IRS form 8606

[Black Bart]

Client's has a $15,000 balance (total value of non-deductible IRAs--only has this one fund) carried forward from 2005 on this 8606 form. He took a $10,000 premature IRA distribution from it in 2006. The 1099-R lists code one in box seven. My tax program shows no tax and no penalty on it. Is this right?

[ChEAr$]

Don't sound right

Client's has a $15,000 balance (total value of non-deductible IRAs--only has this one fund) carried forward from 2005 on this 8606 form. He took a $10,000 premature IRA distribution from it in 2006. The 1099-R lists code one in box seven. My tax program shows no tax and no penalty on it. Is this right?

Missing figure is FMV of IRA 12/31/2005. Plug that figure in on appropriate line and
see what happens. Of course if THE fund consists of all non deductible contributions,
then it is right.

[Black Bart]

The fund is all non-deductible contributions and

...Of course if THE fund consists of all non deductible contributions,
then it is right.

it's enough to cover this withdrawal, but I'm trying to grasp the theory behind this. Is it that, since the IRA was never deducted (they're both in plans and income's too high), then it's never taxed? It's in mutual funds and grows occasionally. Is it like a Roth in that it isn't taxed?

Even though it isn't deductible, the money he puts into may eventually produce a capital gain, so why wouldn't that be taxed eventually?

Too, about this withdrawal, I worry that some IRS clerk would simply bill him next year for the tax, penalty, and interest (he's got refunds of $2,000 if not taxed and owes $1,900 if it is).

[Snaggletooth]

Works better with a decimal

Bart this one would illustrate the functionality of the 8606 if only a PORTION of his IRA was post-tax.

If his total value was $15,000, then some lesser amount should be his post-tax contributions. Perhaps $12,000 for purposes of illustration? The 8606 tracks his post-tax contributions from year to year to validate them. In their way of speaking, he has a $12,000 "basis" in his $15,000 IRA. This means 80% of any distribution will be tax free.

If he withdraws $2000, then his "basis" is $1600 in the withdrawal, and he is only taxed on $400. If he takes out the whole thing, then he pays tax on only $3,000.

The 8606 does a number of things:

1) Sets forth the total accumulated value and running total of post-tax contributions (or "basis" if you will). These numbers are transitive from one year to the next and both numbers can change.

2) Determines a "universal" percentage for any withdrawals during the year. The percentage applies to ALL distributions during the year. This stops the taxpayer from taking out only part of the money and declaring it ALL to be basis and not taxable. Any distribution is prorated.

3) By applying this percentage to ALL IRA's (some customers have several), this stops the taxpayer from calculating different percentages to each IRA and then "cherry picking" a distribution which has a rich basis.

I'm about ready to drop, Bart. Waiting til April 15th.

Snag