Taxes on Non-deductible IRA contrib’s
Last year I converted one of my two traditional IRA’s to a Roth IRA. Part of “that” IRA contained approximately $6000 worth of non-deductible contributions all of which I had made in the 1990’s. My other traditional IRA (which I did not convert) does not have any non-deductible contributions. My accountant advised me that I must pay taxes on the $6000 again since the contributions were made so long ago and not last year. I stated my belief that I must add the total value of the two IRA’s to determine the percentage (of the two IRA’s as a whole) that was converted to a Roth IRA. I would then be permitted to avoid paying taxes on that same percentage of the approximately $6000. Am I right? If so, at which point during the year is the total value determined for the IRA values?
Permalink Submitted by mk foss on Sat, 2010-07-24 22:02
You should get the 2009 version of Form 8606 to make the calculation. The form leads you through the calculation so that a portion of your nondeductible contributions are treated as part of the Roth conversion and not taxable. You’ll need year end IRA values to calculate the amounts.
You should have filed Form 8606 when you made the nondeductible contributions in the 90’s. If you did so, everything should be fine. If you didn’t file the form in the years that you made the contributions, you should file it now. Get the oldest Form 8606 you can find, cross through the year listed and put the year of your contribution. For the next year, you’d add the nondeductible amount from the previous year on the appropriate line and show your additional nondeductible contribution.
There is a penalty for not filing form 8606 when you make a nondeductible contribution and a penalty for claiming basis that should have been reported on Form 8606. If you neglected to file the form previously, file it now and enclose a letter asking IRS to waive the penalty.
Good luck
Permalink Submitted by Edward Czapor on Sun, 2010-07-25 14:24
All prior year Forms 8606 can be found on the IRS web site at: http://www.irs.gov/formspubs/article/0,,id=98339,00.html
Permalink Submitted by Alan Spross on Mon, 2010-07-26 01:06
It is better to download the appropriate year’s 8606, and start with the earliest year you made a non deductible contribution because the 8606 form is cumulative. Each year’s form brings forward the remaining basis from the prior year.
With respect to when the taxable portion of a conversion or distribution is determined, it is the adjusted year end value of all your TIRA accounts. For example, if you did a conversion in the year, you would add the conversion to the remaining year end value of all your TIRA accounts. All this is calculated on the 8606, so if you correctly follow the 8606 Instructions for each line, you will end up with the correct taxable amount.
If you took any distributions between the years you made the non deductible contributions and closed tax years, ignore them when filing the retroactive 8606 forms.
Permalink Submitted by James Claiborne on Tue, 2010-08-31 01:22
Client rolled over $140k from a 401(k) earlier this year into an existing traditional IRA with a balance of $56,000. He also has approx. $13k of non-deductible contributions in the same account. I know it might have been better to wait to move money out of the 401(k) since the percentage of taxes he would have to pay on the after-tax contribution amount would be smaller.(13k non-ded. contributions of existing IRA bal. of $56k prior to rollover) however, from what I have read from other sources, the IRS looks at the balance of all traditional IRA balances as of Dec.31st in year of conversion to determine the partial tax on non-deductible conversions made during the same year as traditional IRA conversions. Is this true?
If this is the case and the client wants to do the $200k and the $13k after-tax conversion in 2010, he would still have to rollover the desired conversion amount from the funds in his 401(k) piror to Dec. 31st of 2010 to make up the desired conversion amount. In other words, does the IRS look at the order in which a convesion of after-tax contributions vs. pre-tax dollars is made in 2010 to determine whether any taxes will be due on the after-tax conversion amount? Can an individual first make an after-tax Roth conversion then later the same tax year make a pre-tax IRA conversion and not have to deal with the formula on form 8606?
Permalink Submitted by Alan Spross on Tue, 2010-08-31 02:59
The order of conversions and other activity during the year is immaterial. The taxable % when there is basis in the IRA is determined by the year end value of the IRA with the converted amount added back in. The taxable amount will be the same whether two conversions are done, one before and one after the rollover, or if there is just one conversion after the rollover has been done.
You are correct that the rollover will dilute the basis of 13k and result in a higher % of a partial conversion that is taxable. But if the entire IRA is converted by the end of the year, none of this matters. The total amount converted less 13k will be taxable.
These calculations are all completed on Form 8606. An 8606 will be needed for all TIRA distributions or conversions until the entire account has been distributed.
There is a way the client can change things however. If he is working for a company whose defined contribution plan will accept IRA rollovers, he could still roll his entire pre tax balance into that plan, and then convert the 13k of basis remaining tax free. If he wants a larger conversion he could roll only part of his pre tax amount into the plan and then convert what is left along with the 13k.
Permalink Submitted by James Claiborne on Tue, 2010-08-31 17:09
Ok so by doing your last suggestion, he pays a smaller tax on the $13k after-tax conversion since only the amount he wants to covert that is pre-tax is counted in the conversion formula and not the total of his entire IRA balance. In this particular case since the total of after-tax contributions is so small, would you agree that the difference would not be very significant?
Permalink Submitted by Alan Spross on Tue, 2010-08-31 20:01
It depends on the total amount he chooses to convert. If he only wants to convert 20k, then if he rolls over all but 20k, he pays tax on 7k of the 20k conversion.
But if he does not want to pursue the rollover, then a 20k conversion would be mostly taxable since the 13k of basis is only about 6.5% of the total IRA value. About 18,700 would be taxable. If he wants to be able to convert all the 13k of basis, he must convert everything left in the TIRA. But if the rollover to an employer plan is not done, that would require converting the entire 200k and paying tax on 187k.