Nondeductible IRAs

[Black Bart]

Last year a client brought me a year-end IRA statement from his insurance company which listed a $200 contribution. He makes too much money for it to be allowed, so I told him to call the company and have it switched to a non-deductible IRA. I entered it into the program which took it 8606 as non-deductible and it wasn't deducted on the return. He never checked back with me on the status and this year he brings in another company statement, unchanged, and now including a 2012 $500 contribution.

It's been a few years since I've done it, but as I recall you used to have to pull an excess contribution out of the account before April 15th and switch to a non-tax sheltered account to avoid the excess contributions penalty. However, when I entered it this time, the program again simply took it to 8606 which lists the $500 on line one as "...nondeductible contributions to traditional IRAs for 2012..." and kills the deduction off the 1040.

Seemingly everything's okay, but doesn't the insurance company have to cancel the traditional IRA account and transfer it to a different non-deductible IRA account? And, is the program's 8606 treatment making everything acceptable to IRS with nothing more needing to be done?

[Roland Slugg]

No. IRA trustees don't know, and don't NEED to know the tax status of IRA contributions. Only the person preparing the tax return ... or his tax prep software ... needs to know that.

[FEDUKE404]

Seems fine as stated

Your description seems pretty much in line with what I have encountered.

Assuming the client has met the rules to make any IRA contributions, the fact he chose to make non-deductible IRA contributions should not be a major issue.

This assumes, of course, that he likes dealing with Form 8606 for the remainder of his life. . . .

Also, I'm not sure the scenario described properly fits into the category of "excess contributions," which is an entirely different ball of wax.

FE

[Burke]

No. IRA trustees don't know, and don't NEED to know the tax status of IRA contributions. Only the person preparing the tax return ... or his tax prep software ... needs to know that.

You would think they should have some smattering of the general rules.
I just had two elderly (in early 80's) clients in, who informed me they put $5K in a ROTH. Really? Their ins agent said they could! Amazing.

[Lion]

You should check to see if your client qualifies for a Roth and suggest that if he does, otherwise non-deductible Traditional IRA with Form 8606.

[Burke]

I should have elaborated further. Neither of them works or has any earned income.

[DonPriebe]

Ain't no such thing

There is no such thing as a deductible conventional Individual Retirement Account (IRA) vs a non-deductible conventional IRA. Even if you established one IRA with Fidelity and made only deductible contributions to it, and established a second IRA at Schwab and only made non-deductible contributions, you would still have only one Individual Retirement Arrangement (also IRA), which contains a mix of deductible and non-deductible contributions and earnings. No matter which account you take a withdrawal from, you use the 8606 to calculate the taxable portion based on the contributions and earnings in ALL the accounts.

[Black Bart]

Okay,

I guess I've had a misconception of the way it works all these years. While I've only had 3 or 4 people around here ever actually make too much money (like the guy I asked about); those went to the bank and had it either pulled out or (more usually) just switched it to a contribution for the next year. Like the Duke said, the 8606 is a lifetime job I don't want (guess I have one now with this guy). But anyway, most of my problems come from brokers/bankers selling IRAs to anybody/everybody who are ineligible (no earned income usually). I have those people switch the money to a regular savings CD, although I thought the brokerages also had IRA accounts they designated as "non-deductible" IRAs. At the same time, I also thought that an "excess contribution" penalty would accrue to ineligible people who did not pull it out by 4-15.

[S T]

Guess now I am confused
My experience has been

Client has W-2 wage earnings - or "taxable compensation "- can make a contribution to an IRA account, bank or brokerage do not have any concept whether it is deductible or not - Preparer makes that determination while preparing the Tax return --- i.e, too much income to qualify, a retirement plan in place at employer, etc - thereby the form 8606 - to make it a non-deductible contribution.

Other scenairo that I have had happen, is client is not aware of the rules nor do they convey to the Bank or Brokerage, that they have NO W-2 or other "taxable compensation " trot down to the Bank or Brokerage and say I want to contribute to an IRA account for tax year ----- The bank or brokerage gladly take the $$ and then-------- preparer says no-no you can't contribute as you have no W-2 earnings-taxable compensation for that year

You discover that they are not qualified to have contributed to an IRA account due to the lack of W-2 or taxable compensation . In that case the $$ should be withdrawn and reversed - as if it never occurred and moved back to another regular checking/savings account - etc - paperwork trail for correction - no form 8606 or the form to correct taking to -0-

From IRS Tax Topic 451

To contribute to a traditional IRA, you must be under age 70½ at the end of the tax year. You, and/or your spouse if you file a joint return, must have taxable compensation, such as wages, salaries, commissions, tips, bonuses, or net income from self-employment. Taxable alimony and separate maintenance payments received by an individual are treated as compensation for IRA purposes.

Compensation does not include earnings and profits from property, such as rental income, interest and dividend income, or any amount received as pension or annuity income, or as deferred compensation.

From Pub 590 - Roth

Can You Contribute to a Roth IRA?
Generally, you can contribute to a Roth IRA if you have taxable compensation (defined later) and your modified AGI (defined later) is less than:

So either plan requires taxable compensation - not discussing "rollovers" or conversions.

Banks - Brokerages do not designate between deductible vs non deductible IRA accounts - at least not in my experience.

I have had to "unwind" two or 3 over the last year or so when a Retired Person or an Unemployed Person decided to invest in an IRA at their local Credit Union or Bank.

Sandy

[FEDUKE404]

Role of banks

It has been my experience (including re my own trad/Roth IRA accounts) that "the banks" really do not get involved with anything along the lines of "can you really do that?" when funds are placed into an account.

While you might get a helpful person who would ask a few qualifying questions, that is not the current norm. (And, not to be overlooked, there have been some recent TTB threads where a preparer did not want to "audit/interrogate" any client ! )

A banker would need magical powers to know about all wage income, other personal income, whether employer has retirement plan, and much more.

The client bears some reasonable degree of personal responsibility for making a "correct" (and informed) IRA contribution decision. And even then, I've had clients who planned ahead well and then later had to regroup because of financial/employment changes that occurred later in the calendar year.

The best you can do is try to have a good relationship with your clients and, whenever the opportunity arises, give them a quick rundown of "the rules." A few moments of personal client attention may well save several hours of work down the line. And most clients appreciate that approach!

FE

[mactoolsix]

Like the Duke said, the 8606 is a lifetime job I don't want (guess I have one now with this guy).

Bart - don't let an 8606 be a problem. We do lots of them every year - the software handles it - you just have to remember to enter the year end balance of all IRAs each year. The nice thing about those with form 8606 - they usually make bigger money, have bigger returns and pay you more.

Mike

[Black Bart]

Thanks for

Like the Duke said, the 8606 is a lifetime job I don't want (guess I have one now with this guy).

Bart - don't let an 8606 be a problem. We do lots of them every year - the software handles it - you just have to remember to enter the year end balance of all IRAs each year. The nice thing about those with form 8606 - they usually make bigger money, have bigger returns and pay you more.

Mike

the encouragement Mike. I can see how handling the 8606s could be a lucrative thing (and good luck to you with it), but I really would prefer to have clients just switch the money to an ordinary savings account. And that's because I once had a client having three IRAs who constantly made contris, both deductible and non-deductible, over several years but switched tax preparers several times before I got him. One had made 8606s, one hadn't, and he'd lost the other guy's copies. He occasionally brought a 5498, but the whole business was such a holy mess to sort out that I finally ran him off (not good customer support, I know, but I rationalized it since he kept insisting on a low fee for his "short form").

I understand how the 8606 works but just had it in my head that somehow the brokerages and banks were also keeping track. But logically, of course, they couldn't know what clients were doing and even if they could, we wouldn't know what they had done, so it does now seem absurd to me (and to everyone else here I guess) why I even thought such. Here's a related earlier post from another clueless inquirer (I thought Josh's answer was pretty good):

04-04-2008

There are nondeductible IRA's

Client can not make a traditional IRA contribution due to income limitions but wants to make a nondeductible IRA contribution. He called the broker and they told him there is no such tool. Am I wrong because on ttb page 13-13 it shows about nondeductiable IRAs. Our goal is next yr make this recharatize this as a ROTH contribuation. Any help is appriciated.

Superman

but most brokerages don't call them that. It is simply a Traditional IRA that the TP does not take a deduction for because of the income limitation. The brokerage has no idea whether the client can or cannot take the deduction, so they don't make a differenitation. I agree with the other posters that if the client is eligible for a ROTH then that is what he/she should do. If not eligible than they should just open a Traditional IRA and then you, as the tax pro, do not take the deduction. Hence, it becomes a NONDEDUCTIBLE IRA.