Form 8606 IRA Basis Question

[MarkBarb]

I think I filed the wrong basis on my 2011 8606 form and I don't understand how to correct it.

Background:
Start - Rollover IRA with about $300,000
3/31/2011 - Made a $5,000 after-tax contribution to a new IRA for 2010
12/30/2011 - Converted money from both the rollover and new IRA. The portion from the new IRA was $1,750.
1/1/2012 - Made a $5,000 after-tax contribution to the non-rollover IRA for 2011
1/1/2012 - Made a $5,000 after-tax contribution to the non-rollover IRA for 2012

When I filled out the Taxable IRA Distribution Worksheet, it had me include the $5,000 contribution for 2010 plus the $5,000 contribution for 2011, even though that money wasn't in the IRA when I did the conversion. The net effect is that messed up my basis and made it look like I converted $3,458 of pre-tax dollars instead of the $1,750 that I really did convert.

Should I ignore the worksheet and file an amended return with a correct 8606 based on my calculations? Did I do something wrong by converting before making my 2011 contribution? I'm really not sure where to go from here, but I don't want to lose $1,750 in basis unnecessarily.

[BolderBoy]

I think I filed the wrong basis on my 2011 8606 form and I don't understand how to correct it.

Background:
Start - Rollover IRA with about $300,000
3/31/2011 - Made a $5,000 after-tax contribution to a new IRA for 2010
12/30/2011 - Converted money from both the rollover and new IRA. The portion from the new IRA was $1,750.
1/1/2012 - Made a $5,000 after-tax contribution to the non-rollover IRA for 2011
1/1/2012 - Made a $5,000 after-tax contribution to the non-rollover IRA for 2012

Did you use TurboTax or something like that to do this?

Anyway, your starting position was with $300k in a tIRA (rollover = traditional for basis purposes). To that you added $5k for 2010 and $5k (both after tax) for 2011. So at that point you had a basis of $10k in an IRA worth $310k, so your basis was worth 3.2258% of your total tIRA. Whatever amount you converted to a rIRA was converted in that proportion of taxable to non-taxable. If you converted $5k, then you will be taxed on $4838.71 and your new basis will be something like $9838.71.

Am I with you on this?

[JW Nearly Retired]

What work sheet? Just fill out the paper form 8606 to see how it should work. You will see it mixes all your IRA money together for the pro-rate calculation of what's converted. You started with a $300,000 rollover in pretax and only 5,000 in post tax money. A rollover IRA from a pre-tax 401k or the like is a traditional IRA. I bet that's the problem? Did you include the rollover on line 6 of the 8606?

Practically all your conversion is going to be taxable ....like 98%. It makes no difference which account you took money out of to put in the Roth account, the IRS views all your IRA accounts together. That includes the rollover and non-rollover as just one lump. You don't seem to be doing that.

We would need to know how much money you converted and exactly how big the Rollover IRA was to check your numbers?
JW

[MarkBarb]

I appreciate the attempts at help. It looks like I did a lousy job of explaining the situation, so here is more information.

The problem stems from the Taxable IRA Distribution Worksheet.
1. Enter all contributions made to your traditional IRA for 2011, whether or not deductible. Include contributions made during 2012 for 2011, but not rollover contributions properly rolled over into the IRAs. $5,000.

2. Enter the basis in your traditional IRA(s) as of 12/31/2010. $5,000.

3. Add lines 1 and 2. $10,000.

4. Enter the value of all of your traditional IRA(s) as of 12/31/2011 (including any outstanding rollovers from traditional IRAs to other traditional IRAs). $221,780.

5. Enter your distributions from traditional, SEP, and SIMPLE IRAs in 2011. Do not include rollovers conversions to a Roth IRA, certain returned contributions, or recharacterizations of traditional or SEP IRAs contributions. $0.

6. Enter the net amount you converted from traditional, SEP, and SIMPLE IRAs to Roth IRAs in 2011. Do not include any portion of an amount converted that you later recharacterized. $117,715.

7. Add lines 4, 5, and 6. $339,495.

8. Divide line 3 by line 7. Enter the result as a decimal. 0.02946.

9. Nontaxable portion of the amount converted to Roth IRAs. Multiply line 6 by line 8. $3,468.


The problem is with the inclusion of the $5,000 contribution for 2011 on Line 1. That money was contributed in January of 2012, which was after I did the conversion. I don't think it should be included in the calculation for proportionality because it wasn't there at the time the conversion occurred. By strictly following the worksheet, it was added in as though it was in the conversion, but it actually wasn't. As a result, it reduced my pre-tax basis in my IRAs.

Now that I think about it, it also reduced the amount that I paid taxes on, so I guess maybe it washes out. Perhaps the lesson is that if you make an IRA contribution after a conversion but in the same tax year, that later contribution is still included in the proportionality calculation. If anyone is still with me at this point, does that sound right?

[kaneohe]

as jwnr asked previously.........what wksht? why don't you look at the actual form 8606 as suggested: http://www.irs.gov/pub/irs-pdf/f8606.pdf

there you will see in lines 4/5 that the later TIRA contribution that was added up above is subtracted if you did a Roth conversion.
Perhaps that gets what you thought should happen and perhaps there is a problem with your wksht or perhaps you are using it inappropriately......
is there a Roth conversion wksht? is it TT?

[JW Nearly Retired]

8. Divide line 3 by line 7. Enter the result as a decimal. 0.02946.

9. Nontaxable portion of the amount converted to Roth IRAs. Multiply line 6 by line 8. $3,468.

Agree with kaneohe, the work sheet is the problem. Putting your numbers straight into Form 8606 makes the above numbers change to 0.014728 and $1734.

Is this work sheet from an IRS document or in tax software or what? It would be helpful to warn folks about it.
JW

[MarkBarb]

I agree that the worksheet is the problem. The worksheet is from IRS Pub 590 (http://www.irs.gov/pub/irs-prior/p590--2011.pdf) and is worksheet 1-5 on page 39. From IRS Pub 590, "To report your nontaxable distribution and to figure the remaining basis in your traditional IRA after distributions, you must complete Worksheet 1-5 before completing Form Taxable Amounts 8606." The problem is that the worksheet appears to assume that you made your IRA contributions before your did your conversion, not after.

I used TurboTax to do my taxes and it filled out the worksheet and Form 8606 for me. I don't blame TurboTax because it appears to have followed the instructions as written.

[kaneohe]

just taking a wild guess here but I wonder if the term "distribution" means that in a narrow sense as defined in the 8606 for line 7

7 Enter your distributions from traditional, SEP, and SIMPLE IRAs in 2011. Do not include rollovers, qualified charitable distributions, a one-time distribution to fund an HSA, conversions to a Roth IRA, certain returned contributions, or recharacterizations of traditional IRA contributions (see instructions) . . . .
. . . . . . . . . . . . . . .

although you may be thinking you did a distribution and then a conversion, IRS may be thinking of a distribution as something else..............
I guess I've never seen/used that wksht, only F8606 and instructions.

[MarkBarb]

I just tried filling out the 2011 8606 form directly. It works perfectly. The key is that line 4 removes contributions made January 1 or later from the calculation, so everything works OK.

The problem is the Taxable IRA Distribution Worksheet. On line 1 it says to include contributions made during 2012 for 2011. That forces those contributions to be included in the calculations even though they weren't there when you converted. The result is that you end up with a reduced tax basis.

[MarkBarb]

I just worked everything out both ways in a spreadsheet. If you convert an IRA to a Roth IRA in one year and then make an after-tax contribution for that year at the start of the following year, you get different results based on whether you directly use the 8606 or whether you use the IRA Worksheet 1-5 for the 8606 in the Pub 590. With the 8606, the result is as though you did the conversion without the later contribution. With the worksheet, it is as though the contribution were in your account before you did the conversion. The resulting proportion of pre-tax and after-tax involved in the conversion will differ between the two results. It basically washes out because any change in the pre-tax dollars converted is offset by an opposite change in the after-tax dollars converted.

[Alan S.]

Correct.
The problem here is that people are using Worksheet 1-5 when they shouldn't be. Per Pub 590, use this worksheet when you have both a distribution and a contribution that may be partially deductible in the same year. The worksheet will treat your contributions as fully non deductible (even when they are not), reducing the taxable portion of the distribution on Form 8606 and thereby not allowing such taxable portion to increase MAGI resulting in a further reduction of the deduction. This is a chicken and egg situation, as is determining the deduction when you are drawing SS and making a contribution (Appendix B in Pub 590).

If you are making a fully non deductible contribution, there is no need for these worksheets or the artifically completed 8606 that it generates, which may differ from a stand alone 8606 when contributions are made for a prior year between Jan and 4/15.

Note that this worksheet explains why many cheap tax programs bypass the indented lines 6-12 of Form 8606 and go directly to line 13. As a shortcut, they run everything through the worksheet. I am working with a crappy free file program right now that does this and also produces an incorrect amount on line 14 of Form 8606. There are different types of errors that this can create depending on circumstances. Sometimes you would luck out and there would not be an error at all.

[sscritic]

I will only add that Alan S. addressed this question less than 24 hours ago and gave the same answer yesterday as today (or is that today as yesterday?).