Can I pull out after tax cost basis without penalty?
Hi all
I wrote in last year about a client who had stock from a prior employer in which some of the shares were purchased with qualified money and some of them were purchased after tax, however, when the shares were moved out of the company account, they were all commingled together as an IRA rollover.
Not too long after I took over the account I was asked to sell the shares but I kept them all in this separate IRA account because I was unsure of what was qualified money and what was not qualified money and didn’t want to commingle them all in the client’s regular IRA account.
Recently, the client was able to find evidence, in the form of cancelled checks, showing that indeed $11,180 of the roughly $47,000 of the amount in the separate IRA is after tax money.
The client also indicated that they would prefer to have this money to do as they wish if possible(i.e. withdraw it from the separate IRA). I have no problem with this, my only question is how to properly disassociate this after tax basis amount from the qualified money even though they technically should have never been commingled by the former employer’s brokerage in the first place. Can I just ask for a distribution? Will there be an early withdrawal penalty even though it can be proved that this was after tax basis that was never intended to be commingled?
Thanks for any insight you can give.
Chris
Permalink Submitted by Alan Spross on Tue, 2008-02-19 18:03
Chris,
Unfortunately, once the after tax amount is rolled into an IRA, it becomes an indivisible share of the client’s total balance in all his traditional, SEP and SIMPLE IRA accounts. Any distribution follows the pro rata rules, ie only the proportion that represents after tax contributions relative to the total balance is the tax free share of any distribution. If the 11,180 is 10% of the total of all IRA accounts at year end, then only 10% of any distribution is tax free.
To recover the 10%, the client must also have filed Form 8606 to report the added basis for the year of the rollover. It is reported on line 2 of the form, and carries forward as part of whatever other basis the client has in his IRA. If he did not file 8606, it needs to be done retroactively for that year. The IRS has not been levying a penalty for doing this.
You might also re check the after tax balance against the 1099R issued for the distribution and/or plan statements prior to the distribution is the 1099R is questionable for whatever reason. Cancelled checks are not very conclusive as they do not show how the plan actually characterized the contributions. Best to do this prior to filing a retroactive 8606 to be sure the figure is correct.
Having kept the after tax amounts in a separate account is actually immaterial to the tax accounting, since all IRA accounts are considered as one. Whatever basis the IRA has is not attached to any investment, so you could have sold the shares in the IRA and the IRA would still have whatever basis was reported on the 8606. Hope this helps.
Permalink Submitted by Christian Halas on Tue, 2008-02-19 19:07
Thanks Alan,
The only problem I have with getting documentation other than the cancelled checks is that the brokerage firm that was handling the particular stock whenever my client was still with the company is now defunct. The firm that took over (JPMorgan) has no record or history in their computer on any transactions of the stock.
The clients’ advisor before me is the one that did the original transfer out of the account. I’m still left to wonder if this would have not made a good NUA situation, but I’ll never know now. While I can’t say in what form the stock came from the original brokerage firm to the prior advisor’s firm. I know when I transferred it to my prior clearing firm, National Financial, the entire account was classified as ” IRRL” or IRA Rollover. I ordered the stock sold on my client’s instructions and then transferred it to my RIA at TD Ameritrade. As I indicated in my prior posts, I kept it seperate until futher documentation was found, these cancelled checks are what was found, but I wanted to wait before I told them to take the money out and I’m glad I did.
I don’t think any 1099Rs exist to be honest with you.
They won’t be happy to hear these findings though I know that.
Chris