How To Contribute to The Mega-Backdoor Roth

May 2023

How To Contribute to The Mega-Backdoor Roth

The “mega-backdoor Roth” is a retirement saving strategy that technically allows individuals to make much larger contributions to certain workplace retirement accounts than the annual elective deferral limits.

To use a mega-backdoor Roth, the following must exist:

  1. The client must be eligible to contribute to a Sec. 401(k) or Sec. 403(b) workplace retirement plan;
  2. The plan must offer a Roth option for contributions;
  3. The plan must allow participants to convert prior contributions to Roth inside the plan, as more than half of plans do, or it must allow participants to roll dollars out of the plan while still participating; and
  4. For the ultimate mega-backdoor Roth, the plan must also allow what are known as “after-tax contributions,” as defined below.

After-tax contributions

All 401(k) and 403(b) plans allow employees to make pretax elective deferrals up to annual limits ($22,500 for 2023, or $30,000 for those age 50 or older), which is the essence of these accounts.  A vast majority of plans also offer workers the option to designate their contributions as Roth.

A third, less-available option for 401(k) and 403(b) accounts is making after-tax contributions above and beyond those designed as Roth.  This third “bucket” allows workers to make up the difference between the total of their elective deferrals plus any employer contributions and the IRS maximum allowed contribution amount. For 2023, the maximum mega-backdoor Roth amount that can be contributed is $66,000 ($73,500 for those age 50 and older), which is the IRS maximum allowed for all contribution sources.

For example, if a taxpayer under age 50 earning $200,000 has an employer match of 5% and elects to contribute the maximum of $22,500 for 2023, between her own contribution and her employer’s, she would have a combined total of $32,500 contributed to her account.  If her plan allows for after-tax contributions, she could contribute up to $33,500 more to get to the $66,000 total allowed for the year.

If she were to leave, the funds classified as after-tax, $33,500 can be withdrawn tax-free at any time, while any growth on those funds would be taxed upon withdrawal and subject to the 10% early-withdrawal penalty rules. NOTE: it would be better to convert the after-tax contribution to Roth shortly after funding to avoid the earnings on after-tax contributions.

Reporting mega-backdoor Roth contributions on the tax return

With respect to tax return preparation, any conversion of untaxed funds in a retirement plan to Roth will be reported on Form 1099-R.  Determining how much of that to include as taxable income could be challenging for preparers, particularly when the client waits to perform the conversion and the funds experience growth while classified as after-tax. Ideally, the retirement plan recordkeeper will report the taxable amount in box 2a as any growth of funds, but more likely, box 2b, “Taxable Amount Not Determined,” will be checked, meaning the taxpayer will need to produce records of contributions to avoid double-taxation of those funds.

IRS form 8606 is used to keep an account of non-deductible IRA contributions and Roth contributions from year to year, and I suggest a similar system of accountability for the Mega-backdoor Roth.

NOTE:  The above is taken from an article in the Journal of Accountancy by, Kelley C. Long, CPA/PFS, CFP, dated May 9, 2023.

When Is The Best Time To Fill Your Car’s Gas Tank?

According to” Gas Buddy,” the best day of the week to fill your gas tank is Monday. This day has the least demand and could save you between $50 and $100 per year, depending on your car. The worst days of the week are Wednesday and Thursday, according to their study.

Charitable Donations of Noncash Items of Clothing, Household Goods, and Furniture: When is an Appraisal Required?

In a recent Tax Court case, Bass, TC Memo 2023-41, 3/27/23, you must obtain an independent appraisal if the total value of your gifts exceeds an annual threshold.

In 2017, the taxpayer, a resident of North Carolina, donated men’s, women’s, and children’s clothing and various non-clothing items to Goodwill and the Salvation Army.  He made 173 separate trips to Goodwill and the Salvation Army, often multiple times on the same day, to avoid, in his viewpoint, the need to have the items appraised. His total deduction for 2017 came to $25,651.

The taxpayer attached two Forms 8283 to his return but did not obtain a written appraisal. He claimed he did not need an appraisal as no item was worth over $5,000.   But the Tax Court affirmed that all similar donated property must be aggregated for this purpose. A qualified appraisal is required since the taxpayer donated over $5,000 in clothing to two charitable organizations. Result:  The taxpayer’s entire deduction for the property was denied.

Moral of the story: Adhere strictly to the substantiation rules for charitable donations. Non-cash donations are limited to $5,000 or less without an appraisal.

What should be included on Form 8283: Identify the items donated, the date donated, and the condition of the items (excellent, good, fair, poor). How you acquired the items (purchase, gift, inherit, exchange) and the date of acquisition (actual date or various), and the estimated value of the donated property (use thrift store suggested sales price). Contact our office for a list or use other thrift store valuations online.

The Residential Clean Energy Property Credit

The credit equals 30% of the cost of materials and installation for a system you install in your home through 3032.  It falls to 26% in 2033, 24% in 2034, and then expires.  There is no dollar limit for solar, geothermal, wind, or battery storage systems.  But fuel cells are capped at $500 for each half-kilowatt power capacity, with unused credit for future years.

Taxpayers in Nevada are currently being inundated with telephone solicitation calls about putting solar on their homes. Solar panels are the most common type of use of this credit.  People who install alternative energy systems such as solar panels, solar-powered water heaters, geothermal heat pumps, wind turbines, fuel cells, etc., qualify for the credit.

NOTE:  Residential fuel cells must be installed in your main home to qualify for the credit.  The rest are credit-eligible, whether installed in a primary or vacation home.

Other clean energy credits are not as robust as the ones mentioned above.  Many specific types of home improvement projects have lower credit limits: Here is the item-by-item yearly cap:

  1. $150 for a home energy audit
  2. $500 in the aggregate for exterior doors (no more than $250 per door)
  3. $600 for windows; skylights; natural gas, propane, or oil water heaters; electric panels; central air conditioners; natural gas, propane, oil furnaces, or hot water boilers.

Some items have a higher yearly credit of $2,000:  Biomass stoves or boilers; electric or natural gas heat-pump water heaters; or electric or natural gas heat pumps.

Example:  In 2023, you put in your home a natural gas heat pump that costs $8,000 with installation, a $3,000 natural gas tankless water heater,  and a central air conditioner costing $7,000.  Your maximum credit is $3,200, $2,000 for the heat pump, $600 for the water heater, and $6,009 for the air conditioner.

Know the $75 Rule for Business Expenses

The $75 rule applies to certain business expenses where you do not need a receipt. But we emphasize that this rule does not apply to all tax deductions.

Many taxpayers mistakenly apply the $75 rule to all their tax deductions, which can result in a significant loss of deductions and penalties. We encourage you to know the $75 rule and its limitations to avoid potential negative consequences.

IRS Reg. Section 1.274-5(c)(2)(iii) contains the $75 rule, and Notice 95-50 provides a clear explanation of what it applies to. The rule applies to business travel expenses, vehicle expenses, and gifts that cost less than $75. But remember that the $25 limit on deductions for business gifts applies, meaning the practical limit is $25.

It’s worth noting that your bank and credit card statements do not provide sufficient proof of expenses for tax purposes. You need the receipt (proof of what you purchased) and the canceled check or credit card statement (proof of payment) to substantiate the expenditure.

While the $75 rule may allow you to avoid having a receipt for some expenses, it is crucial to document all your expenses properly. To document a $60 meal consumed during deductible business travel with or without a receipt, for example, you need to prove the amount spent, the date of the meal, and the name and location of the restaurant.

While you don’t need a receipt for the $60 travel meal, your documentation of business receipts is best for recordkeeping.

We encourage you to keep all your receipts for tax purposes, as they often take less time to keep track of and are better evidence in the event of an IRS audit.

If I Hire My Kids, Can I Give Them Tax-Free Education Benefits?

If your children work in your business, consider giving them education fringe benefits. Doing this right creates:

  • tax deductions for the business, and
  • tax-free fringe education benefits for the child.

You can accomplish this without a Section 127 plan when your child needs the education to do the job for your business or to comply with a law or regulation.

In general, you can’t treat undergraduate degree programs as work-related education. If you pay for such programs outside of a Section 127 plan, you must treat the payments as taxable income to the child-employee.

But certain individual courses within a program may be evaluated separately, and certain courses, such as accounting courses for an employee-child with an accounting job, may qualify for tax-free working condition fringe benefit payments.

On the other hand, MBA programs can qualify as work-related education if they maintain or improve the employee’s skills for his or her current profession or business.

In addition to the possibilities listed above, if your child is age 21 or older, the Section 127 plan can offer up to $5,250 in tax-free education benefits.

Business Gym for Your Employees, and Maybe You Too

To be tax-deductible, your gym or other athletic facilities must be primarily for the benefit of your employees—other than employees who are officers, shareholders, or other individuals who own a 10 percent or greater interest in the business or other highly compensated employees.

For the 10 percent ownership test, the law treats employees as owning any interest owned by their brothers and sisters, spouses, ancestors (such as parents and grandparents), and lineal descendants (such as children and grandchildren).

The highly compensated group consists of employees who earned over $150,000 for the preceding year.

The gym or other athletic facility must benefit the rank-and-file employee group more than the owner and highly compensated employee group. Think of this primary-benefit test as a 51-49 test.

This means that the rank-and-file employees and their families must use the facility on more days than the owner and highly compensated group do.

To see if you pass the 51-49 test, look only at days of use of the facility.

Example. Rank-and-file employees and their families use the gym 235 days during the year, and you, the business owner and your family, use it 137 days. The gym passes the 51-49 test. It’s tax-free to the users and deductible to the business as an employee recreational facility.

Take Advantage of the Once-in-a-Lifetime IRA-to-HSA Rollover

Health Savings Accounts (HSAs) are designed for use alongside high-deductible health plans, assisting you in covering your medical expenses. They can also function as an incredible retirement account due to their triple tax benefit:

  • You can deduct contributions from your taxes.
  • Your account balance grows without being taxed.
  • Withdrawals for medical expenses are tax-free.

And after age 65, you can use the monies for non-medical purposes, as you can with a traditional IRA, and pay taxes at ordinary income rates but without penalties.

We recommend fully funding your HSA each year until you enroll in Medicare and ideally minimize distributions. By doing so, even if you start at age 50, you could accumulate $200,000 or more by the time you reach age 65.

To assist in funding your HSA, there is a special, lesser-known rule: you can roll over funds from your IRA to your HSA once in your life through a qualified HSA funding distribution.

The rollover amount is limited to your HSA contribution limit for the year. In 2023, this amounts to $3,850 for individual coverage and $7,750 for family coverage. If you are over age 55, you can add a $1,000 catch-up contribution.

The rollover amount doesn’t count as income, isn’t deductible, and reduces the amount you can contribute to your HSA for the year. The big benefit is that you turn this otherwise taxable money into tax-free money when you use it for medical expenses.

Holding Real Property in a Corporation: Good or Bad Idea?

As the real estate market has cooled off in many parts of the country, investing in property may seem wise in the long run. But taxes can be a significant concern.

Owning real estate in a C corporation may not be wise when considering taxes because it puts you at risk of being double-taxed.

This means that if you sell the property and make a profit, the gain may be subject to taxation twice—once at the corporate level and again at the shareholder level when the corporation pays out profits to shareholders as dividends.

The Tax Cuts and Jobs Act reduced the double taxation threat, but with our current federal debt, you face the risk that lawmakers will hike the corporate tax rates and possibly also tax dividends at higher ordinary income rates.

To avoid this threat, I usually recommend using a single-member LLC or revocable trust to hold real property. A disregarded single-member LLC delivers super-simple tax treatment combined with corporation-like liability protection, while a revocable trust can avoid probate and save time and money.

If you are a co-owner of real property, it is advisable to set up a multi-member LLC to hold the property. The partnership taxation rules that multi-member LLCs follow have several advantages, including pass-through taxation.

In conclusion, holding real property in a C corporation can expose you to the risk of double taxation, and I don’t recommend it. Instead, consider a single-member LLC, revocable trust, or multi-member LLC, depending on your situation.

Helicopter View of 2023 Meals and Entertainment

As you may already know, there have been some major changes to the business meal deduction for 2023 and beyond. The deduction for business meals has been reduced to 50 percent, a significant change from the previous 100 percent deduction for business meals in and from restaurants, which was applicable only for the years 2021 and 2022.

To help you better understand the current situation, see the table below:


  Amount Deductible for Tax Year 2023 and Beyond
Description 100% 50% Zero
Restaurant meals with clients and prospects   X  
Entertainment such as baseball and football games with clients and prospects     X
Employee meals for the convenience of the employer, served by an in-house cafeteria   X  
Employee meals for required business meetings, purchased from a restaurant   X  
Meal served at the chamber of commerce meeting held in a hotel meeting room   X  
Meal consumed in a fancy restaurant while in overnight business travel status   X  
Meals cooked by you in your hotel room kitchen while traveling away from home overnight   X  
Year-end party for employees and spouses X    
Golf outings for employees and spouses X    
Year-end party for customers     X
Meals made on premises for the general public at a marketing presentation X    
Team-building recreational event for all employees X    
Golf or theater outing, or football game with your best customer     X
Meal with a prospective customer at a country club following your non-deductible round of golf   X  


Are You a Regular Investor or a Tax-Favored Securities Trader?

As we navigate the recent volatility in the stock market, think about the possible favorable federal income tax treatment the tax code gives to a securities trader.

Suppose you can qualify as a securities trader for federal income tax purposes. In that case, you deduct your trading-related expenses on Schedule C, Form 1040, making the taxpayer-friendly mark-to-market election unavailable to garden-variety investors.

The mark-to-market election has two important federal income tax advantages:

  1. Exemption from the capital loss deduction limitation
  2. Exemption from the wash sale rule

But there is a price to pay for these tax advantages. As a trader who has made the mark-to-market election, you must pretend to sell your entire trading portfolio at the market on the last trading day of the year, which may have little or no tax impact if you have little or nothing in your trading portfolio at year-end.

Your trading activities must constitute a business for you to qualify as a securities trader, and you must meet both of the following requirements:

  1. Your trading must be frequent and substantial.
  2. You must seek to profit from short-term market swings rather than longer-term strategies.

If you are a calendar-year taxpayer, the deadline to make the mark-to-market election for your 2023 tax year is April 18, 2023, or October 15, 2023, if a timely extension was filed. You make the election by including a statement with your 2022 Form 1040 filed by that date or with a Form 4868 extension request for your 2022 return filed by that date.

Avoid This Family-Member S Corporation Health Insurance Mistake

There are two important issues related to health insurance deductions for S corporations.

First, if you own more than 2 percent of an S corporation, there are three steps you need to follow to claim a deduction for health insurance:

  • Step 1. The cost of the insurance must be on the S corporation’s books.
  • Step 2. The corporation must include the cost of the health insurance premiums on your W-2 form as taxable income (but not subject to payroll taxes).
  • Step 3. If eligible, you must claim the health insurance deduction as an above-the-line deduction on Schedule 1 of Form 1040.

Second, this three-step procedure applies to your spouse, children, grandchildren, great-grandchildren, parents, grandparents, and great-grandparents if they work for your S corporation and the corporation covers them with health insurance.

The three rules apply to the relatives listed above who work in the S corporation, even if they don’t own any stock directly. For health insurance purposes, the tax code attributes your stock ownership to them and deems that they own what you own.

It’s crucial to get this right, as failing to do so could result in a lost health insurance deduction for your family members and zero deductions for the S corporation.

If you or your S corporation did not handle this correctly in the past, you need to amend the returns to ensure that you create and protect the proper tax deductions.

The IRS Has An Updated Guide Instructing Agents On Auditing Entertainers.

This affects performers, producers, directors, managers, songwriters, etc. Hot button items include the tax treatment of royalties and copyright sales, whether perks are taxable fringe benefits, passive activity losses, business-related and substantiated deductions, and cost recovery issues.

IRS Pledges Not To Increase Audit Rates For People Earning $400,000 Or Less

Over 50% of the IRS’s $80 billion windfall over 10 years will be used for enforcement. The new IRS Commissioner, Danny Werfel, has provided two preliminary details.

  1. The vow applies only to taxpayers with a total positive income of up to $400,000, meaning one’s income before taking losses and deductions on the federal return.
  2. The audit rate on 2018 returns will be used for this purpose. The overall audit rate in 2018 was 0.3% for individuals, 0.6% for C corporations, and 0.1% for both partnerships and S corporations.

Every Family Needs Estate Planning

You need an estate plan, regardless of whether or not you are among the ultra-rich. As recent news has shown, even those, who have won the lottery or have substantial wealth can fall victim to poor estate planning.

While federal estate taxes may not concern you, you need the will to have your wishes honored after your death. Without a will, state law dictates the distribution of your assets, which may not align with your intentions. Additionally, if you have minor children, a will allows you to name a guardian to care for them in the event of your untimely passing. Otherwise, the state will decide who has guardianship over your children, and they can place them with anyone, not necessarily a family member, or they may split up your children.

Your heirs will want to avoid probate because it can be a costly and time-consuming legal process. A living trust gives you a valuable tool to avoid probate. By transferring legal ownership of your assets to the trust, you can ensure that your beneficiaries receive them without suffering through probate. Probate can be very costly, time-consuming, and a public affair.

You can amend your living trust as circumstances change, providing flexibility and control over your assets.

It is also essential to keep your beneficiary designations up-to-date, as they take precedence over wills and living trusts regarding asset distribution.

Additionally, if your estate suffers from federal or state death taxes, you should plan to minimize your exposure.

Estate planning is not a one-time event but a process that you should review and update regularly to accommodate life changes and fluctuations in estate and death tax rules. We recommend checking your estate plan annually to ensure it aligns with your wishes and circumstances.

If you have any questions or concerns about estate planning, please do not hesitate to call me on my direct line at 702-878-3900.

Now that the April 18, 2023 rush is behind us, I have more time to work on Tax-Tip Letters. It is a perfect time to review your family estate plan and schedule tax planning for next year.


Al Whalen, EA, ATA, CFP®


CPA Practice Advisor

Bradford Tax Institute

Accountants Daily Insights

Journal of Accountancy

IRS Form 8283

The Kiplinger Tax Letter

The Tax Cuts and Jobs Act (President Trump)

The Inflation Reduction Act (President Biden)

Nancy Eade, Proof Reader, Whalen Financial