Let’s say
that you are married. Together you and your spouse earn $200,000.
BTW,
congratulations. You have done well. Not Thurston Howell III well, but well
enough that Congress considers you wealthy. Then again, one of the last times I
paid attention Congress was working on a 10-percent approval rating.
How much of
a Roth contribution can you make?
You know you
can put away $5,500. If you are age 50 or over you can put away another $1,000.
There are two of you – you and your spouse.
So, how much
can you contribute?
Would you
believe nothing?
Yep, zero.
You make too much money.
How’s Lovey,
Thurston?
And there is
our segue to the nondeductible IRA. The “nondeduct” still exists, but it has
been eclipsed (and rightfully so) by the Roth.
The
nondeductible preceded the Roth. The idea is that you get no deduction going in,
but only a percentage is taxable coming out.
Here is an
example. You fund a nondeductible for a decade. You contribute $55,000. Years later,
it is worth $550,000 and you start taking withdrawals. How is this taxed?
$55,000
divided by $550,000 is 10 percent. The inverse – 90 percent – is your gain. You
pull out $20,000. Your taxable amount is $20,000 times 90% or $18,000.
This thing
is a distant cousin to the Roth, where the whole $20,000 would be nontaxable.
You would always Roth rather than nondeduct – if you can.
But you make
$200 grand. No Roth for you.
But you can
nondeduct. It is one thing the nondeduct brings to the party – there is no
income limit. Make a zillion dollars and you can still put $5,500 into your
nondeductible IRA.
If you do,
the IRS wants you to attach a form to your return – Form 8606. It alerts them
that a nondeductible exists, and it also reminds you of your accumulated
contributions decades later when you begin withdrawals. You are going to need
that number to calculate your percentage.
I was
looking at case where the taxpayer had a nondeductible IRA and it was decades
later. He had to calculate the taxable percentage, but he had never completed Form
8606 to do the calculation or to alert the IRS.
He withdrew
$27,745. He did not report the $27,745 because it came from his nondeductible IRA.
COMMENT: And we know this is wrong. He was thinking of a Roth, where the whole thing is nontaxable. This is a nondeductible, and only a percentage is nontaxable.
The IRS
wanted to tax it all. He had – gasp! – failed to attach…the…proper… form.
Problem was;
he did not have the best documentation. No doubt it would been better to file
and update that 8606 as he went along.
The Court
looked at available documentation, which was sparse.
(1) There was a Citibank summary
statement sometime around 1998 showing cost and value.
(2) The taxpayer had Forms 5498 from 2007
through 2013. If you have ever funded an IRA, then you have received one of these.
Form 5498 shows your contributions for the previous calendar year. His 5498s
showed that he put in no fresh money from 2007 onward.
(3) Taxpayer showed that he was
high-income for the years before 2007 when he made his IRA contributions.
The Court
gave him the benefit of the doubt. It knew that the IRA account was not a Roth.
That left only deductible and nondeductible IRAs. If he was high income and
covered by a plan at work, he could not have made a deductible IRA
contribution. By process of elimination, the IRA had to be nondeductible.
He was not
in the clear though. The Court reminded him that a nondeductible percentage of
zero is almost impossible, as the IRA would have to go down in value. He had to
calculate his percentage and would have taxable income, but not as much as the
IRS wanted.
I suspect I
will see this fact pattern as boomers with nondeductible IRAs enter retirement.
The Tax Court has given us guidance on how to work around poor recordkeeping.
The case for
the home gamers is Shank v Commissioner.
