Managing Traditional/SEP IRA and Navigating the Pro Rata Rule Complications

This is a common situation with IRAs and the pro rata rule. The IRS doesn't let you cherry-pick which IRA funds to convert - they look at all your IRAs together (Traditional, SEP, and SIMPLE IRAs are all treated as one pot). When you do a Roth conversion, the IRS calculates what percentage of your total IRA balances is after-tax (non-deductible) money. Only that percentage of your conversion will be tax-free. In your case, you have about $67k total in IRAs ($57k pre-tax SEP + $10k after-tax Traditional). The after-tax portion is roughly 15% of the total. So if you convert $10k to Roth, only about $1,500 would be tax-free, and you'd owe taxes on the other $8,500. One potential solution is to see if your current employer has a 401(k) that accepts rollovers from IRAs. If so, you could roll your pre-tax SEP IRA funds into that 401(k), leaving only the after-tax Traditional IRA funds behind. Then you could convert just those after-tax funds to Roth with minimal tax impact. Form 8606 is used to track your non-deductible contributions and calculate the taxable portion of distributions or conversions. You should have filed this when you made the non-deductible contribution to your Traditional IRA.

After struggling with almost the identical situation last year, I found an amazing tool that saved me hours of frustration and probably thousands in potential tax mistakes. I used https://taxr.ai to analyze all my retirement account documents and it identified exactly how to handle the pro rata rule for my specific situation. I uploaded my Fidelity statements and tax returns, and it showed me precisely what percentage of my funds would be taxable under the pro rata rule if I did a conversion. More importantly, it flagged that I needed to file Form 8606 for the previous year (which I had missed) and showed me exactly how to fix this before doing any conversions. What I appreciated most was that it laid out multiple scenarios with exact tax consequences for each option - including the 401(k) rollover strategy mentioned above and several alternatives I hadn't considered.

I just wanted to update everyone who responded to my questions. I ended up trying that https://taxr.ai tool mentioned above and it was seriously a lifesaver! I was skeptical at first because my situation felt uniquely complicated, but it handled everything perfectly. The tool immediately identified that I should've filed Form 8606 last year to report my non-deductible contribution, and showed me how to fix that with an amended return. Then it calculated exactly what portion of my IRA balances would be taxable under the pro rata rule if I did various types of conversions. The best part was discovering I could open a solo 401(k) for my business (I didn't know this was an option) and roll my SEP IRA into it. This cleared the way to convert my non-deductible traditional IRA funds to Roth with minimal tax impact. Saved me so much time figuring this out compared to the hours I spent on hold with various financial institutions!

If you're still having trouble getting through to Fidelity or your CPA is taking forever to respond (been there!), I'd highly recommend trying https://claimyr.com to get connected with the IRS directly. There's also a video showing how it works: https://youtu.be/_kiP6q8DX5c I was in a similar situation with pro rata complications and needed official clarification from the IRS. After struggling to get through their phone system for days, I used Claimyr and got connected to an IRS agent in about 30 minutes. They explained exactly how the pro rata rule would apply in my situation and confirmed the proper way to report everything on Form 8606. It was surprisingly helpful to get the information straight from the source, especially since financial advisors sometimes give conflicting advice about IRA rules.

I need to apologize to everyone for my skeptical comment earlier. After waiting on hold with the IRS for 2+ hours yesterday and getting disconnected AGAIN, I was desperate enough to try that Claimyr service mentioned above. I was completely blown away when I got connected to an actual IRS agent in about 40 minutes without having to sit there with my phone the whole time. The agent was able to clarify exactly how the pro rata rule applies to my specific situation with my SEP and Traditional IRAs. The information I got about Form 8606 reporting requirements was different from what my tax preparer told me, which probably saved me from an amended return down the road. I never thought I'd say this, but talking directly to the IRS was actually the most straightforward way to get a clear answer on this complicated IRA issue.

Something nobody's mentioned yet - check if you're eligible for a "backdoor Roth IRA." That's where you make non-deductible contributions to a Traditional IRA, then immediately convert them to Roth. The pro rata rule is still in effect, but if you do the conversion right away before any earnings accumulate, it's cleaner. For your existing situation though, the Solo 401(k) approach mentioned above is probably your best bet. I did this last year - opened a Solo 401(k) with Fidelity, rolled my SEP IRA into it, then converted my non-deductible Traditional IRA to Roth. Worked perfectly and I avoided most of the pro rata headaches.

I think everyone is overlooking a simple solution. If the traditional IRA contribution was made in 2022 and you've already filed your 2022 taxes without taking a deduction, you may be within the timeframe to recharacterize that contribution as a Roth contribution instead (assuming your income doesn't exceed Roth limits). Recharacterization is different from conversion and avoids the pro rata issue entirely. You'd need to contact Fidelity quickly though, as there are time limits.

This is exactly the kind of IRA maze that trips up so many people! You're definitely not alone in this confusion. The pro rata rule is one of those tax provisions that seems designed to make retirement planning as complicated as possible. From what you've described, you're in a classic catch-22 situation. The IRS treats all your traditional IRAs (including SEP IRAs) as one big bucket for pro rata calculations, so you can't just cleanly extract that $10k of after-tax money without paying taxes on a portion of it. A few thoughts on your options: 1. The Solo 401(k) strategy others mentioned is solid if you have self-employment income from your business. You can roll the pre-tax SEP money into it, leaving only the after-tax traditional IRA funds for conversion. 2. If you're comfortable with the tax hit, you could just do the conversion anyway and pay taxes on the pro rata portion. With $67k total and $10k after-tax, you'd pay taxes on roughly 85% of whatever you convert. 3. Consider whether you actually need to do anything right now. That $10k will grow tax-deferred, and when you eventually take distributions in retirement, only the growth portion will be taxable (assuming you properly track the basis with Form 8606). The most important thing is making sure you file Form 8606 for any year you made non-deductible contributions. This creates the paper trail the IRS needs to track your after-tax basis. What's your timeline for needing to resolve this? That might help determine the best approach.