IRA Deduction not Taken in Prior Years

Submitted by C Smith on Tue, 2023-06-27 13:57

Hi,

I have a client that was eligible for an IRA deduction in previous years but never took it on their tax return. I understand their options are the following:

1. File an amended return
2. File 8606 for previous years
3. Do nothing

I’m not going to recommend option #1 due to time and the fact that it won’t change their tax brackets. We’d like to employ the backdoor ROTH strategy here due to their income so we’ll need to eliminate the IRA balance. If we go with option #2, is it possible to file one 8606 with an explanation letter stating the basis for the missed years? In addition, is it true that the IRS isn’t currently charging the penalty fee? If we go with option #3, how does the IRS view the IRA? Could it be rolled into an employer retirement plan as pre-tax dollars? I understand the client would be subject to double taxation here, but I am just trying to clarify the options.

TIA!



Submitted by Alan - IRA critic on Tue, 2023-06-27 14:39

Re Option 2 – yes, a single 8606 for 2023 can be filed showing the accumulated basis on line 2 with an explanatory statement listing the years of the prior ND contributions. This same 8606 will report the non taxable conversion assuming that the total amount of all IRAs less the accumulated basis have been rolled into an accepting employer plan. It is better to complete that rollover before converting in case the employer does not accept the rollover. 



Submitted by C Smith on Tue, 2023-06-27 17:37

Thank you! Any thoughts on option 3 and tax treatment/rollover potential?



Submitted by Alan - IRA critic on Tue, 2023-06-27 18:41

  • The IRS views the IRA as fully taxable if there is no 8606 filed to document that contributions were non deductible. That said, the administration of Form 8606 by the IRS has been historically deficient, and they don’t question the amounts entered on that form unless they throw up a huge red flag (eg 1mm IRA with basis of 800k). Any rollover of IRA amounts to a qualified plan cannot include IRA basis or an excess amount occurs in the qualified plan, therefore the amount of the rollover should be consistent with the 8606. That applies whether old 8606 forms are sent to the IRS for each year as used to be the general practice, or if the ND contributions date far back, just updating the current 8606 on line 2. 
  • Of course, if the ND amounts are too small to bother with, a client can always treat the IRA as pre tax, but that would eliminate the non taxable conversion as a way to recover (apply) the basis, and result in eventual double taxation of the contributions that were never deducted. 
  • Not sure if this answers your question…………


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