Eliminate 8606 Filing…?
Hello,
This part of the answer to an earlier post caught my attention…
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Some years back (around 1997 I think) there was a year the IRS allowed a double deductible TIRA contribution in a single year. I did that for both my own and wife’s accounts. Unfortunately, I misunderstood the filing time limits and one of each of our contributions wound up being disqualified as deductible, so we wound up with that single $2000 contribution going in as non-deductible. The problem is, that simple mistake now requires that I file the 8606 form every year for the rest of my life to separate out that rather trivial non-deductible percentage of my distributions.
I’m wondering if the strategy above might allow me to somehow do a Roth conversion which would move those non-deductible amounts out of our TIRAs and into Roths. I would not want to convert any entire account, only up to say $10K or $20K which would include ALL of the approximately $3500 of the non-deductible remaining. I cannot identify any particular account which contains the non-deductible… it is just a (phantom?) accounting figure intermingled with my total TIRA resources. I am now retired and my income is way below the limits that would disallow Roth contributions.
Any suggestions as to if and/or how this might be done…?
Thanks,
Gerry.
Permalink Submitted by Alan Spross on Wed, 2009-03-25 23:13
Gerry,
There was never a year that allowed a double contribution. I wonder if you are thinking of 1998 when Roth conversions were taxed 25% each over 4 years rather than up front.
With respect to 2,000 of basis, it would be up to you to determine if it is worth the effort to retroactively file the 8606 forms to record that basis. You are correct that once you record any basis at all, every distribution you take for the rest of your life will require an 8606 to pro rate the taxable amount. If you have a total balance of 200,000, then 2,000 of basis would mean that 1% of your distribution is tax free. A 10,000 RMD would result in $100 of tax free income.
The only way to end the 8606 filings would be to convert or distribute your entire balance. The pro rating of the taxable amount applies to conversions just as it does to RMDs. It is not worth it to convert so much in a single year that it increases your marginal tax rate.
For those that are still working, one way out of this is to transfer the pre tax IRA balance to an employer plan such as a 401k, then convert the remaining small amount of basis tax free. But even this is not easy because many employer plans will not accept IRA rollovers, and others will accept only IRA rollovers from conduit IRAs that never received regular IRA deductions. But that is the only instant way out of the issue that does not have an abnormal cost attached to it.
Whether you file the backdated 8606 or not may depend on how you file your taxes. If you use software or pay a preparer, the 8606 is automated and spits out the correct amount of basis recovery every year, and it is not much of a problem or cost. If you do paper returns, having a separate 8606 calculation for each spouse can become rather tedious especially when the % of basis is very low.
Permalink Submitted by mk foss on Thu, 2009-03-26 00:24
I’m a little bit confused by the facts but this is how I see the situation.
When there is a nondeductible contribution made, Form 8606 must be filed. If it wasn’t filed with the initial return,it should be sent in late with a note explaining there was a lack of understanding and asking that the penalty be waived (Yes! there is a penalty for not filing Form 8606).
If that is the only nondeductible contribution, the Form 8606 need not be filed again until there is an IRA distribution. It doesn’t matte if it’s the same account in which the nondeductible contribution was deposited.
Even though Form 8606 is only required when nondeductible contributions are made and when distributions occur, some people do attach it every year to keep track of the basis in the IRA.
If you do a Roth conversion, that’s considered a distribution of the IRA. Since basis is recovered pro-rata, you’d have to convert ALL IRAs to Roth in order to use up the Form 8606 basis.
This may be exactly what Alan said but I was a little confused and wanted to give you another explanation.
Permalink Submitted by [email protected] on Thu, 2009-03-26 04:07
Thanks to both of you. I think I’ll just keep on filing the 8606’s, as I already have for the past 3 or 4 years since I started taking distributions.
I am a bit confused as the the value of the strategy you mentioned:
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Seems highly unlikely to be practical — anyone in high enough income bracket to be unable to do a Roth contribution likely has already a big TIRA amount built up from past contributions. He’d have to convert all of it, no….?
Looks like it’s no help to me anyway.
Permalink Submitted by Alan Spross on Thu, 2009-03-26 04:41
Yes, to eliminate the 8606 you would have to convert your entire TIRA. That would probably not be wise unless you had a very high % of basis in your TIRA. In your case you have a very low %, so converting the entire amount would just push you into a high tax bracket such that you might be paying a higher rate than your expected average rate in retirement.
With reference to the financial press recommendation, it was for primarily for those people whose income was always too high to deduct a TIRA contribution, and therefore might have not had a TIRA. By making non deductible contributions for the last couple of years, there IRA would not only be small, but would have a very high % of basis. That would make their conversions mostly tax free and would also eliminate the 8606 along with the total conversion. If they had done a 401k rollover in a prior year, then this would not work since their IRA balance would be much higher with pre tax amounts swamping the basis.
Bottom line, it looks like you are stuck with the 8606 every year unless you forego the modest tax benefit of filing it.
Permalink Submitted by [email protected] on Sun, 2009-03-29 03:23
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Would it be legal to do that — just stop filing the 8606 and pay tax on the full distribution…? I had thought about that, but after filing the 8606 a couple years, I thought it best not to rock the boat.
Alan, your answer re the non-deductible conversion strategy gave me an idea. Is it not possible to do a reverse 401k to IRA rollover (i.e. IRA to 401K…?) Then someone with a big deductible TIRA could find a job with a company offfering to take IRAs into their 401K plan, rollover some portion of his TIRA into the 401K and convert all the rest of it to Roth…
Maybe AIG could offer their execs a deal like this… instead of a BONUS…!
Permalink Submitted by Alan Spross on Sun, 2009-03-29 03:52
Yes, the rollover to an accepting qualified retirement plan can be done. See paragraph 4 of my 3/25/09 16:13 response, where I mentioned this option, but it is often a struggle to get all the pieces to come together. Many QRPs are afraid of taking in non deductible contributions which is not allowed, and could possibly result in a plan disqualification.
As for opting not to bother with the 8606, I doubt you would ever hear from the IRS and I have never heard of someone who did despite the fact that plenty of people probably forget to attach the 8606. And there is no possible tax benefit that would accrue to the taxpayer that did this. It’s not like increasing taxable income by declining deductions to get a larger earned income credit or something like that.
Permalink Submitted by [email protected] on Sun, 2009-03-29 18:20
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Eureka…! Does this transaction thereby become an effective way of separting out the non-deductible contributions….? So the 401K takes all the deducted portion of the TIRA, and leaves the non-deducted portion in TIRA. Which seems to be the best result possible….!
My apolgies for taking up so much of your attention… sometimes I get carried away looking for tax loopholes… even tho they won’t ever apply to me….
Gerry.