Does N.J. tax ‘backdoor’ Roth IRAs?

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Q. I contributed to a traditional IRA and automatically converted that same amount to a Roth IRA – a backdoor Roth – I was not subject to any tax on the conversion. Does New Jersey tax backdoor Roths?
— Investor

A. Let’s first go over what a backdoor Roth really is. It’s a way for taxpayers who are ineligible to contribute to a Roth IRA to skirt the rules.

For 2018, a single taxpayer with modified adjusted gross income (MAGI) above $135,000 and a joint filer with MAGI above $199,000 are each prohibited from making a Roth IRA contribution, said Neil Becourtney, a certified public accountant and tax partner with CohnReznick in Eatontown.

Taxpayers in this situation will instead make a traditional IRA contribution where no income limits apply and then shortly after convert the traditional IRA to a Roth IRA – the “backdoor” contribution.

“For many years, taxpayers have been executing such transactions despite there being no clear authority to do so,” Becourtney said.

He cited an IRS webcast last July in which Donald Kieffer Jr., a tax law specialist in the IRS Tax Exempt and Government Entities Division, said this technique was allowed under the law, citing the conference report to the Tax Cuts and Jobs Act.

The New Jersey Division of Taxation, Tax Topic Bulletin GIT-2, IRA Withdrawals, says that if a taxpayer qualifies to convert an existing IRA to a Roth IRA for federal tax purposes, the taxpayer also qualifies for New Jersey tax purposes regardless of the level of their New Jersey taxable income, Becourtney said.

“With the IRS allowing backdoor Roth IRA contributions, it calls into question why there is an income limit in the first place, since any taxpayer can circumvent the income limit by making a traditional IRA contribution and then have the financial institution convert the account to a Roth IRA,” he said.

No federal deduction is obtained for a Roth IRA contribution, with the trade-off being future tax-free distributions if certain requirements are met.

“New Jersey does not allow a deduction for any IRA contribution, so the distinction for state purposes is whether the investment growth in the IRA is taxed once withdrawals begin,” he said. “Since New Jersey follows federal treatment, future distributions will also not be subject to tax, provided the distribution is not subject to tax for federal purposes.”

Email your questions to moc.p1561420393leHye1561420393noMJN1561420393@ksA1561420393.

This story was originally published on April 15, 2019.

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