Unintentional nondectible traditional IRA contribution


M

mikepantera20061

A couple of years ago, I made what I thought was a then tax deductible $5000 contribution to a traditional IRA. Come to find out it wasn't deductible, so now the IRS wants the tax associated with the income. I can suck that up, but now I have $5000 that I thought was tax deductible that wasn't sitting in a traditional IRA account. Can I do anything (without penalty) to do something more constructive with this money? Like take it out for personal use before I retire? Or is it pretty much stuck in there until I can withdraw it at the qualifying age penalty free? I understand that it counts as non-taxable basis when I start making withdrawals, but that's a lot of extra bookkeeping I'll have to do to remember that in over 10 years.
Thanks
 
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D

dvsarwate

A couple of years ago, I made what I thought was a then tax >deductible $5000 contribution to a traditional IRA. .....
.... it wasn't deductible ... I understand that it counts as >non-taxable basis when I start making withdrawals,

Was a Form 8606 filed along with your income tax return
(or perhaps separately) when the determination was made that
the IRA contribution was not tax-deductible? I had a friend
who made several nondeductible contributions to his IRA
without reporting the matter on Form 8606, and the IRS's
position was that he had no basis in his IRA at all and
all distributions from the IRA were ordinary income. Thus,
those contributions were taxed twice: once in the year of
contribution and again when they were withdrawn.

Dilip Sarwate
 
M

Mark Bole

Was a Form 8606 filed along with your income tax return
(or perhaps separately) when the determination was made that
the IRA contribution was not tax-deductible? I had a friend
who made several nondeductible contributions to his IRA
without reporting the matter on Form 8606, and the IRS's
position was that he had no basis in his IRA at all and
all distributions from the IRA were ordinary income. Thus,
those contributions were taxed twice: once in the year of
contribution and again when they were withdrawn.

Dilip Sarwate
Good point about filing the Form 8606 to establish basis in the Trad
IRA. The OP implies this is being adjusted through IRS and is within
the amendment window, so wishfully this will be taken care of (via
amendment).

To answer the OP, one optimal way get the money out without penalty is
to convert the Trad IRA to Roth IRA, then wait five years and you can
take the money out penalty-free (tax was already paid). However this
won't work the way you want if you have significant other pre-tax money
in your combined Trad. IRA accounts, as the taxable conversion must be
allocated across the entire amount, cannot just be the non-deductible
portion of your Trad IRA. However if this is your entire Trad. IRA,
then you're good.
but that's a lot of extra bookkeeping I'll have to do to remember that in over 10 years.
Actually, it's not. The Forms 8606 from the years where you had
basis-related activity in your IRA is all you need, plus current
balances. I want to say, just your most recent Form 8606 is all you
need, but I'm not totally sure on that at the moment.
 
G

Gary Goodman

A couple of years ago, I made what I thought was a then tax deductible $5000 contribution to a traditional IRA. Come to find out it wasn't deductible, so now the IRS wants the tax associated with the income. I can suck that up, but now I have $5000 that I thought was tax deductible that wasn't sitting in a traditional IRA account. Can I do anything (without penalty) to do something more constructive with this money? Like take it out for personal use before I retire? Or is it pretty much stuck in there until I can withdraw it at the qualifying age penalty free? I understand that it counts as non-taxable basis when I start making withdrawals, but that's a lot of extra bookkeeping I'll have to do to remember that in over 10 years.
Thanks
have you considered converting the IRA to a Roth? You should file an
amended Form 8606 to show your cost basis in the IRA, then you can
convert the IRA to a Roth this year. Unless you have done very well
with the underlying investments, you most likely won't have much extra
income to declare on the conversion. You won't get a current
deduction, but at least the withdrawals will be free of tax and you
don't have to keep track of your basis in the IRA.

Gary
 
D

D. Stussy

"Mark Bole" wrote in message
Was a Form 8606 filed along with your income tax return
(or perhaps separately) when the determination was made that
the IRA contribution was not tax-deductible? I had a friend
who made several nondeductible contributions to his IRA
without reporting the matter on Form 8606, and the IRS's
position was that he had no basis in his IRA at all and
all distributions from the IRA were ordinary income. Thus,
those contributions were taxed twice: once in the year of
contribution and again when they were withdrawn.
Good point about filing the Form 8606 to establish basis in the Trad
IRA. The OP implies this is being adjusted through IRS and is within
the amendment window, so wishfully this will be taken care of (via
amendment).

To answer the OP, one optimal way get the money out without penalty is
to convert the Trad IRA to Roth IRA, then wait five years and you can
take the money out penalty-free (tax was already paid). However this
won't work the way you want if you have significant other pre-tax money
in your combined Trad. IRA accounts, as the taxable conversion must be
allocated across the entire amount, cannot just be the non-deductible
portion of your Trad IRA. However if this is your entire Trad. IRA,
then you're good....
==================

Converting the traditional IRA to a Roth IRA does not avoid the problem of
having not reported the non-taxed basis in the account. It actually
accelerates the problem to the current year, as opposed to some future year
when a withdrawl is made.
 
W

W

dvsarwate said:
Was a Form 8606 filed along with your income tax return
(or perhaps separately) when the determination was made that
the IRA contribution was not tax-deductible? I had a friend
who made several nondeductible contributions to his IRA
without reporting the matter on Form 8606, and the IRS's
position was that he had no basis in his IRA at all and
all distributions from the IRA were ordinary income. Thus,
those contributions were taxed twice: once in the year of
contribution and again when they were withdrawn.
I read the original poster's case differently. He is not saying that he
made a nondeductible contribution to an IRA and then forgot to file the
8606. He appears to be saying that he stuck $5,000 into an ordinary
brokerage account and then claimed it as a deductible contribution.

Would it be possible in his case to file an amended return with an 8606 and
then move the money into a real IRA account? I assume there is not a lot
of forgiveness for these kinds of errors. But what I think the original
poster is asking for is help in getting that money into a real IRA, where it
can compound tax free.
 
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M

Mark Bole

[...]
I read the original poster's case differently. He is not saying that he
made a nondeductible contribution to an IRA and then forgot to file the
8606. He appears to be saying that he stuck $5,000 into an ordinary
brokerage account and then claimed it as a deductible contribution.

Possibly... but then why is he asking about a possible penalty for
taking it out before retirement age?

OP hasn't replied in a long time, we may never know.

Would it be possible in his case to file an amended return with an 8606 and
then move the money into a real IRA account? I assume there is not a lot
of forgiveness for these kinds of errors. But what I think the original
poster is asking for is help in getting that money into a real IRA, where it
can compound tax free.
I can't imagine that making such a late IRA contribution would work.
For starters, the 1099-R won't be for the desired year.
 
M

Mark Bole

Converting the traditional IRA to a Roth IRA does not avoid the problem
of having not reported the non-taxed basis in the account. It actually
accelerates the problem to the current year, as opposed to some future
year when a withdrawl is made.
No one said it did. But since the IRS is adjusting his return to undo
the mistaken deduction, clearly he will now have basis. His adjusted
return will effectively include the Form 8606 as it should have been filed.
 
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T

Tom Healy CPA

Don't assume the IRS will do the 8606 in the audit. Include it in your response. Then file amended returns for all later years to file the 8606 for those years. I just got a client back after a year of trying a CPA in their new state. Seems he forgot a couple of issues, one of which was omitting the 8606. The other was omitting the sale of their former home on Schedule D, because the home was sold at a loss; but the IRS asked, because the selling price was above $500,000. He also didn't ask questions the way I do, and they missed that (I love that kind of client).
 

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