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Taxes

How to plan for taxes and pay as little as legally possible

How to do backdoor Roth conversion using Schwab

by Yoda March 3, 2025

Roth IRA is one of the few accounts which grows tax free. Withdrawals after 59.5 years of age are also tax free. Your social security is taxed, your pension payments are taxed, but not Roth IRA withdrawals. Its a pretty great account to invest in. However if your Modified Adjusted Gross Income (MAGI) is over 150K filing single or combined MAGI is over 236K(married filing jointly), then you are ineligible to contribute to a Roth IRA. This is where a backdoor Roth conversion comes to the rescue.

Backdoor Roth conversion/contribution is a completely legal strategy you can use to get around the MAGI limits and still invest and grow your Roth IRA tax free. Here is how you can achieve this using Schwab.

Step 1: Ensure you have the right accounts at Schwab

You need to have a Roth IRA and a Traditional IRA at Schwab at a minimum. If you have a Schwab checking account, the process is smoother:

accounts required to do backdoor roth conversion

If you do not have any of the above mentioned 3 accounts, you can simply login to your Schwab user and click on open an account and follow the instructions.

Step 2: Timing the backdoor Roth conversion right

If you need to contribute to a Roth IRA for 2025, best is to do these transactions in the same calendar year. This helps in making tax reporting easier. Otherwise if you split the transactions across 2 years then you need to report it differently and that just gets confusing. So help yourself and do these transactions in same year.

Step 3: Make the traditional IRA transfer

Ideally, you should have the funds for conversion ready in Schwab checking account. if you do not, first move it there. This will help you in moving money quickly for backdoor roth conversion. It will also help to avoid any gain in interest that could take your balance above the max limits.

Once you have the money in your Schwab checking account, go to Move Money –> Online transfer. Choose your checking account that has the money as From account. Select your traditional IRA as To account.

As you can see, I currently have 0 in my traditional IRA account. In order to have easier tax reporting, its always better to make sure you do not have any money in any of your traditional IRA account under any broker(from rollovers or prior years). This is to avoid triggering the pro-rata rule that could lead to you paying tax on the backdoor Roth conversion.

This transaction is the first step in backdoor Roth conversion. We are just moving our after-tax money from a checking account to a traditional IRA. If the money came from your Schwab checking account this transfer will happen instantly. However if it came from an external account to Schwab, it will be held for a couple of days for confirmation and you could gain interest on that money. Lets move to next step.

Step 4: Move the money from a Traditional IRA to Roth IRA

This is the actual backdoor Roth conversion transaction. Head over to Move Money–> Online Transfer. Choose Traditional IRA as your from Account. Select your Roth IRA as your To account.

backdoor roth conversion transaction start

Schwab will recognize the transfer as backdoor Roth conversion and show you the pop up in red above. Click on the link and choose the accounts again. Choose Full as conversion type and click Continue.

re-enter backdoor roth conversion transaction

In the next page, choose No to withholding any taxes. Click Submit. Voila! your backdoor Roth conversion is now complete.

If you moved the money from your checking account at Schwab, this process can be done on the same day for all transactions. This avoids gaining any interest and making tax reporting cleaner. Good thing about Schwab is that next year you can use the same accounts to move money and do the backdoor Roth conversion again.

Check out my other article if you need help in tax reporting the backdoor Roth conversion in your tax return.

Disclaimer: The content presented here is solely for entertainment and informational purposes; please do not consider it as professional advice or a substitute for consulting a qualified expert in the relevant field. I am not your fiduciary or an investment advisor or tax advisor.

March 3, 2025 0 comments

Taxes

Reporting Backdoor Roth IRA Taxes

by Yoda February 2, 2025

Congratulations! you worked hard and made so much that you had to do a backdoor Roth IRA conversion. Now its tax return filing time and you are wondering how do we report backdoor Roth IRA taxes ? This is a vital step which needs to be done correctly to ensure compliance and make sure you are not paying any extra taxes.

This guide will walk you through reporting backdoor Roth IRA taxes using TaxAct software for filing tax return. It only covers the base case where:

You created/contributed to a traditional IRA before the end of the year. We will characterize this contribution as non-deductible when reporting during tax return time.
Before end of same year, you completed backdoor Roth IRA strategy by converting the contribution to a Roth IRA.

Doing contribution to traditional IRA and converting it to ROTH in same year helps you make the reporting backdoor Roth IRA taxes very easy. Here the documents you would need to gather from your broker before reporting backdoor Roth IRA taxes:

Form 5498 which shows your traditional IRA contribution. Your broker sends this to the IRS and a copy to you. This reports that you made some contributions to your IRA account. We need to characterize this as a non-deductible contribution later in TaxAct.
Form 1099-R, this shows your IRA distributions. Even though you moved money from a traditional IRA to Roth IRA, this still counts as money being withdrawn from your traditional IRA. Usually in case of IRA distributions you are on the hook for taxes and penalties if you are less than 59.5. This is why its important to let IRS know about your withdrawal when filing backdoor Roth IRA taxes.
Form 5498, another one from your broker mentioning the deposit to your Roth IRA account. This should ideally match the amount in the first 5498 form. Again, because of the multiple 5498 forms your broker reports to the IRS it might seem like you contributed twice the limit into your IRA accounts in a year. its important to make sure we clarify this as well while reporting backdoor Roth IRA taxes.

Steps to report Backdoor ROTH IRA Taxes using TaxAct

Head over to TaxAct, login –> Open your tax return–> Federal–> income section of your current tax return.
Click on Review under the Taxable IRA distributions section

Next click on add 1099-R form in the next page

Select yourself or your spouse(in whosever name the 1099-R form is). Fill out other radio buttons based on details in your 1099-R form. Also fill out the Broker’s name, address as it shows on the form in the next page on the wizard.

Next, look at the 1099-R and start filling the fields in TaxAct form accordingly. Make sure to check the checkboxes as well.

In the next page, since this distribution is not from an HSA account, keep the box unchecked and move forward.

On the next screen, enter the amount you converted to Roth account. This would change based on the limits every year assuming that you do the maximum amount allowed each year.

In the next section, assuming you have no other traditional IRA’s with balances or have been doing backdoor Roth in previous years or doing it for the first time and have met the conditions mentioned at beginning of this article. Then you are good to not check this box. This is just saying you do not have any other balance in traditional IRA except for what you converted to Roth. So the pro-rata rule will not apply.

If you get warnings towards the end of the form, ignore them.

We are done with entering details from 1099-R. If you head over to Income menu from left pane, you will see that so far we see a 6500$ taxable distribution for our backdoor Roth IRA taxes. This is mostly because we still need to notify the software that this was after tax money and should not be taxed again.

To do this, from left pane, go to Federal menu option–>Retirement Plan Income–> Click on nondeductible IRA’s form.

Next just enter the same amount that you converted. Again this will change every year assuming you contribute maximum allowed and whenever government updates it.

As soon as you enter this amount, you will see the taxable IRA distribution goes back down to 0. In the final form 8606 before submission, in Part 1 it should show your nondeductible traditional IRA contribution.

Part II of the form should show that you converted the IRA distribution to Roth IRA leaving you with 0 tax amount.

This completes the backdoor Roth IRA tax reporting using TaxAct. If you are interested in knowing about adjusting cost basis for ESPP please check my other post on it.

February 2, 2025 0 comments

Taxes

Don’t forget investing tax-efficiently

by Yoda July 18, 2020

Ben Franklin once said, there are only two things certain in life: Death & Taxes. Both you cannot avoid but you can try and defer them as much as possible. I am no medical expert, but I am sure everyone wants to stay healthy and live as long as possible. Taxes are something that not a lot of people try to avoid or defer or do anything about. Especially when it comes to investing, its imperative that you are investing, tax-efficiently. Here are some reasons why taxes matter and why you should focus on reducing them:

Taxes reduce your available income to invest

Even before you begin investing with your hard-earned money, you pay income tax. Depending on your annual salary it can be anything from 0 to 37%. So even before you start investing, you are losing a huge cut of your income! Why should you pay taxes again when investing?

There are ways like investing in employer 401K plans, solo 401K’s, HSA’s that help in reducing your taxable income, hence reducing the taxes that come out of your paycheck. There are other considerations: if you want to pay taxes now, then invest in Roth flavors of retirement accounts. But point is you need to and should reduce your taxable income as much as possible.

Taxes are frictional costs in trading

Warren Buffet always says his favorite holding period is forever. The biggest reason for this is because buying and selling stocks generates lot of tax liability. Every time you sell at a gain, you owe Uncle Sam some capital gains taxes. Every time you sell at a loss, you need to track it and make sure you claim on your tax returns. Not only is it cumbersome, but if you trade stocks very often, you end up loosing a lot of your gains to the IRS as taxes in short run. In the long run then, you would be left with very little wealth to show for it. Mutual funds are very notorious for this. A lot of times the fund manager will try to keep trading in order to improve performance and just pass on the taxes and commission costs to you as fee. This is opposite of investing tax-efficiently.

Inflation already an enemy

Inflation is your biggest enemy. Managing the rate of inflation is often the job of the Federal Reserve. Currently they plan on a 2% rate of inflation every year. What this means is, say this year you buy x amount of groceries with 100$. Next year that same x amount would cost you 102$. Now I am sure you have heard about compound interest and how it can be your best friend long term. But similarly, inflation “compounds” and the effect can be very negative over long term. So, when you already have this big force working against you which you can frankly not do much about, why would you want to further lessen your gains by paying taxes? Lets say you make around 10% on an investment, 2% of that gets eaten up by inflation, now if it was a short term on, you are probably looking at another 1.0 to 3.7% in taxes based on your annual income. If it was a long term gain, then looking at 0-2% off on your gains. But you can easily avoid this. Just do not sell “every year” to realize the gains and buy something else from the proceeds. Invest for the long term. Imagine not giving up on those 1-3.7% gains every year and allowing them to compound. Results will be wonderful by the time you retire.

Incorrect tax decisions can cost you over your lifetime

Filing a tax return is definitely great to make sure you paid least amount of tax previous year and get back if you paid in excess. Similarly when you make investing decisions, you need to also account for taxes in your decision. Things like your income level, timing of transactions in your taxable accounts, special tax treatment on some type of investments etc. need to be considered before buying any investment. If you do not consider such factors, you may as well end up paying a huge tax bill when the tax man cometh. These decisions might seem small, but will impact you over your lifetime in the long run and can be very costly!

Investing, Tax-Efficiently

While it’s not possible to avoid taxes completely, they should be deferred. Taxes are like speed bumps on your road to financial independence! They slow you down and might even derail you if you are not smart about your investing decisions. However, each person’s tax saving strategy must depend on their own situation. Like your age, income, retirement age, future after retirement etc.

In the days of online brokers like Robinhood and Webull which gamify investing, encourage short-term trading, there is an even bigger need to understand investing, tax-efficiently. There are a lot of ideas like retirement accounts, tax deductions, tax credits on foreign investments etc. Don’t worry! they are all easy to understand and follow & completely legal! I discuss them in my guide below. Sign up below to get a free copy of comprehensive strategies and ways to reduce taxes on your journey to financial independence!

July 18, 2020 0 comments

Taxes

Adjust cost basis for ESPP/RSU tax return

by Yoda March 25, 2020

If you received Employee Stock Purchase Plan (ESPP) or Restricted Stock Units (RSU’s) from your employer and you sell them within 2 years. You may have noticed that the reported income your company reports on W2 box 1 is way more than the money you were actually paid in salary. This is because they also include some amount from ESPP and RSU’s as your income. You also get a 1099-B from your broker with details of transactions. But if you do not fill your tax return properly you might end up getting taxed twice on any ESPP and RSU you sold the previous year.

How do you get double taxed?

Your broker sends you the 1099-B form to report the gain/loss on sale of transactions. However, the cost basis that they put in these transactions(ESPP/RSU) is usually incorrect. When you enter this information directly from your 1099-B to a tax return software like or Turbo Tax without making adjustments to the cost basis, you are taxed twice/double on the stocks which you were granted.
On the ESPP side let’s look at an example.

ESPP Events	Amounts
My contribution in a quarter for 1 Lot	2774.20$(gets taxed from regular paycheck)
My cost of basis with 15% discount on W2	2358.07$
Selling price of 1 Lot	3022.66$
So according to my broker (on 1099-B), my gain	664.59$(3022.66-2358.07)
Actual gain	248.46$(3022.66-2774.20)

However, I had contributed 2774.20 and paid taxes on that amount from my paycheck itself. So that means my actual gain which I should pay taxes on should only be 3022.66-2774.20 = 248.46$.
Hence I need to make an adjustment to my cost basis so that its 2774.20 and not 2358.07 as shown on 1099B. Do this if you sell your ESPP within 2 years of grant date.
On the RSU side , lets look at another example

RSU Events	Amounts
Dollar amount of RSU vested	6000$
Taxes paid when RSU vested	Taxed at normal tax rate deducted at source/paycheck
Selling price while selling the vested RSU	6050$
So according to my broker (on 1099B), my gain	6050$(6050-0)
Actual gain	50$(6050-6000)

Usually with RSU’s since you already pay tax on the amount vested, your actual gain is only 6050-6000=50$. Not the 6050 your 1099B tells you.

How do we adjust ESPP cost basis while filing tax returns?

Now that we know why we need to change our cost basis for ESPP and RSU’s in some cases, lets see how to do this. I usually use to file my tax return. I am going to put some screenshots for you to follow step by step on your own:

Step1: Complete your basic and life events tab and then go to the Federal tab. Under the federal tab, look at Income–> Capital Gain or loss –> Review:

Next select Form 8949 (Schedule D lines 1a,1b…) and hit review:

This is where you can enter any capital gains or losses, Choose –> Add form 1099-B:

Basically in your tax software you want to go and start entering a 1099-B form under this step.

Step 2: Go to quick entry and start:

Step 3: Look at your 1099-B from the broker and fill in the normal details. No need to adjust ESPP cost basis yet. Just fill in the details as shown. Here is what my broker showed on 1099-B:

Using the red lines above, I entered the following in my software:

Step 4: Now you may have received a supplement form from your broker. Here is what mine looks like:

The form shows my cost basis with 15% discount and adjustment.

Note: if you did not receive this supplemental form from your broker, you may even look at some documentation your employer sent to you which may have the same info. Alternatively, you can also calculate the 15% discount or whatever discount you get and then in next step enter the amount in the fields shown below:

If original cost of basis is too low, then enter the adjustment amount with negative sign, if cost of basis reported in 1099-B is too high, then enter positive sign. Since our cost of basis entered in 1099-B is lower than the expected, we enter a -ve amount as shown:

As soon as you enter this negative amount and save the form, your tax owed to IRS will go lower or else if you are getting a tax return, it will go higher.

Next just mention this is an ESPP sale.

Select Continue and say Yes to the next question, since we did pay taxes as part of our W2 when we got the ESPP allotted.

Next, you just need to enter the actual adjusted cost basis. This is again present in the supplement form from our broker.

This is all you need to adjust cost basis for espp on your tax return.

How do we adjust RSU cost basis while filing tax returns?

The process is much simple to adjust RSU cost basis. Reason is same, your cost basis is 0 for most RSU’s. So, if you sell them at gain of 200$ (assumption) for total proceeds of 6200$. Your 1099-B might show cost basis of 0 and gain of 6200$. Which is incorrect. Since, you probably already paid some taxes either via paycheck deduction or via sale of some RSU for when RSU vested. So you need to adjust RSU cost basis.

Step 1: Go to the add 1099-B menu option as shown in previous section.

Step 2: Next check out the 1099-B entry for RSU sale from your broker. Here is how mine looks like:

Notice how my cost basis shows up as 0 for all 3 sales I made. First 2 of these were for payment of tax for the whole lot. Also, notice how the second line says the category for 8949 form is Part 1 with Box B checked. Make note of what the Box 12 is and if its a short term or long term transaction. We will use these in next step.

Step 3: Since, this cost basis of 0 is not reported to IRS(Box 12). According to IRS guidelines, you need to enter the actual cost basis in column e directly. No adjustment is required as shown:

Step 4: So, I will look at my supplement from broker and enter the form 8949 as shown below for the first line of 1 stock of RSU shown above.

So, my form 8949 entry on to the ui will be:

Notice how the adjusted cost basis is directly entered into field 1e. Also, check out how the adjustment section has no entry. This is especially because the BOX 12 mentioned no cost basis was reported to IRS. So it is our job to just directly enter the cost basis. No need for any adjustments. You would still need to make sure the reporting category is still correct in next section of the form(short term B in my case):

This is all you need to make an adjustment to cost basis. Its pretty straight forward, only problem is not a lot of people know about it and they realize it too late. So just knowing about it and glancing through this page will hopefully help you remember to do this when you sell any ESPP or RSU’s when filing tax return.

If you need any more info on things to remember while filing taxes do visit my earlier post here.

In case you do backdoor Roth IRA every year, make sure you are in compliance and avoid paying extra taxes while reporting your backdoor Roth taxes using this guide.

March 25, 2020 2 comments

Taxes

Mistakes to Avoid while filing Tax Return

by Yoda March 10, 2018

With the tax return filing in full swing, here are some points to remember while filling in the forms. Make sure to avoid making the following mistakes.

1. Not Including all income: Make sure to include income from all your W2 if you had multiple jobs. Many people get dividends or savings interest from some high yield accounts throughout the year. Banks or brokers send a form called 1099 forms which have details about these incomes and need to be reported as well. Usually deadline for getting these forms have been 16^th Feb. So wait at least until then to file your taxes. Sometimes a bank might not even send the form. In such cases its a good idea to proactively enter an entry based on how much money you got in dividends or interest from a bank in previous year.
2. Not selecting correct deductions: Filing as single or head of household are different things and you need to make sure you are not filing in a wrong category to get more deductions.
3. Not filing on time: Although IRS gives usually till mid-April to file returns. It’s a good idea to do them by end of February. This allows you to get your refund on time and also allows you to make an amendment in case you catch a mistake later on. If worst comes to worst, then make sure to get an extension to file your returns late.
4. Not adjusting cost basis for ESPP/RSU’s: When you sell your ESPP or RSU’s within 2 years of them being granted. Your cost basis is reported incorrectly by the broker in the 1099 form. So you need to get it reported correctly by adjusting the cost of basis. This avoids getting double taxed on some income of yours.
5. Not double checking: Most software’s now a day allow you to save your progress while filing returns and continue later. They also allow you to review your return before submission. It’s a great idea to make sure nothing went wrong while filling your return. Make sure to check for right amounts, deductions, account numbers where you get back your return, social security numbers etc.
6. Not filing tax returns at all: Based on your filing status, income earned and age. You may or may not be required to file tax returns. But if you are eligible to file tax return then you must file them even if you don’t expect to get tax return from the government or you don’t owe any taxes. Usually most tax software allows you to fill your information for free. They will let you know if you will receive any returns or if you owe any taxes before filing. You must use them to figure out if you are required to fill tax returns and make sure you do them. This also prevents you from being potentially audited in future.
7. Filing wrong tax forms: There are different forms like 1040, 1040A, 1040 EZ, 1040 NR. One is for nonresidents, one for simple tax return, one more complex and for itemization. Most tax software do walk you through the whole process. It will ask you questions based on which they will determine which form you need to fill.

So keep these things in mind while filing your tax return and hopefully you should not have to file an amendment later.

March 10, 2018 0 comments