What Is IRS Form 8606 and Who Needs to File It?

IRS Form 8606, Nondeductible IRAs, is a tax document used to report specific transactions related to individual retirement arrangements (IRAs). Its primary function is to track after-tax amounts within your IRAs to ensure that this money, which has already been taxed, is not taxed again when you withdraw it. This form is part of your tax return if you have engaged in certain IRA activities, such as making contributions with money you’ve already paid taxes on or moving funds between different types of IRAs.

Properly maintaining this record through Form 8606 helps you accurately calculate the taxable portion of your future IRA distributions. It provides the IRS with a clear record of your IRA basis, which is the total of your nondeductible contributions, preventing potential overpayment of taxes.

Who Must File Form 8606

Certain actions involving your IRAs will require you to file Form 8606 with your tax return. The most common reasons include:

• Making nondeductible contributions to a traditional IRA. This occurs when you contribute to a traditional IRA but do not, or cannot, take a deduction for that contribution on your tax return, often because you are covered by a retirement plan at work and your income exceeds certain limits.
• Taking distributions from a traditional, SEP, or SIMPLE IRA if you have ever made nondeductible contributions to any of your traditional IRAs. In this situation, Form 8606 is used to calculate the portion of the distribution that is tax-free, ensuring you recover your after-tax contributions without being taxed on them again.
• Converting funds from a traditional, SEP, or SIMPLE IRA into a Roth IRA. This transaction is reported on Form 8606 to determine the amount of the conversion that must be included in your taxable income for the year. The form helps track the movement of pre-tax and after-tax dollars during the conversion.
• Taking a distribution from a Roth IRA. While qualified Roth IRA distributions are tax-free, this form is used to report the distribution and show that the requirements for a tax-free withdrawal have been met. It is also used to calculate tax on the earnings portion of a nonqualified distribution.

Information and Calculations Needed for Form 8606

You must gather several pieces of financial information to complete Form 8606. A primary figure is your total basis in traditional IRAs. Basis is the amount of money in your IRAs that you have already paid income tax on, which consists of your cumulative nondeductible contributions. This figure is found on the Form 8606 you filed for the most recent previous year.

You will need specific tax documents to find the required numbers. Form 5498, IRA Contribution Information, which you receive from your IRA custodian, reports the contributions you made for the year. You will also need Form 1099-R, Distributions From Pensions, Annuities, Retirement Plans, IRAs, etc., which details any distributions, withdrawals, or conversions you made from your IRAs.

Several specific figures must be compiled from these documents and your records. You need the exact amount of any nondeductible contributions you made to your traditional IRAs for the current tax year. You must also determine the total value of all your traditional, SEP, and SIMPLE IRAs as of December 31, a figure found on your year-end account statements or Form 5498.

Additionally, you will need the gross amount of any distributions you took from these IRAs, which is reported on Form 1099-R. If you converted any funds to a Roth IRA, the amount of the conversion is also found on Form 1099-R. For those who took distributions from a Roth IRA, you will need to know the total amount of all regular contributions you have ever made to your Roth IRAs.

Completing Form 8606 Line-by-Line

The form is divided into three parts, and you will only complete the parts that apply to your specific situation for the tax year.

Part I is for Nondeductible Contributions to Traditional IRAs and Distributions from Traditional, SEP, and SIMPLE IRAs. You begin by entering your new nondeductible contributions for the year and your total basis from the prior year’s Form 8606. The form then guides you through calculations involving your year-end IRA values and total distributions to determine the taxable portion of any money you took out.

Part II is used to report conversions from traditional, SEP, or SIMPLE IRAs to a Roth IRA. You will enter the net amount converted, and the form then uses your basis from Part I to calculate the taxable amount of the conversion. This taxable amount, which represents the pre-tax funds you converted, is then carried over to your Form 1040.

Part III addresses distributions from Roth IRAs. You start by entering your basis in Roth IRA contributions. The form then has you list your distributions and uses your contribution basis and any conversion amounts to determine if any portion of the distribution is taxable. The taxable amount, if any, is reported on your main tax return.

Filing and Recordkeeping

After completing Form 8606, you must attach it to your federal income tax return. The form is submitted as part of your overall tax filing by the annual tax deadline in mid-April, or the extended deadline if you file for an extension. If you are required to file Form 8606 but do not have to file a full income tax return, you must still sign and send the completed Form 8606 to the IRS by itself.

Failing to file a required Form 8606 can result in a $50 penalty for each instance you do not file the form when required. A penalty also applies if you overstate your nondeductible contributions on the form; this penalty is $100 for each overstatement unless you can show a reasonable cause for the error.

You should keep a copy of every Form 8606 you file indefinitely. Each year’s form builds upon the information from the previous year to correctly track your total basis. Losing these records can make it difficult to prove your basis in the future, potentially causing you to be taxed on the same money twice when you take distributions in retirement.