Contributions to a Roth IRA aren’t deductible. The amount that can be contributed to a Roth IRA is subject to the same limitations as apply to regular IRAs. Qualified distributions from a Roth IRA aren’t included in income, and other distributions are treated as a return of investment to the extent of contributions to Roth IRAs.
A taxpayer is permitted to make a contribution to a Roth IRA only if the taxpayer’s modified adjusted gross income (“MAGI”) is less than a specified limit that is indexed for inflation. For example, for 2015, a married taxpayer filing a joint return is permitted to make a full contribution to a Roth IRA if the taxpayer’s MAGI is less than $183,000, and the contribution limit is phased out over the range of $183,000 to $193,000.
However, there are currently no income limits on a person’s ability to make nondeductible contributions to a regular IRA or to convert money from a regular IRA to a Roth IRA. A taxpayer who converts an amount held in a traditional IRA must include the entire converted amount in their taxable income. That is, the amount is includible in taxable income to the extent it is not a return of basis.
This ability to convert money from a regular IRA to a Roth IRA provides a “back-door” to a Roth IRA for those taxpayers who cannot otherwise contribute to a Roth IRA because their income is over the limit. That is, a taxpayer who is not able to make a contribution to a Roth IRA can nonetheless put just as much into a nondeductible IRA and then convert that nondeductible IRA into a Roth IRA (and pay tax on the amount converted).
President Obama’s 2016 budget proposal provides that future Roth conversions be limited to pre-tax money only. Thus, after-tax amounts (i.e., nondeductible contributions, which are attributable to basis) held in a traditional IRA could not be converted to Roth IRA amounts. A similar rule would apply to amounts held in eligible retirement plans. This proposal would effectively kill most back-door Roth IRAs.
For more information about the President’s 2016 budget proposal, go to https://www.whitehouse.gov/omb/budget.