The ERISA consultants at the Columbia Management Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with a financial advisor in Pennsylvania is representative of a question we commonly receive related to tax reporting and the importance of IRS Form 8606. The advisor asked:
“My client wants to convert her traditional IRA to a Roth IRA, and claims her traditional IRA consists solely of nondeductible contributions and their earnings. How do she and her tax advisor determine the amount of basis and the amount of earnings in the IRA?”
Highlights of Discussion
• Answer: IRS Form 8606. Your client should have been filing Form 8606 along with her income tax returns for the years she made nondeductible contributions to her traditional IRA to accurately establish the basis in her traditional IRA. If she has not, it would be prudent for her to file the missed Forms 8606 with the IRS. An individual who fails to file IRS Form 8606 when required to do so is subject to an IRS penalty of $50 for each failure to file, unless the individual can show reasonable cause.
• Since filing a Form 8606 can be a complicated tax matter, it is always a best practice to suggest your client discuss the issue with a tax advisor.
• Form 8606 has multiple uses. Taxpayers file the form with the IRS to report:
— traditional IRA nondeductible contributions;
— conversions from traditional, simplified employee pension (SEP) or savings incentive match plans for employees (SIMPLE) IRAs to Roth IRAs;
— distributions from non-Roth IRAs that contain basis, and
— distributions from Roth IRAs.
• To verify the nontaxable part of distributions from IRAs, including Roth IRAs, taxpayers should keep a copy of the following forms and records, until all distributions are made:
— page 1 of Forms 1040 (or Forms 1040A, 1040NR, or 1040-T) filed for each year a nondeductible contribution was made to a traditional IRA
— Forms 8606 and any supporting statements, attachments and worksheets for all applicable years
— Forms 5498 or similar statements received each year showing contributions made to a traditional IRA or Roth IRA
— Forms 5498 or similar statements received showing the value of traditional IRAs for each year a distribution was received
— Forms 1099-R or W-2P received for each year in which a distribution was received (Forms 1040-T and W-2P are forms that were used in prior years.)
Conclusion
IRS Form 8606 is an essential form for taxpayers with nondeductible contributions in their traditional IRAs. While you don’t have to be a tax expert, financial advisors who understand the form’s importance can be of great assistance to their clients.
The Columbia Management Retirement Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC, a third-party industry consultant that is not affiliated with Columbia Management. For informational purposes only. Please consult a tax advisor or attorney for specific tax or legal needs. © 2014 Columbia Management Investment Advisers, LLC. Used with permission.
