Tiny non-deductible IRA contribution - can we ignore it?

[Zona]

In 2011, DH made a $5000 contribution to his traditional IRA on the advice of our then-accountant. We later received a CP11 saying he overcontributed by $4000 so we then paid the taxes on that portion and reported it on form 8606 in 2011. In later years he made only pre-tax contributions to that traditional IRA, so that $4000 is the only post-tax contribution in any of his traditional IRA accounts (he has two traditional IRA accounts, one Roth IRA account, and a SEP IRA).

This year we would like to partially convert that IRA to a Roth IRA (and planning on doing more Roth conversions in future years). But I'm reading that we have to use a pro-rata basis to split out this measly $4000 contribution against *all* the dollars in *all* of his traditional IRA assets (including the SEP IRA?) for *every* Roth conversion or future distribution. It seems like a lot of work for such a small amount.

We anticipate that this particular traditional IRA account can be fully Roth converted within two or three years; it has the smallest balance of all his IRA accounts. My question is, are we *required* to do this correctly by the IRS, or can we just treat all IRA assets as pre-tax and go ahead and pay the tax on the full amount as we do Roth conversions out of this account? We realize we will be paying double-tax on that $4000 but we anticipate doing Roth conversions for the next 20 years or so (DH is 51 and his SEP IRA is much larger and will require many years to convert to Roth) and would love to avoid a tracking/pro-rata nightmare each time we do a Roth conversion.

Thanks in advance for any insight you can provide.

 

[NW-Bound]

I believe that if you pay more taxes than necessary, the IRS will not bother you.

It's the same thing when you neglect to claim a mortgage interest or a charity donation deduction. The IRS will not know or care.

They don't even have enough time and manpower to go after fraudulent tax returns.

 

[xlf11]

It's pretty easy calculation if you use Turbo Tax software to take care of the nondeductible contribution using form 8606. Once you input your nondeductible amount and the year it will remember the base and carry it to next year...

 

[cathy63]

Technically, yes, you do have to fill out Part I of form 8606, but as NW-Bound points out, the IRS is not going to come after you if you don't. If they were to do a random audit and make you fill it out, you'd end up getting a small refund on your taxes.

You really do have to fill out Part II of form 8606 though, since you're doing Roth conversions. The IRS will come after you if you skip that.

Since you're doing Part II anyway, my take is you might as well do Part I. It consists of copying one number from the previous form, adding up your total IRA values, then doing one addition, one division, one multiplication and one subtraction right on the form. With a calculator you can probably do it in 5 minutes or less by hand. If you use tax prep software it's even less time. If you use a tax preparer who charges by the form, it probably doesn't add any cost since it's just filling in extra lines on a form you're already filing.

And yes, you include the SEP IRA when calculating the value of all your IRAs.

 

[copyright1997reloaded]

Form 8606 part I is a PITA, and it requires you to add up all of the sep/simple/traditional IRA's as of year end....every year you have to do the form which will be every year.

I have the same issue (a single small non-deductible IRA) which would be amongst much larger401K->traditional IRA rollover + Roth (for after-tax) with similar issues with a 403B and 457 that I would eventually like to rollover and combine.

Since I am still w*rking and my current employer's 457 plan allows rollovers INTO the plan, I am taking the other traditional IRA's and moving them into the 457. I am in process of doing that this now. In addition, I plan to take all of the small non-deductible IRA this year, so it will be the ONLY IRA/SEP/Simple that I have at YE 2022, file the 8606 (which would just include it) and then in 2023 do the 401k/403/457 rollovers to IRAs and ROTH IRA's.

If I can't get this all arranged over the next month plus, my plan B will be similar to you ...just forget about the non-deductible basis and pay taxes on it and go on with my life with less hassle.

Since I am jumping into this thread, I will also throw out a question - I have a small 401(a) plan - Is this treated like a 401(K) i.e. not included on line 6 of form 8606 or do I need to also either roll it into my 457 (pre-tax) or withdraw it (i.e. take it as income in 2022)?

 

[Zona]

Thanks for the replies. I thought we would need to do some kind of calculations and additional tracking before we even started doing each Roth conversion. But based on Cathy’s answer we don’t need to give it a lot of thought until tax time. We do pay our accountant per form but I am hoping to eventually do the taxes myself which is why I had concerns about adding complications. We are hoping to simplify our taxes in retirement, so that we can better plan for annual Roth converting and/or tax loss/gain harvesting at year end. Any tax savings from tracking this amount will probably be negligible, but if we did track it going forward it’s good to know we wouldn’t need to fill out an additional form.

As always, thanks for the helpful replies. I learn so much here!

 

[Sunset]

I use tax software, and it's really a no brainer, only once had to put in the numbers and now the software tracks it all and saves me some taxes.
I do need to know all IRA values at the end of the year, and how much I converted, but it's not hard at all.

 

[gauss]

...

Since I am jumping into this thread, I will also throw out a question - I have a small 401(a) plan - Is this treated like a 401(K) i.e. not included on line 6 of form 8606 or do I need to also either roll it into my 457 (pre-tax) or withdraw it (i.e. take it as income in 2022)?

You would only include your 401(a) balance on line 6 of 8606 if it is a traditional IRA, a SEP IRA, or a SIMPLE IRA (plus any outstanding rollovers.)

If you don't know if this is true or not, you may need to consult your plan documents.

My speculation is that since IRAs are generally defined in section 408 of the tax code, then your 401(a) plan is not any type of IRA and would not be included on line 6, but check your plan documents to confirm.

edit: If you have ever taken a distribution from your 401(a) plan, you could check the 1099-R form that was issued. There is a checkbox (IRA/SEP/SIMPLE) that indicates these types of accounts on 1099-R.

Also IRS form 5498, which is issued in May the year after any contributions were made, will show in box 7 if one of these account types apply.

-gauss

 

[jebmke]

It's pretty easy calculation if you use Turbo Tax software to take care of the nondeductible contribution using form 8606. Once you input your nondeductible amount and the year it will remember the base and carry it to next year...

If using software it is an easy adjustment to make. I train novice tax preparers to do this in TaxAide and none of them have trouble doing this on sample returns.

 

[Midpack]

It's pretty easy calculation if you use Turbo Tax software to take care of the nondeductible contribution using form 8606. Once you input your nondeductible amount and the year it will remember the base and carry it to next year...

Once you enter your numbers the first time, TurboTax keeps track for you thereafter and enters the right “basis” - couldn’t be easier. You can always pay more in taxes without the IRS objecting, I just wouldn’t want to…