Trying to file taxes, I stumbled over a strange behavior of the software, and now I am wondering if this is actually the IRS regulation or just a bug.
Assume this situation:
- On Jan/1 of 2016, X. has a Traditional IRA, consisting completely of Deductible Contributions from earlier years.
- In March 2016, X. does a backdoor conversion of the complete Traditional IRA amount to a Roth IRA. X. expects the complete amount to be taxable income for the year 2016.
- From April to August, the Traditional IRA has a balance of 0 (just to make this clear)
- In September, X. makes a Non-Deductible Contribution of 6500 $ to the Traditional IRA. He understands that he needs to track this 'Basis' on form 8606.
- The year ends with no further activities in those two accounts.
My assumption was that the complete conversion in March is fully taxable, and the 'new' money contributed in September is the new 'Basis' to be tracked (and its conversion next year should be tax-neutral).
However, the software assumes that the two amounts merge first, and then the rollover consists of the respective percentages of original deductible money and the new money, resulting in a lower tax payment, but also in a lower Basis for the next year.
I know that if you 'merge' contributions in the IRA account (even using different account with different providers), this would apply. However, I assumed that the clear separation of the activities by time - the IRA account was empty for months in between - would avoid this merging rule. How could money that comes in September 'merge' with money that is gone in March?
Which one is right?
Does the IRS require to merge the contributions, basically ignoring the sequence of activities within the year, considering all activity within the year happened at the same 'moment'?
Or is the software just not able to handle that correctly?