After-Tax IRA Contributions, Distributions, Conversions at Tax Time

Friday, April 11, 2014

By Beverly DeVeny, IRA Technical Expert

Follow Me on Twitter: @BevIRAEdSlott

How do I tell IRS that my IRA distribution or Roth conversion is not taxable? We get this question fairly frequently at tax time – especially if the client has done a “backdoor” Roth conversion.

The answer is IRS Form 8606.

You make an after-tax contribution to your IRA or a series of after-tax contributions to the IRA. Now it is time to take the money out or you want to do a Roth conversion of the IRA. How will IRS know that some of the funds are after-tax so you won’t have to pay tax again when they are distributed?

The first thing to realize is that the IRA custodian does NOT keep track of your after-tax contributions – even if you tell them that the funds are after-tax or keep the after-tax funds in a separate IRA. They have no way of knowing what you do on your tax return so they have no way of knowing if you really take a deduction for that IRA contribution. The 1099-R that you receive from the IRA custodian for the distribution is going to say that the taxable amount is not known.

Any time you make an after-tax contribution to an IRA, you need to file IRS Form 8606 with your tax return to tell IRS that you have after-tax funds in your IRA. Without this form, IRS will assume that any funds that are distributed from your IRA account are taxable.

Secondly, you have to tell IRS that you did a Roth conversion, even if the entire amount converted is IRA-after-tax funds. There is a special section on Form 8606 for reporting Roth IRA conversions.

Finally, Form 8606 will tell you how much of your IRA distribution is taxable. This is going to depend on the total amount you have in all your IRA accounts, including SEP and SIMPLE IRAs and the total amount of after-tax dollars in your IRA. You cannot isolate only the after-tax amount and say that is what you took out of your IRA. You have to divide your total account balance into the total of your after-tax amount and come up with a percentage. The percentage is applied to your total distributions for the year to determine what amount is taxable and what amount came out of your after-tax amounts.

Example: Your total IRA balance is $100,000 and your after-tax contributions are $10,000. $10,000/$100,000 = 10%. Ten percent of all your distributions for the year will not be taxable.

 

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