How Is Tax Basis Determined on a Roth IRA Rollover?

You can move money to a Roth IRA from a tax-deferred account, but doing so has tax consequences. Some of the funds you move when making a Roth IRA rollover may not be taxable. The nontaxable funds in the tax-deferred account are called your tax basis, or IRA basis.

Rollovers and Taxes

Transferring money from a tax-deferred account such as a traditional IRA or 401(k) to a Roth IRA is referred to as a conversion. Funds in a tax-deferred account are usually pre-tax dollars, since you get to deduct contributions from your taxable income. All money added to a Roth IRA must be after-tax dollars. To convert pre-tax dollars to after-tax dollars, you have to pay income taxes on the transferred funds.

Tax Basis

Sometimes a portion of the funds in a tax-deferred account is after-tax money. This happens when you make nondeductible contributions to a traditional IRA. Designated Roth contributions to a 401(k) plan are also after-tax dollars. Nondeductible contributions are not taxed again when withdrawn from the account or rolled over to a Roth IRA. These funds make up your tax basis.

Basis Calculation

The tax basis in a tax-deferred account consists of all nondeductible contributions made to the account since it was opened, minus any nondeductible contributions that have previously been withdrawn. For example, if you made $10,000 in nondeductible contributions to a traditional IRA in previous years and you have removed $2,000 as part of earlier withdrawals, the tax basis is $8,000.

Partial Rollovers

The Internal Revenue Service does not allow you to roll over only tax-basis dollars from a tax-deferred account. When you convert only part of the funds, the proportion of tax-basis dollars converted must be the same as the proportion of the tax basis in the tax-deferred account. Suppose your traditional IRA has a balance of $100,000 and a tax basis of $8,000, or 8 percent. If you roll over $25,000 to a Roth IRA, only 8 percent of that, or $2,000, counts as nontaxable tax basis dollars. You must pay income taxes on the remaining $23,000.

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