Non-deductible IRA Contribution

Submitted by Todd Kirsch on Fri, 2021-09-03 16:27

My client made a 2020 contribution to her IRA for $7,000 (age 69). After filing an extension for their 2020 taxes, they just found out from their accountant that the income for her and her husband caused the IRA contribution to become a nondeductible. We could withdraw it along with the gains (a bit complicated, but doable). But perhaps we can simply have him file the 8606 for 2020 showing the nondeductible contribution and then withdraw the $7,000 this year. Can we isolate the after-tax dollars (unlike a Roth conversion) for withdrawal? They are over 59 and 1/2, so no tax penalty. Thank you.



Submitted by Alan - IRA critic on Fri, 2021-09-03 17:22

There are various options. Client can still request the return of the contribution with allocated earnings, but the earnings returned will be taxable in the year the contribution was actually made. The 2020 contribution might have been made in 2020 or up to 5/17/2021. If made in 2020 and returned, the accountant needs to hold off filing the 2020 return until the amount of earnings is known after the contribution is returned.
Another option to be considered is recharacterizing the contribution as a Roth contribution, but this can only be done if their joint MAGI for 2020 will fall under the Roth MAGI limit, which is considerably higher than the MAGI for the TIRA deduction. This would be a wise choice if the gains are substantial because it will turn those gains into Roth gains, and it will also avoid the tax due on the earnings if the earnings were returned with the returned contribution. This option will also be beneficial, but less beneficial if the gains are small.
Of course, there is no deduction available for 2020 no matter what they do.

Submitted by Todd Kirsch on Tue, 2021-09-07 21:51

Thank you Alan – that’s helpful.  But can the client withdraw the $7,000 in 2021 and take the position that this only  non-deductible dollars being withdrawn.  That way, the earnings can stay in the IRA.  He’s over 59 and 1/2, so we don’t have to worry about a 10% penalty.   

Submitted by Alan - IRA critic on Tue, 2021-09-07 22:52

She can always withdraw 7000, but that is treated as a normal IRA distribution from the total IRA, not a specific return of the 2020 contribution, which requires that earnings come out with it. As such, the pro rate rules of Form 8606 would apply, and while client’s basis is increased by 7000 due to the non deductible contribution, the 7000 distribution must be pro rated over all client’s TIRA values. So if client’s total TIRA value was 100,000 and the 7000 is the only non deductible contribution ever made, the distribution of 7000 would be 93% taxable (6510 taxable). On the other hand, if a specific return of the 2020 contribution is requested, allocated earnings must come out with it and only the earnings would be taxable. The 1099R reporting the distribution is coded differently for a normal distribution v. a return of a specific contribution.

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