What Is IRS Form 8606 for Nondeductible IRAs?
The IRS Form 8606, titled “Nondeductible IRAs,” is crucial for filers who make nondeductible contributions to an individual retirement account (IRA). It is essential to file a separate form for each tax year that nondeductible contributions occur.
Usually, contributions to an IRA can be deducted from your ordinary income. Nevertheless, individuals participating in an employer retirement plan and exceeding a specific threshold of modified adjusted gross income (MAGI) may not be eligible to make these deductible contributions, although an IRA contribution is still possible.
Key Takeaways
- Filers making nondeductible IRA contributions use IRS Form 8606.
- Any taxpayer with a cost basis above zero for IRA assets should use this form to differentiate taxable and nontaxable distribution amounts.
- Form 8606 must be filed with Form 1040 or 1040NR by the due date, including any extensions.
- Neglecting to file Form 8606 in a distribution year may result in owing income taxes (and possibly penalties) on what could be tax-free funds.
Who Should File IRS Form 8606?
Form 8606 should be filed alongside the standard income tax forms (1040 or 1040NR) for individual tax filers. Any taxpayer with a zero or higher cost basis in IRA assets (including a combination of post- and pre-tax contributions, or deductible and nondeductible contributions) must use this form to apportion taxable versus nontaxable distribution amounts.
If a taxpayer fails to file IRS Form 8606 in any given distribution year, income taxes, and possibly penalties, may become due. This situation can turn potentially tax-free money into taxable income.
Re-Characterizing Your IRA Assets
Younger investors may want to consider “re-characterizing” traditional and Simplified Employee Pension (SEP) IRA assets as Roth IRA assets. Assets that undergo this re-characterization become immediately taxable as ordinary income, because traditionally or SEP-IRA invested money has usually never been taxed. Upon exiting a traditional or SEP IRA, the funds are generally taxable; already-taxed money comes out tax-free.
The long-term benefit of not having to pay taxes on future distributions might outweigh the immediate tax burden resulting from re-characterization. Consulting with a tax professional is recommended before making such decisions.
Form 8606 is also mandated whenever a taxpayer either converts a traditional or SEP IRA to a Roth IRA, or receives an IRA distribution that relates to previous nondeductible contributions.
Filing Process for IRS Form 8606
File Form 8606 together with Form 1040 or 1040NR by the designated due date, including any possible extensions. If no income tax return is required but you are mandated to file Form 8606, sign and send Form 8606 to the IRS at the same time and place you would typically send Form 1040 or 1040NR.
Generally, after submitting your tax return, you can switch a nondeductible contribution to a traditional IRA to a deductible contribution (or the other way around) within the time frame allowed for filing Form 1040X, “Amended U.S. Individual Income Tax Return.”
Related Terms: Nondeductible IRA, IRA Contribution Limits, Tax-free Distributions, Roth IRA, Conventional IRA, SEP IRA.
References
- Internal Revenue Service. “Instructions for Form 8606”, Pages 1 and 3.
- Internal Revenue Service. “IRA FAQs”.
- Internal Revenue Service. “Instructions for Form 8606”, Page 2.
- Internal Revenue Service. “About Form 1040-X, Amended U.S. Individual Income Tax Return”.
