NONTAXABLE IRAs

NONTAXABLE IRAs CAN BE CONFUSING

The form you must prepare is not worded in a way that is easy to interpret. If you have made both deductible and nondeductible contributions to traditional IRAs, then part of your withdrawals are attributable to the nondeductible IRAs and can be withdrawn without paying tax again. But to make it complicated, you have to calculate the percent that can be withdrawn tax-free using Form 8606.. All withdrawals have to be allocated between taxable and nontaxable every year in which you make a withdrawal. You must also update your basis every year in which you make a contribution.

You must update your nondeductible IRA basis, using Form 8606, whether you made withdrawals or not.

NOTE: The allocation applies only to traditional IRAs, not Roth IRAs which do not enter into this calculation. Traditional IRAs are any IRA other than a Roth IRA.

The first line of Form 8606 seems self-explanatory. It asks for nondeductible contributions for the tax year, including those made through April 15 of the year after the tax year.

Line 2 is somewhat confusing.
It asks for your basis in traditional IRAs. The key word is basis. You only have a basis if you paid for it with after-tax money. If you deferred the tax by deducting an IRA contribution, your basis is zero.

So, ENTER just the value of your nondeductible IRAs on line 2

Line 6 asks for the value not basis of your traditional IRAs. The value is both the basis of your nondeductible IRAs plus the value of your deductible IRAs. This amount is the value of your IRAs as of December 31 of the tax year for which you are reporting.

Line 7 asks for distributions you received during the tax year. This amount is added back to the year-end value to get the total you would have had if there had been no withdrawals.

Line 8 asks for anything you converted to a Roth IRA. This is also to be added back to the year-end value since a conversion would be equivalent to a withdrawal.

Line 9 is the Total of Lines 6+7+8.

Line 10 is line 5 (nondeductible IRA basis) divided by line 9 (total value at year-end plus withdrawals and conversions) divided.

The rest of the form is used to calculate the taxable and nontaxable portion of your IRA withdrawals for the year and to calculate the remaining basis of your nondeductible IRAs which will become Line 2 on next year’s Form 8606.

LINKS and References – go to

IRS References

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.