Use of cost basis of nondeductible traditional IRA
Ricard Schoenhammer wants to convert his nondeductible traditional IRA in the amount of $10,000. His pre-tax contributions were $8,000. He has two other IRA accounts which are taxable. They amount to $90,000. The taxable amount of the nondeductible traditional IRA will be $9,000, or 90% determined by adding the two accounts together and dividing into the $90,000 of taxable accounts. Here’s the downside. Ricard doesn’t get to deduct his $8,000 in nondeductible contributions
John Epeneter
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Permalink Submitted by Alan Spross on Tue, 2009-09-29 00:43
I’m not sure I follow your math here.
1) What is the total amount of non deductible TIRA contributions made as reported on Form 8606?
2) What is the total amount of ALL TIRAs estimated to be as of year end? Include the amount that is actually converted to a Roth.
3) The tax free % of any conversion is 1 divided by 2
Also, remember that all TIRA accounts are added together for purposes of calculating the taxable amount of a conversion. It does not matter which TIRA account actually funds the conversion.
Permalink Submitted by John A Epeneter on Tue, 2009-09-29 07:12
Reply by specific responder’s line items :
Line 1) of reply: assume $8,000 as given in the question/problem.
Line 2) of reply: assume $90,000 as given in the question/problem.
Line 3) of reply: do you have the IRC citation for your “1 divided by 2” rule? Never heard of that rule.
The question/problem assumes all three accounts are added together in coming up with the 90% taxable portion, but the question/problem as given “misspoke” when it said only two accounts are added together. I meant to say three accounts are added together to compute the denominator in the fraction to come up with the percentage taxable.
Is this enough additional information and clarification to be able to verify the answer given in the question/problem?
Permalink Submitted by Alan Spross on Tue, 2009-09-29 18:09
If 8,000 is the total non deductible basis and 90,000 the total year end adjusted value, then the non taxable portion of any distribution or conversion is 8.889%. This factor is determined on line 10 of Form 8606. The basis of 8,000 would be the line 5 result, and 90,000 would be the line 9 figure. Line 10 result is line 5 divided by line 9. In other words, the numerator is 8,000, not the 9,000 produced by gains in the account.
I just abbreviated the process in my prior post where I boiled those 10 lines down to 2 lines prior to dividing. If 10,000 is the amount converted, then $889 is the non taxable portion, and the taxable amount is $9,111. You may have come up with the 90% factor by dividing the account balance of the IRA that received the non deductible contributions by the total value, but the gain of 1,000 in the account that received the non deductible contributions is not part of the basis of actual contributed dollars. It does not matter which account has gains or losses, since they are all added together prior to dividing.
The instructions for Form 8606 detail how to determine what goes on each line in Part I of the form.
In the first post you indicated he did not get to deduct the 8,000.This is due to the pro rate rules that apply to each distribution/conversion. In this particular conversion, he uses up $889 of his $8,000 basis and Form 8606 will then show on line 14 that he has $7,111 of basis left for future years. If he converted all of his TIRAs to a Roth, then he would use up the full 8,000 at one time. This is why an 8606 will continue to be required as long as you have a TIRA balance, and that includes all the annual RMDs that start at age 70.5. The only way to eliminate the 8606 is to distribute or convert the entire balance of all TIRAs.