RTS #007 – Using the “Back-door” correctly
Tax planning only counts if it’s reported correctly. That applies to EVERY tax strategy but can create huge issues when it comes to backdoor Roth (BDR) contributions. It’s bad enough if a QCD doesn’t get reported; that means you missed out on a deduction. But sometimes, when a BDR is done wrong, the taxpayer ends up paying taxes on the same income TWICE! What a terrible way to tip the IRS.
We recently created a guide to help Financial Advisors and their teams execute and report BDR contributions correctly (see links below) and even to cover the most basic situation, we went three pages deep. With all the nuance and caveats and exceptions and sheer volume of places on a tax return, you need to check to make sure the strategy is reported correctly; it makes sense to ask, is it worth it?
I mean, a taxpayer can only put $6,500 a year ($7,500 if they are 55 or older), why hassle with it? Don’t worry, we did the math for you, and over time the difference can be massive. Like, six figures of tax savings massive (you can see more math on that in our recent article published in partnership with our Media Sponsor for the RTS Tax Planning Summit, Rethinking65).
The great news is that with the right process and a little bit of education, this strategy does not have to be a headache. The starting point is to make sure you ask these five questions on every BDR contribution:
- Is a BDR right for this client? If they are eligible to contribute directly to Roth, just do that.
- Was the traditional IRA contribution done correctly? Was the contribution properly reported as after-tax on IRS form 8606?
- Was the distribution from the traditional IRA done correctly? It’s easy to forget that the BDR strategy includes distribution.
- Was the conversion to Roth executed and reported correctly? It doesn’t get the full benefit until the dollars are actually in the Roth account.
- Was the tax return filed correctly? Get every tax return every year. It has to be reported to the IRS correctly to count.
There are plenty of exceptions and unique situations, but that will cover the basics and help you through most of the situations you will encounter.
What can you do about it?
Have a checklist! This could apply to any tax planning strategy, but especially when there are so many key data points, a repeatable process is key. Whether you use the RTS 8606 guide or create your own, having a checklist will help you, your team, and your clients.
Happy Tax Planning!
P.S. The RTS 8606 guide is available for FREE within the membership for the RTS members.
