Hank is back with IRA Questions

[Hank]

I have one Rollover IRA account. Over a period of about 25 years I have contributed to it in the form of:

1) Direct Rollovers from 401Ks held at former employers

2) Non-Tax Deductible contributions made during my employment years

3) Tax deductable contributions made from earned income during years when I made little enough income to qualify for the deduction.

4) Growth of the investment, interest, dividends etc.

So here's my questions.....

A. When I take distributions some day do my contributions from the non-tax deductible contribution (from after taxed earned income) get taxed as ordinary income as well?

B. I never bothered to keep track of how much was contributed in tax-deductible and non-tax deductible. How would I figure this out? I read I was supposed to fill out form 8606 for each non-tax deductible contribution. I never did this. Can I go back and figure out the cost basis now? Does it matter? My guess is that the IRS doesn't care if you neglect to fill out the form because it works in their favor to just tax it all as ordinary income when you finally withdraw.

C. I also never kept track of any asset cost basis or cap gains / losses inside the IRA because I figured it didn't matter. Is this true?

Any help would be appreciated.

 

[MichaelB]

A. When I take distributions some day do my contributions from the non-tax deductible contribution (from after taxed earned income) get taxed as ordinary income as well?

No. Only pre-tax income and all earnings. No after tax income.

B. I never bothered to keep track of how much was contributed in tax-deductible and non-tax deductible. How would I figure this out? I read I was supposed to fill out form 8606 for each non-tax deductible contribution. I never did this. Can I go back and figure out the cost basis now? Does it matter? My guess is that the IRS doesn't care if you neglect to fill out the form because it works in their favor to just tax it all as ordinary income when you finally withdraw

. Yes, you can and should go back, figure out your basis and file form 8606. One form per year. IRS charges (or used to) a $50 penalty per form/year.

C. I also never kept track of any asset cost basis or cap gains / losses inside the IRA because I figured it didn't matter. Is this true?

Yes. It doesn't matter. It all gets taxes as ordinary income on withdrawal.

Michael

 

[Hank]

Thanks Michael.

I could probably figure out the contributions I made into the IRA but I could never accurrately figure out the growth of the assets from tax-deductible vs. non-tax deductible assets respectively. Is there a way to estimate or prorate this? Do I only have to figure out the non-tax deductible contributions or the growth of the contributions as well?

Thanks again.

 

[kaneohe]

The non-deductible contributions, unless they are identified and quantified, will be taxed as ordinary income as you suspect. I understand that IRS has been very forgiving about allowing 8606s to be filed retroactively. You need to file one for each year you had non-deductible contributions, starting with the earliest year and working forward since they build on each other. No one cares about this more than you. Whether or not you can figure it out depends on what records you kept....IRA statements, income tax forms. For a fee, IRS can provide some records.

I don't think you needed to keep track of anything except the non-deductible contributions. When you start withdrawing, you will also need to keep track so you know what part is taxable. Good luck on the search.

edit: my understanding was that IRS could but does not routinely charge the $50 for missing 8606s.

 

[kaneohe]

Thanks Michael.

I could probably figure out the contributions I made into the IRA but I could never accurrately figure out the growth of the assets from tax-deductible vs. non-tax deductible assets respectively. Is there a way to estimate or prorate this? Do I only have to figure out the non-tax deductible contributions or the growth of the contributions as well?

Thanks again.

The growth from all contributions is taxable like the deductible contribution so you don't have to separate out deductible/non-deductible growth. Only the non-deductible contribution is sheltered from taxes.

 

[Hank]

Sheez, this is gonna be fun.

I have another question that I have avoided researching but I think I should ask the board now. For many, many years when I was working I used to max out my 401K and also make a non-tax deductible contribution to my IRA. I always assumed this was okay and that both are treated as having two different contribution thresholds unrelated to each other.

Is there a chance that my IRA contributions were above some limit or something and were not qualified to be contributed to IRA in the first place? That would be a problem.

 

[kaneohe]

I don't think the 401K and IRA contribution limits are inter-related but there certainly are limits on how much you can contribute to an IRA. I would have thought that if you were over the limit, IRS would have notified you by now.

 

[youbet]

Sheez, this is gonna be fun.

.

Well, not too bad really. You only have to file those delinquent 8606 forms which, as long as you know which years you made the non-deductible contributions, would be simple.

Now, so we can all learn something from you....... With the IRS screaming in your ear and rubbing your nose in it, how did you ever miss out on filing the 8606 forms each year you made a non-deductible contribution? It's a common thing to do, it's quick and easy, etc. What happened?

 

[Koolau]

Non-deductible IRAs and other tax related minutia are the reasons I pay an accountant $200/year to do my taxes. Yeah, it's outrageous, but I'd pay twice that to avoid the hassles of tax prep.

By the way, the non-deductible IRAs cause you to figure the non-deductible portion each and every time you cash in, recharacterize or take RMDs from your IRAs. You must calc. the % of deductible and non-deductible every blasted time. So, since DW did a small amount of non-deductible one time, we were stuck making the calcs until we had completely converted all her IRAs to Roths. Again, the accountant did the dirty work, but I paid for it (I'm guessing $25 each time) for a total of maybe $2K in non-deductible contributions. Good news was our guy knew to file the right forms when DW did the contribution in the first place.

 

[OAG]

You may want to read Publication 590 at the IRS Site. It can be down loaded and read with Adobe Reader (Free from the Adobe Site). It goes through the calculations required.

 

[Hank]

YOUBET SAID: "Now, so we can all learn something from you....... With the IRS screaming in your ear and rubbing your nose in it, how did you ever miss out on filing the 8606 forms each year you made a non-deductible contribution? It's a common thing to do, it's quick and easy, etc. What happened"

I never heard from the IRS about this. I wish i had then I would have corrected the mistake years ago. I have never filled out even one 8606 in 20 years. My accountant never mentioned it ($400 per year). I always receive a statement from the IRS that confirms my contribution 54XX something i think after tax season so I never give this to my accountant the following year. I guess that was my mistake. CPAs should be asking me for the correct questions. I am going to call him today and see what he says and let you guys know.

I don't believe the IRS cares to alert anyone to this since it is strongly in their favor to tax the entire non-deductible contributions upon withdrawal.

 

[OAG]

That form you get late in the year is for your information and has no tax implications for your CPA - of course a copy of the form is sent to the IRS by the form issuer for their future current and future use. You may want to either call or write the IRS regarding what you should do now. I really hope you have the records to retroactively submit the 8606 or, like you implicate, you my be taxed on every dollar withdrawn.

That being said I cannot understand how the CPA could make the entries on IRA data without knowing if they were or were not deductible (and of course trigger the need for a 8606). Are you sure you and your CPA are communicating on the same level?

 

[Martha]

I too am very surprised if the accountant didn't do the 8606 forms. Are you sure that he or she didn't? After all, the accountant needed to know if they were deductible or not.

 

[Nords]

For many, many years when I was working I used to max out my 401K and also make a non-tax deductible contribution to my IRA. I always assumed this was okay and that both are treated as having two different contribution thresholds unrelated to each other.
Is there a chance that my IRA contributions were above some limit or something and were not qualified to be contributed to IRA in the first place? That would be a problem.

There is a chance that you exceeded some IRS limit, but the limit is pretty high. Individual 401(k)/IRA account custodians would immediately warn you if you tried to exceed their limits. If you split your IRA contribution among more than one custodian but exceeded the total limit, the IRS matching computers would figure that out during the following tax year from the 5498s. So you're probably OK on this one.

I don't believe the IRS cares to alert anyone to this since it is strongly in their favor to tax the entire non-deductible contributions upon withdrawal.

Yep. The IRS doesn't worry about you paying more taxes than you should.

I too am very surprised if the accountant didn't do the 8606 forms. Are you sure that he or she didn't? After all, the accountant needed to know if they were deductible or not.

You either have a bunch of 8606s that you're just beginning to recognize the importance of... or you really need a new accountant.

The good news is that you only file 8606s when you make a non-deductible contribution. Each form feeds into the following year's form by tracking the basis of the IRA (the after-tax contributions). That last 8606 establishes the basis for conversions or withdrawals.

 

[youbet]

YOUBET SAID: "Now, so we can all learn something from you....... With the IRS screaming in your ear and rubbing your nose in it, how did you ever miss out on filing the 8606 forms each year you made a non-deductible contribution? It's a common thing to do, it's quick and easy, etc. What happened"

I never heard from the IRS about this. I wish i had then I would have corrected the mistake years ago. I have never filled out even one 8606 in 20 years. My accountant never mentioned it ($400 per year). I always receive a statement from the IRS that confirms my contribution 54XX something i think after tax season so I never give this to my accountant the following year. I guess that was my mistake. CPAs should be asking me for the correct questions. I am going to call him today and see what he says and let you guys know.

I don't believe the IRS cares to alert anyone to this since it is strongly in their favor to tax the entire non-deductible contributions upon withdrawal.

As said by others, it's hard to imagine your CPA didn't file the 8606. Either the contribution is deductible and you deduct it or it isn't deductible and you don't deduct it and file a form 8606. It's a quickie, simple form requiring only the previous year's form to quickly complete this year's form. Either your CPA filed them and you're unaware of it or your CPA screwed you by not wanting to spend five mins to save you some money.

Have you actually looked in your past returns to see if there is a 8606? You actually only need the one from last year to establish how much of your IRA will be used in the calculation to determine the taxable portion of your distribution.

 

[thefinancebuff]

As said by others, it's hard to imagine your CPA didn't file the 8606.

Hank, did you tell your CPA about the IRA contributions? If your CPA didn't know you made IRA contributions, that may be why he/she didn't file Form 8606 for you.

 

[Nords]

Have you actually looked in your past returns to see if there is a 8606? You actually only need the one from last year to establish how much of your IRA will be used in the calculation to determine the taxable portion of your distribution.

Technically, it'd be the tax return of the year when you last made a non-deductible contribution to an IRA... or a year when you converted a conventional IRA to a Roth, or a year when you made some sort of IRA withdrawal.

 

[Alan]

Interesting thread and raises a question I have. Both DW and I have a regular IRA that is composed only of non-deductible contributions, plus we each will have a roll-over IRA composed of deductible contributions from our 401k's.

When we start withdrawals in a few years are they treated differently for tax purposes? i.e. if we take a sum from a rollover IRA is the whole distribution taxed and if we take from a regular IRA is only the gains in that IRA taxed? Or is the total of all taxed contributions counted as one pool of money and withdrawals from any IRA treated in the same proportions for tax purposes?

 

[OAG]

See response #10. I believe that while the money may be in a single or several accounts the components (deductible and non-deductible) are treated differently for tax purposes. Some has been previously taxed and some has not. I would suggest a reading of the referenced publication should (maybe) clear up the tax treatment. Again you should have the latest IRS Form 8206 to be able to discern the different components.

 

[Alan]

Thanks OAG - I'll have a look at the publication.

 

[kaneohe]

Interesting thread and raises a question I have. Both DW and I have a regular IRA that is composed only of non-deductible contributions, plus we each will have a roll-over IRA composed of deductible contributions from our 401k's.

When we start withdrawals in a few years are they treated differently for tax purposes? i.e. if we take a sum from a rollover IRA is the whole distribution taxed and if we take from a regular IRA is only the gains in that IRA taxed? Or is the total of all taxed contributions counted as one pool of money and withdrawals from any IRA treated in the same proportions for tax purposes?

All IRAs are assumed pooled together, as you suggest, even though you may be pulling from a particular IRA. This applies whether you are, e.g. doing a Roth conversion of a particular non-deductible IRA which you might assume might not cost much in taxes (but unfortunately may not be true) or withdrawing from that IRA.

 

[Alan]

All IRAs are assumed pooled together, as you suggest, even though you may be pulling from a particular IRA. This applies whether you are, e.g. doing a Roth conversion of a particular non-deductible IRA which you might assume might not cost much in taxes (but unfortunately may not be true) or withdrawing from that IRA.

Thanks for the clarification. I did read the publication 590 that OAG referred me to and that is how I read the situation as well.