If you’re contributing to nondeductible IRAs or if you have a nondeductible IRA, you’ll want to become familiar with IRS Form 8606-Nondeductible IRAs. Many people contribute to their Roth IRAs without considering reporting them on their tax returns.
These taxpayers erroneously believe that since Roth IRA contributions grow tax-deferred, and qualified distributions are tax-free, they’ll never need to report anything. But Form 8606 covers so much more than that.
And there could be any number of life-changing circumstances that require IRS reporting. Not to pay more in taxes, but the exact opposite. Not properly maintaining Form 8606 could result in paying more in taxes than is necessary. And increasing your tax liability is counterproductive to sound financial planning.
While there are IRS instructions available, this article will break down exactly what you need to know.
What is IRS Form 8606?
IRS Form 8606 is a tax form that helps an IRA owner keep track of, and report tax basis in IRA accounts to the Internal Revenue Service.
Purpose of IRS Form 8606
Despite its limiting title, IRS Form 8606 actually serves multiple purposes.
Reporting nondeductible IRA contributions.
Of course, if you’re making nondeductible contributions to a traditional IRA (individual retirement account), you’ll report them here. Reporting nondeductible contributions allows you to report (and keep) track of the basis inside your traditional IRAs.
Keeping track of basis in your IRAs isn’t that important while you’re still accumulating retirement savings. However, if you have after-tax and pre-tax money in your IRAs, then qualified withdrawals are subject to the pro rata rule. And in your retirement years, knowing the basis of your IRA accounts will allow you to better determine the tax treatment of your withdrawals.
And if you’re doing executing a backdoor Roth strategy every year, you’ll be reporting your nondeductible contributions as part of your backdoor Roth conversion strategy.
Backdoor Roth IRAs
If you’re not familiar with the concept of a backdoor Roth IRA contribution, the premise is simple.
When most people start their careers, their gross income is low enough so they can contribute directly to their Roth IRAs. As their careers progress, their income gradually (or suddenly) increases.
At some point, the taxpayer may exceed the income limits for being able to make a direct Roth IRA contribution. Hence, the backdoor Roth conversion.
Instead of contributing directly to a Roth IRA, many taxpayers will make a nondeductible IRA contribution. From there, they’ll make a Roth conversion from their traditional IRA account. Since they’ve already paid tax on the contribution, the Roth conversion is a tax-free transaction.
Nondeductible IRA contributions are reported on Part 1 of Form 8606.
Reporting distributions from traditional IRAs, SEP IRAs, or SIMPLE IRAs if there is basis in these accounts.
Normally, distributions from an IRA in any given tax year are reported on IRS Form 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.). And if the distribution is reported only on the 1099-R, and is not a designated Roth distribution, then the assumption is that 100% of the distribution came from pre-tax money.
But if you made a non-deductible IRA contribution into a traditional account, then you’ve established tax basis in that account, simply known as basis. Generally speaking, basis is the cost of an investment.
For example, let’s imagine you have an IRA with $5,000 in pre-tax money. You make a $5,000 nondeductible traditional IRA contribution. You now have an IRA account worth $10,000, $5,000 of which is your IRA basis. When reported properly, qualified withdrawals from the portion that’s allocated to basis will be excluded from taxable income.
Form 8606 will help ensure that you don’t get taxed twice on the same IRA contribution by helping you keep track of the taxable part of the distribution. Distributions from accounts with after tax amounts are reported on Part 1 of Form 8606.
Reporting Roth conversions
If you’re implementing your Roth conversion strategy, then you’ll be reporting Roth conversions on Form 8606 as well. Form 8606 helps track the basis of all IRA balances, including non-deductible contributions.
Again, the intention is to avoid paying taxes twice on the same investment in your own IRA. Roth conversions from a traditional, SIMPLE, or SEP IRA are reported on Part 2 of Form 8606.
Reporting Roth IRA distributions
Nonqualified Roth IRA distributions are reported on Part 3 of Form 8606. This includes a one-time distribution for a first-time homebuyer.
Part 3 is used to determine whether a tax penalty might apply to a non-qualified Roth IRA distribution. If so, it will be recorded here.
Who must file Form 8606?
According to the IRS, a taxpayer must file Form 8606 if they:
- Made any nondeductible IRA contribution. This includes repayment of a qualified natural disaster or reservist distribution.
- Received distributions from a traditional, SIMPLE, or SEP IRA, and the basis is greater than zero.
- This doesn’t include rollovers, qualified charitable distributions (QCDs), a one-time distribution to fund a health savings account (HSA), conversion, recharacterization, or the return of certain contributions.
- There was a transfer of part or all of an IRA as part of the divorce agreement, and that transfer changed the basis in the account.
- There was a distribution from a Roth IRA.
- There was a distribution from an inherited IRA that had basis, or there was a distribution from an inherited Roth IRA that wasn’t a qualified distribution.
If you’ve filed Form 8606 on your federal income tax return in previous years, you’re probably going to be filing Form 8606 going forward.
How to complete Form 8606
This section will give you a layman’s guide to filling out Form 8606. As a reminder, this is not tax advice. These are not official instructions from the Internal Revenue Service, and this does not cover every tax situation.
If you’re using tax software like TurboTax, you probably will answer some questions and the software will autopopulate the form for you. But be careful in answering these questions, because mistakes in calculating basis will carry forward each year.
Part I-Nondeductible contributions to traditional IRAs and distributions to traditional, SIMPLE, and SEP IRAs
You only fill out Part I of Form 8606 if one of the following apply:
- You made nondeductible IRA contributions in the current tax year
- You took distributions from a traditional, SIMPLE, or SEP IRA in the current tax year AND you made nondeductible IRA contributions in the current year or an earlier year
- You converted part (but not all) of your traditional, SEP, or SIMPLE IRA assets in the current tax year AND you made nondeductible IRA contributions in the current tax year or an earlier year
If this applies to you, then here’s what you should include for each line.
Line 1-Nondeductible traditional IRA contributions.
You’ll include all nondeductible traditional IRA contributions for the tax year here. The tax year includes up to the filing deadline. So for 2021 (filing in 2022), you could include any nondeductible IRA contribution made from January 1, 2021 through April 18, 2022 (2021 tax filing deadline).
But if you made a contribution in January-April of 2022 for tax year 2022, do not include that number here. You’ll save it for when you file taxes in 2023.
If you used the IRA deduction worksheet either in your Form 1040, or from IRS Publication 590-A, you should refer to the instructions.
Line 2-Basis in traditional IRAs
This is basis carried over from previous tax years. If this is your first year filing Form 8606, then this number will probably be zero.
However, even if this is your first filing year, you may still have basis if:
- You had a return of excess traditional IRA contributions
- You had a transfer of part or all of a traditional, SIMPLE, or SEP IRA incident to divorce or separation
- You had a rollover of a nontaxable amount from a qualified retirement plan to your traditional, SIMPLE, or SEP IRA that wasn’t previously reported.
If you’re carrying forward basis from a previous tax year, you’ll use the carryforward number from that year’s tax return. For example, if your most recent Form 8606 was in 2020, then you would carry forward the number located in Line 14 of that year’s Form 8606. This is the case for all tax returns on or after tax year 2001.
For taxpayers whose most recent Form 8606 was filed in 2000 or earlier, please refer to the IRS instructions.
Add Lines 1 and 2.
If you did not take a distribution from a traditional, SIMPLE, or SEP IRA, or do a Roth conversion, then the instructions tell you to skip down to Line 14.
Line 4-Contributions made in the current calendar year
Line 4 has you back out the contributions for the current year. For example, a 2021 tax return would back out contributions made from January 1 to April 18, 2022.
If you made deductible AND nondeductible IRA contributions in both years, you can decide which contributions were deductible (and which were nondeductible), regardless of tax year.
But for purposes of figuring the nondeductible distributions, contributions made in the later year do not count.
Subtract Line 4 from Line 3.
Line 6-Total value of ALL traditional, SIMPLE, and SEP IRAs plus outstanding rollovers
This is the total of your IRAs at calendar year-end. You’ll usually get a year-end statement account from your financial institution around the end of January.
There are a couple of things you’ll want to refer to the instructions on:
Outstanding rollovers. Usually, outstanding rollovers are subject to a 60-day rollover rule. For purposes of reporting on Form 8606, an outstanding rollover is a rollover made after November 1 of the given tax year, but within the 60-day rollover rule.
If a rollover falls outside the 60-day rule, the taxpayer can certify (in writing) why they missed the deadline to the IRA custodian or financial institution. This will allow the institution to properly report the transaction to the Internal Revenue Service. IRS Revenue Procedure 2020-46 gives more guidance on written certifications.
Direct rollovers (within one financial institution) or trustee-to-trustee rollovers are not subject to a 60-day rollover rule.
Line 7-Distributions from traditional, SIMPLE, and SEP IRAs
This includes distributions in the given tax year only. For tax year 2021, this would include only distributions made in 2021.
However, you should not include the following:
- Roth conversions
- Recharacterizations of traditional contributions to Roth contributions
- Rollovers into a qualified plan
- A one-time distribution to fund an HSA
- Distributions that are treated as a return of contribution
- Qualified charitable distributions
- Certain qualified distributions for qualified disasters (see Instructions for more detail, if this applies to you).
- Distributions incident to divorce
Line 8-Net Roth conversions
If you did Roth conversions from a traditional, SIMPLE, or SEP IRA, you’ll enter the net amount here.
This will be the same number you enter on Line 16.
Add lines 6, 7, 8.
This represents the total of:
- Your year-end account balances
- Your total distributions
- Your total Roth conversions
Divide Line 5 by Line 9. Input as decimal using 3 decimal places.
This represents the ratio of basis to total IRA assets. For example, if Line 5 was $5,000 and Line 9 was $10,000, then Line 10 would be .500.
This ratio is used to calculate the nontaxable portion of any distributions or Roth conversions (Line 11).
Multiply Line 8 by Line 10.
For example, if Line 10 was .500 and Line 8 was $2,000, then Line 11 would be $1,000.
This represents the nontaxable portion of your Roth IRA conversions. This number will also go into Line 17.
Multiply Line 8 by Line 10.
This is the nontaxable portion of your total IRA distributions (not including Roth conversions).
Add Lines 11 & 12.
This represents to combined nontaxable distributions from your IRAs (both distributions and Roth conversions).
Subtract Line 13 from Line 3.
This represents your total basis in traditional IRAs for the reported tax year and earlier tax years.
This consists of 3 sections: Line 15a, Line 15b, and Line 15c:
Line 15a: Subtract Line 12 (nontaxable of total IRA distributions, but not Roth conversions) from Line 7 (total IRA distributions, not including Roth conversions).
Line 15b: The amount from Line 12 attributable to qualified disasters. Note: If you do not have Form 8915-D or Form 8915-F, you probably will leave this blank.
Line 15c: Subtract Line 15b from Line 15a. This is the taxable part of your IRA distribution.
The number on Line 15c (if it is not zero), will be used on Line 4b of your Form 1040 (taxable IRA distributions).
If you are under the age of 59½ at the time of distribution, you may be subject to a 10% early withdrawal penalty. Also, if you withdrew from a SIMPLE IRA within the first 2 years of having the account, you may be subject to a 25% early withdrawal penalty. The IRS Instructions contain more information on how to determine any early withdrawal penalty on IRA distributions.
Part II-Roth conversions
You’ll only fill out Part II if you did Roth conversions.
Carry over the number from Line 8.
Carry over the number from Line 11. If you did not complete Line 11 (nontaxable portion of your Roth conversions), then you would enter the number from Line 2 (total basis) plus the contributions you made for the tax year that were made before the conversion.
Line 18-Taxable amount
Subtract Line 17 from Line 16. If this number is zero or less, do not include on Form 1040, Line 4b (taxable IRA distributions). You will include this number on Form 1040, Line 4a (IRA distributions).
Part III-Roth IRA distributions
Line 19-Nonqualified Roth IRA distributions
Include all nonqualified Roth IRA distributions, including qualified first-time homebuyer distributions and qualified natural disaster distributions (see IRS Form 8915-D and IRS Form 8915-F instructions for more detail).
But you will not include any of the following:
- Outstanding rollovers
- Distributions that are a return of contributions
- Distributions made on or after age 59½, as long as you made a contribution in any year at least 5 years prior. For tax year 2021, this includes contributions for any tax year from 1998 to 2016.
- One-time distribution to fund an HSA
- Qualified charitable distributions (QCDs)
- Distributions made upon death or due to disability for any Roth IRA where a contribution was made at least 5 years prior.
- Qualified distributions from Form 8915-F that were repaid (see IRS instructions)
- Distributions incident to divorce
So, for most retirees worrying about reporting their Roth IRA withdrawals–if you meet the criteria, those qualified distributions do not get reported.
Line 20-Qualified first-time homebuyer expenses
Since the lifetime limit is $10,000, this separate block forces the calculation. Any withdrawals for expenses exceeding this amount may be subject to penalty.
Subtract Line 20 from Line 19. If this number is zero or less, you’ll enter 0.
Line 22-Basis in the Roth IRA
If you’ve never taken a Roth distribution, you’ll simply enter all contributions through the tax year in question. This also includes adjustments for transfers incident to divorce. Finally, for military death gratuity or SGLI recipients, the proceeds that were rolled into a Roth IRA are calculated as basis.
If you did take a distribution, you’ll need to calculate the basis using an IRS worksheet, in the instructions.
Subtract Line 22 from Line 21. If the basis (Line 22) is more than the distribution (Line 21), this number will be zero, and you can skip to the signature block.
If the basis is less than the distribution, then at least some of your distribution might be taxable.
Enter basis from Roth conversions from traditional, SEP, and SIMPLE IRAs, as well as rollovers from qualified retirement plans to a Roth IRA.
If you’ve never done a Roth conversion, this number will be zero.
If you took a Roth distribution (other than a recharacterization or returned contribution), see the instructions for the calculation worksheet.
If you did Roth conversions, but never took a Roth distribution, you’ll include the total of your Roth conversions here. See the IRS instructions for year-by-year instructions on which lines to import conversion amounts from.
This number will be adjusted by any adjustment in basis for conversions or rollovers incident to a divorce.
This consists of 3 sections: Line 25a, Line 25b, and Line 25c:
Line 25a: Subtract Line 24 (basis from Roth conversions) from Line 23 (total distributions minus basis from Roth contributions).
Line 25b: The amount from Line 25a attributable to qualified disasters. Note: If you do not have Form 8915-D or Form 8915-F, you probably will leave this blank.
Line 25c: Subtract Line 25b from Line 25a. This is the taxable part of your Roth IRA distribution.
Essentially, line 25c should be zero, even if you are younger than 59½ if you are withdrawing less than the amount of your total contributions (counted towards basis), and conversions (also counted towards basis). Any additional amounts are considered earnings, and may be taxable if not part of a qualified withdrawal.
How to file Form 8606
Form 8606 is filed annually by a taxpayer as part of their federal income tax return for the prior year. If you’re filing Form 8606, you’ll want to include it when you file your Form 1040.
If you’re not required to file a Form 1040, you might still be required to file Form 8606. For example, you might be taking qualified IRA distributions, and using Form 8606 to report nontaxable amounts.
If you’re required to file without filing an individual income tax return, it’s a good idea to include your address on Page 1 of the form, as well as your signature & date on Page 2.
What happens if you didn’t file Form 8606?
Simply put, if you didn’t file Form 8606, you may have reported incorrect information on your tax return. As a result, you might have paid more in federal income taxes than you needed to.
You may want to check your prior year tax returns to see if you paid taxes on:
- IRA distributions
- Roth conversions
- Roth IRA withdrawals
If so, you should check your previous years’ tax returns to see if Form 8606 was filed previously. If not, you’ll probably want to discuss filing an amended tax return (or multiple amended returns) with your tax advisor or accountant.
Is Form 8606 required for Roth IRA conversion?
For Roth conversions, you can expect to receive a Form 1099-R from the financial institution reporting on the account where your conversion came from.
It’s normally coded on the 1099-R, in Block 7. This block should be marked with distribution code 2 (early withdrawal, but an exception applies).
To prevent the Internal Revenue Service from charging you with a nonqualified withdrawal, you’ll be expected to file Form 8606 with your tax return. This completes the reporting of your withdrawal from one retirement account (reported on your Form 1099-R) by including it in your tax return. The Form 8606 helps you, the taxpayer, properly calculate and report any taxes owed on the Roth conversion.
To keep more of your tax dollars in your own pockets, it’s crucial to become familiar with Form 8606-Nondeductible IRAs. While most tax software fills in these fields for you, mistakes can happen. And when it comes to carrying basis forward, those mistakes can compound from year to year.