Possible Challenge to Backdoor Roth Contributions?

Some tax professionals have raised the possibility that the IRS could challenge the tax treatment of the backdoor Roth technique. Their concern is that the IRS may collapse the two transactions (a contribution to a traditional IRA followed by a conversion) into one (a contribution to a Roth, which is not permitted because of the income limit). In this case you could incur a penalty for making an excess contribution to the Roth. Some have suggested creating a delay, perhaps as long as a year, between the contribution and the conversion, as a way to reduce this risk.

My assessment: there is no cause for concern, for several reasons.

• It would have been obvious to the taxwriters in Congress that they were creating this opportunity when they eliminated the income limit on conversions, and they chose not to block it. As a result, there is a fair argument to be made that Congress intentionally created this opportunity.
• Tens of thousands of taxpayers use this technique each year. Leading mutual fund provider Vanguard Group has recommended the technique for years and has processed hundreds of millions of dollars in backdoor Roth contributions.
• The IRS has known about this technique since before the law eliminating the income limit on conversions took effect, and has not lifted a finger to stop it.

Perhaps any lingering doubt on this point was put to rest when Congress enacted the 2017 tax law. The conference committee report accompanying the legislation seems to endorse the technique. In the course of discussing repeal of the rule allowing taxpayers to undo Roth conversions, it says in a footnote, “an individual may still make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA, but the provision would preclude the individual from later unwinding the conversion through a recharacterization.”

As a reminder, I do recommend making sure the two transactions are distinct: obtain confirmation that the contribution to the traditional IRA has been documented before proceeding with the conversion, and avoid doing both transactions on the same day.