Dave Rumsey, CPA | Pettis Rumsey Inc. P.S. | 4229 76th St. NE, Suite 102 Marysville, WA 98270 | Phone: 360-659-8502




David Rumsey, CPA

Pettis Rumsey Inc.


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As with many of my articles I try to pick topics that have actually come across my desk with the idea that if it applies to one client of mine there are likely others out there who could benefit from the knowledge.


That being said this monthís article focuses on IRA distribution and how it may or may not be taxable. To begin with you may be saying I have always paid tax on my IRA distributions whether they were taken out before age 59 Ĺ or later.


You may also be thinking that you were sent a tax form 1099R that reported the distribution to the IRS and to you. You would be correct on both accounts and it is true most IRA distributions are fully taxable in the year they were withdrawn, but as with many areas of our current tax code there are exceptions to the general rule and that is where my client situation falls.


My client had for many years contributed to his IRA as a part of his overall retirement savings plan. As is the case with many taxpayers out there he worked for different employers some of whom had retirement plans that their employees could contribute to (Example 401k) and some employers who did not offer a retirement plan to their employees.


Whether or not the employer offered a plan or not is a key item to note as it directly impacts whether or not a taxpayer is allowed to deduct their IRA contributions or not. The rule for a married couple is that part or all of their traditional IRA may be nondeductible if one of them is covered by an employer sponsored retirement plan.


The ability to get the deduction is then based on various income levels and phase outs. In plain English the more the taxpayers make the less likely they will be able to take a deduction for traditional IRA contributions. For my client story they had both deductible contributions and non-deductible contributions and they remembered making both so the challenge is how much of each did they have.



In 2010 they took a distribution so this was the year that that record-keeping would pay off. The problem we had is the client wasnít aware or had not reported the proper information on Form 8606. Form 8606 is not a common form but it is the form that needs to filed for any year you make a non-deductible contribution to your traditional IRA.


So in years where your contribution was fully deductible there isnít a requirement to file this form. The other year they were required to file as it relates to my client example is the year that an IRA distribution has occurred. The form 8606 is the form that shows the IRS the basis amount of the taxpayers IRA. Basis is the term we are using to describe the amount of the traditional IRA that is from non-deductible contributions meaning that those dollar amounts have been previously taxed.


The basis of the IRA is the amount of the IRA that you do not have to pay tax on when the IRA is distributed. So if you or your tax preparer have not kept track of those non-deductible contributions in the past it would be very easy to just assume that 100% of the IRA distribution would be taxable but if that assumption was made you are in fact be double taxed on any amount that were not able to deduct on the original tax year the contribution was made.


Nearly everyone agrees Double-Taxation is one thing to avoid and keeping good records of the deductible vs. non deductible contributions is the key to making that happen. Some may say hey why does that matter with the Roth IRA out there? I agree in most cases it would be better to contribute to a Roth and get the tax-free earnings component in your plan.


Remember the Roth hasnít been around all that long and therefore the choice was not available to many baby boomers until later in their working lives and they may therefore have a traditional IRA that has a % that has already been taxed and needs to account for that to avoid being hit with a tax bill on that amount a second time.



As always you can call our offices if you have any questions about these or any other accounting related issues, at 360-659-8502. 


Regards, David Rumsey, CPA





Dave Rumsey, CPA | Pettis Rumsey Inc. P.S. | 4229 76th St. NE, Suite 102 Marysville, WA 98270 | Phone: 360-659-8502 | Fax: 360-653-4019 david@pettisrumseycpa.com | www.PettisRumseyCPA.com