Form 8606 Instructions for Nondeductible IRAs

IRS Form 8606, Nondeductible IRAs, is a tax document for tracking after-tax amounts in your Individual Retirement Arrangements to prevent them from being taxed again upon withdrawal. You file this form to report nondeductible contributions to a traditional IRA. The form is also used to calculate the taxable portion of distributions from traditional, SEP, or SIMPLE IRAs if you have a basis of nondeductible contributions. Additionally, it is required for reporting conversions from these IRAs to a Roth IRA and for reporting distributions from a Roth IRA.

Who Must File Form 8606

You are required to file Form 8606 with your annual tax return if you make nondeductible contributions to a traditional IRA. This often occurs if you have a retirement plan at work and your income exceeds the threshold for deducting traditional IRA contributions. Filing the form establishes a record of your after-tax contributions, referred to as your “basis.”

Another situation that requires filing is when you take a distribution from a traditional, SEP, or SIMPLE IRA, but only if you have a basis in any of your traditional IRAs from contributions made in the current or any previous year.

You must also file the form if you convert funds from a traditional, SEP, or SIMPLE IRA to a Roth IRA, as this process creates a taxable event that must be calculated. A final trigger for filing is taking any distribution from a Roth IRA, as Form 8606 is used to calculate whether any portion of the withdrawal is taxable.

Information and Documents Needed to Complete Form 8606

To complete Form 8606, you will need several documents and pieces of information.

• Your prior-year Form 8606, if you have filed one before. This form reports your total basis in traditional IRAs from prior years, which is the starting point for your calculations.
• Form 1099-R, which you receive from your financial institution if you took a distribution or converted IRA funds. It contains the gross distribution amount and a code explaining the reason for the distribution.
• Form 5498, IRA Contribution Information. This form details all contributions made to your IRAs for the tax year and is sent by your financial institution by the end of May.
• The total value of all your traditional, SEP, and SIMPLE IRAs as of December 31 of the tax year. You must sum the year-end values from all such accounts you own.
• Your personal records of any nondeductible contributions you made to a traditional IRA for the tax year, as Form 5498 does not distinguish between deductible and nondeductible amounts.

Step-by-Step Guide to Completing Form 8606

Part I: Nondeductible Contributions to Traditional IRAs and IRA Basis

Part I is where you report nondeductible contributions and calculate your total basis. You begin by entering your nondeductible contributions to traditional IRAs for the tax year, then add your total basis from any previously filed Form 8606. The form then addresses distributions by having you enter the total value of all your traditional, SEP, and SIMPLE IRAs as of December 31, plus any distributions taken. Using these figures, a pro-rata calculation determines the nontaxable portion of your distribution. The remaining amount is your taxable distribution, and the form calculates your new basis to carry forward.

Part II: Conversions From Traditional, SEP, or SIMPLE IRAs to Roth IRAs

Part II is specifically for reporting conversions to a Roth IRA. You will enter the net amount you converted from a traditional, SEP, or SIMPLE IRA to a Roth IRA. The pro-rata calculation from Part I is used to determine the taxability of the conversion. The taxable amount is found by subtracting the nontaxable portion of your funds from the total amount converted, and this taxable amount is carried to your Form 1040.

Part III: Distributions From Roth IRAs

Part III deals with distributions from your Roth IRAs. You begin by entering your basis in Roth IRA contributions, which is the sum of your direct contributions less any amounts previously withdrawn. After entering the total amount of your Roth IRA distribution, the form walks you through the ordering rules. You first subtract your basis in contributions from the distribution amount. If the distribution is larger than your contribution basis, you then consider your basis in conversion amounts. Any remaining distribution may be taxable earnings, which is reported on your Form 1040.

Filing and Record-Keeping Requirements

You must file the completed Form 8606 with your federal income tax return, such as Form 1040, by the tax deadline, including any extensions. If you are not required to file an income tax return but must file Form 8606, you must sign and mail the form by itself to the IRS. Failure to file a required Form 8606 can result in a $50 penalty unless you can show reasonable cause.

You must keep a copy of every Form 8606 you file, along with your Forms 5498 and 1099-R, until all money has been withdrawn from all of your IRAs. These forms collectively serve as the official record of your after-tax basis.

Without these records, you could face challenges proving your basis to the IRS in future years. This could lead to the IRS treating your nontaxable distributions as taxable income, causing you to pay taxes twice on the same money.