be a significant tax cut for millions of working Americans. Further, it would greatly reduce the number of Americans claiming itemized deductions, making the tax code easier to administer for the Internal Revenue Service.

Lastly, a government with $35 trillion plus of debt probably shouldn’t stop taxing the Elon Musks of the world. My proposal keeps taxing him and is no tax cut for him at all (assuming he makes more than $30,000 annually in charitable contributions). 

Assuming Congress passes significantly increased tariffs in 2025, I recommend a five year doubling of the standard deduction. That would give the government five years to test out the new system to see if increased tariffs and decreased income taxes, hopefully in concert with significant spending cuts, is successful. 

Conclusion

I will cry no tears if the income tax goes away. However, I don’t think we can plan for its demise.

While the income tax is likely here to stay, the trend is becoming obvious. Tariffs are likely on the way up and income taxes are likely on the way down. That informs retirement and tax planning. There’s little reason to rush Roth conversions, and traditional retirement account contributions are more attractive.

Of course, stay tuned. The Election is not over. There are no guarantees as I write this on October 26, 2024. I promise I’ll have plenty of commentary about year-end planning and more after the Election.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on Twitter at @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.