Line-by-Line Instructions for Form 8606

IRS Form 8606, Nondeductible IRAs, is a tax document for individuals who perform specific transactions with their Individual Retirement Arrangements. The form’s function is to track your after-tax amounts, or basis, in these accounts to ensure they are not taxed again when withdrawn. You must file this form if you made nondeductible contributions to a traditional IRA or took distributions from a traditional, SEP, or SIMPLE IRA and have a basis in those accounts. The form is also used to report conversions from these IRAs to a Roth IRA or to report distributions from a Roth IRA.

Information Needed to Complete Form 8606

Before you begin, gather the following documents and figures to complete the form accurately.

• Any Forms 1099-R you received, which report distributions or conversions from your IRAs. The amounts in Box 1 (Gross distribution) and Box 2a (Taxable amount) are needed for your calculations.
• Your prior-year Form 8606 to find your total basis in traditional IRAs. This figure is on line 14 of the previous year’s form.
• The total amount of any nondeductible contributions you made to a traditional IRA for the current tax year.
• The year-end statements for all of your traditional, SEP, and SIMPLE IRAs to find the total value as of December 31 of the tax year.
• Records of all your past Roth IRA contributions to determine the basis for any Roth distributions.

Completing Part I Nondeductible Contributions

Part I is where you report and track your nondeductible contributions to traditional IRAs. A nondeductible contribution is one for which you do not claim a tax deduction on your Form 1040, which creates a “basis” of after-tax money in your IRA.

You begin on line 1 by entering the total nondeductible contributions made to your traditional IRAs for the tax year. On line 2, you will enter your total basis from prior years, which is the amount from line 14 of your most recently filed Form 8606. Line 3 is the sum of lines 1 and 2.

If you did not take any distributions from your traditional, SEP, or SIMPLE IRAs during the year, you will enter the amount from line 3 onto line 14 and can skip the rest of Part I.

If you did take a distribution, you must continue through the subsequent lines to calculate the taxable portion. This involves entering the value of all your traditional, SEP, and SIMPLE IRAs on line 6 and the total amount of your distributions on line 7. The final calculation on line 15c will show the taxable amount of your distribution, which is then reported on your Form 1040.

Completing Part II Conversions to Roth IRAs

Part II addresses the conversion of funds from a traditional, SEP, or SIMPLE IRA to a Roth IRA. This section determines the taxable amount of the conversion, a calculation governed by the pro-rata rule. The pro-rata rule dictates that when you have both pre-tax and post-tax money in your IRAs, any conversion is considered a proportional mix of both. You cannot convert only the after-tax basis to avoid taxes.

The calculation begins on line 16, where you enter the net amount you converted to a Roth IRA, which is found on your Form 1099-R. On line 17, you enter your after-tax basis, carried over from line 11 in Part I. Line 18 is where you subtract your basis from the conversion amount to find the taxable portion of the conversion, which is then transferred to your Form 1040 or 1040-SR.

For example, if your traditional IRAs are worth $100,000 and include a $20,000 after-tax basis, 20% of your funds are after-tax. If you convert $50,000 to a Roth IRA, the pro-rata rule deems 20% of that conversion ($10,000) to be a tax-free return of basis. The remaining $40,000 is a taxable conversion of pre-tax funds.

Completing Part III Distributions from Roth IRAs

Part III is required only if you took a distribution from a Roth IRA. The IRS has specific ordering rules for Roth IRA distributions that dictate the sequence in which funds are withdrawn. Under these rules, your direct contributions, which are always tax-free and penalty-free to withdraw, come out first.

You start by completing the worksheet in the IRS instructions for line 22 to calculate your total basis in Roth IRA contributions. This includes all contributions you have made over the years, less any previous distributions of those contributions. The result is entered on line 22, and on line 19, you enter the total amount of your Roth IRA distributions for the year.

If your total distribution on line 19 is less than or equal to your contribution basis on line 22, the entire amount is tax-free. If the distribution exceeds your contribution basis, the excess amount is then considered a withdrawal of converted funds, and finally, a withdrawal of earnings. The taxable portion of your distribution, if any, is calculated on line 25c and may be subject to income tax and a 10% additional tax if you are under age 59 ½ and do not qualify for an exception.

Filing Form 8606

Form 8606 is not a standalone form and must be attached to your Form 1040, 1040-SR, or 1040-NR. The taxable portion of an IRA distribution from Part I or a Roth conversion from Part II is carried over to your main tax return. The form must be submitted by the tax filing deadline, including extensions, for the relevant tax year.

Failing to file Form 8606 when required can result in a $50 penalty for each failure unless you can show reasonable cause. Additional penalties exist for overstating your nondeductible contributions.

After filing, you must maintain a copy of Form 8606 with your permanent tax records. Because it tracks your IRA basis over many years, you will need the information from line 14 of the form to accurately complete Form 8606 in future years. Keeping these records helps ensure you do not overpay taxes on your IRA distributions in retirement.