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IRA OWNERS BEWARE
DON’T PAY TAXES TWICE!
 As
with many of my articles I try to pick topics that have
actually come across my desk with the idea that if it applies
to one client of mine there are likely others out there who
could benefit from the knowledge.
That being said this month’s article focuses on IRA
distribution and how it may or may not be taxable. To
begin with you may be saying I have always paid tax on my
IRA distributions whether they were taken out before age 59 ½
or later.
You may also be thinking that you were sent a tax form 1099R
that reported the distribution to the IRS and to you. You
would be correct on both accounts and it is true most IRA
distributions are fully taxable in the year they were
withdrawn, but as with many areas of our current tax code
there are exceptions to the general rule and that is where
my client situation falls.
My client had for many years contributed to his IRA as
a part of his overall retirement savings plan. As is the case
with many taxpayers out there he worked for different
employers some of whom had retirement plans that their
employees could contribute to (Example 401k) and some
employers who did not offer a retirement plan to their
employees.
Whether or not the employer offered a plan or not is a key
item to note as it directly impacts whether or not a taxpayer
is allowed to deduct their IRA contributions or not. The
rule for a married couple is that part or all of their
traditional IRA may be nondeductible if one of them is covered
by an employer sponsored retirement plan.
The ability to get the deduction is then based on various
income levels and phase outs. In plain English the more the
taxpayers make the less likely they will be able to take a
deduction for traditional IRA contributions. For my client
story they had both deductible contributions and
non-deductible contributions and they remembered making both
so the challenge is how much of each did they have.
In 2010 they took a distribution so this was the year that
that record-keeping would pay off. The problem we had is
the client wasn’t aware or had not reported the proper
information on Form 8606. Form 8606 is not a common form
but it is the form that needs to filed for any year you make a
non-deductible contribution to your traditional IRA.
So in years where your contribution was fully deductible
there isn’t a requirement to file this form. The other
year they were required to file as it relates to my client
example is the year that an IRA distribution has occurred. The
form 8606 is the form that shows the IRS the basis amount of
the taxpayers IRA. Basis is the term we are using to describe
the amount of the traditional IRA that is from non-deductible
contributions meaning that those dollar amounts have been
previously taxed.
The basis of the IRA is the amount of the IRA that you do not
have to pay tax on when the IRA is distributed. So if you
or your tax preparer have not kept track of those
non-deductible contributions in the past it would be very easy
to just assume that 100% of the IRA distribution would be
taxable but if that assumption was made you are in fact be
double taxed on any amount that were not able to deduct on the
original tax year the contribution was made.
Nearly everyone agrees Double-Taxation is one thing to
avoid and keeping good records of the deductible vs. non
deductible contributions is the key to making that happen.
Some may say hey why does that matter with the Roth IRA
out there? I agree in most cases it would be better to
contribute to a Roth and get the tax-free earnings component
in your plan.
Remember the Roth hasn’t been around all that long and
therefore the choice was not available to many baby boomers
until later in their working lives and they may therefore have
a traditional IRA that has a % that has already been taxed and
needs to account for that to avoid being hit with a tax bill
on that amount a second time.
As always you can call our offices if you have any
questions about these or any other accounting related issues, at 360-659-8502.
Regards, David Rumsey, CPA |
