There has been some talk about eliminating the Backdoor Roth. What is a Backdoor Roth, and what should we know about the planned changes?
Not just talk; this is one of my favorite tax hacks, and it is on the Congressional chopping block. The Roth IRA, the Backdoor Roth and the Jumbo Backdoor Roth are all excellent retirement planning tools. If you are eligible to make a Roth contribution, you should probably do so now. If you will have modified adjusted gross income (MAGI) over 208K and you are married filing jointly, or 140K if you are single, you are ineligible to make a 2021 Roth IRA contribution.
For those not eligible, you may be eligible for a Backdoor Roth. Although, if you already made a 2021 IRA contribution, you can only contribute a total of 6K (or 7K if 50 or older) to all of your IRAs for the year.
To do a Backdoor Roth, you cannot have any other money in traditional IRAs or SEP IRAs in your name, or this strategy will not work as intended: the tax-free treatment would only be partial due to IRA aggregation rules. Although, it could still work for your spouse. Here are the steps: Make a non-deductible 6K (or 7K if 50 or older) IRA contribution. Then immediately convert that non-deductible IRA to a Roth IRA. Make sure you file form 8606 when making a non-deductible IRA contribution.
A Jumbo Backdoor Roth is even better and, if you are eligible for this strategy, take advantage quickly, as you may only have weeks left before if disappears forever. Both the Backdoor Roth and Jumbo Backdoor Roth are eliminated as strategies in the November House-passed version Build Back Better legislation. This would go into effect on Jan 1st 2022, although we still have to see what the Senate agrees to and passes, if anything.
Making a Mega Backdoor Roth Contribution
How to make a Mega Backdoor Roth Contribution: First, you will need a 401K with provisions for Roth Contributions, After-Tax contributions, and provisions for in-plan conversions. You don’t have a lot of time but, if you are self-employed, it is still possible to pull this off before the end of the year. Here are the steps: Make a $19,500 Roth 401K contribution. An extra $6500 if age 50 or older. At the same time, make a $38,500 After-Tax contribution and then convert the $38,500 to your Roth 401K. You now have $58,000 (or $64,500) in your Roth 401K. This takes precise planning, so make sure you work with your tax advisor, pension administrator, and possibly your payroll provider to get this right.
It is my strong belief that taxes, all income taxes, are going up in the next decade and Congress will continue to eliminate tax deductions or phase them out at even lower income levels. On balance, a Roth is a tax-never account or, as I like to call it, a “Tax Freedom” account. And we know Congress and Uncle Sam currently want to curtail the Backdoor Roths, as they also know how valuable they are.
Crypto and Tax
Some people may be sitting on realized gains in crypto currencies in their wallets. How should those be handled? Any other suggestions as far as tax consequences of crypto?
This is a very timely question. If you have unrealized gains and believe that your crypto will be worth more in the future, you may want to consider holding them for at least 365 days so you are subject to long-term capital gains taxes.
The IRS has ruled that crypto is property and all buys and sells of crypto are subject to capital gains and capital losses, just like stocks. If the sale is less than one year from the acquisition date, the transaction would be considered short term and the gain would be subject to ordinary income taxes. In addition, if you trade one crypto asset for another, it would be considered selling the asset and buying a new asset for tax purposes. If you purchase goods or services with crypto, it is also considered a sale, and any gain or loss should be reported. And finally, if you received crypto as a result of a fork, mining, airdrop, or in exchange for goods or services, the value on the day you received it would be considered income.
By the way, there are a few crypto events that are non-taxable: Purchasing crypto with fiat (like US dollars), donating crypto to a charity, transferring crypto from one wallet to another, and gifting crypto (up to 15K/yr per recipient), although the recipient would have to carry over your cost basis.
Finally, it is very important and could save you a bundle by making sure that you report all of your crypto losses, not just your gains. You should add up all of your realized gains and losses for the year (of all assets including crypto) and if you have any unrealized losses, you may consider selling them to offset realized gains. Also, since crypto is PROPERTY (not security) therefore losses from sale of crypto are not subject to wash sale rule for tax year 2021. However, there is a possibility that wash sale rule may apply to crypto starting from tax year 2022 if the BBB act makes wash sale rules applicable to crypto as well. If it ends up that crypto becomes subject to wash sales and if you really like the assets you are selling, you may consider buying something similar. Or buying the asset back in an IRA or Roth IRA.
On Balance, if you trade crypto, you should consider software that tracks all of your buys and sells. This would most likely save you time, money and the hassle of a future IRS audit.
The above information should not be considered tax advice as you should always consult with your tax professional before making any tax decisions.