Form 8606: Essential for High-Income IRA Contributors

When it comes to retirement planning, high-income individuals often face unique challenges, particularly when it comes to Individual Retirement Accounts (IRAs). If you participate in an employee retirement plan and your income exceeds certain thresholds, your traditional IRA contributions may not be deductible.

This is where Form 8606 comes into play. This form is essential for reporting non-deductible IRA contributions, ensuring you stay compliant with IRS regulations and avoid double taxation on your retirement savings.

Why High-Income Individuals Need to Report Non-Deductible IRA Contributions

For high-income earners, the ability to deduct IRA contributions may be limited or eliminated. The IRS sets income limits for those who can deduct contributions to a traditional IRA when they are also covered by an employer-sponsored retirement plan. If your modified adjusted gross income (MAGI) exceeds these limits, your contribution is non-deductible. Despite this, it’s crucial to report these non-deductible contributions using Form 8606.

Here’s why:

Preventing Double Taxation

Non-deductible contributions are made with after-tax dollars, meaning you’ve already paid taxes on the money. However, any growth in the IRA will be taxed upon withdrawal. If you don’t report the non-deductible contributions, the IRS may assume that all your IRA funds are pre-tax, leading to double taxation when you withdraw funds in retirement.

Tracking Basis in Traditional IRA

Form 8606 helps you keep track of the “basis” (the amount of non-deductible contributions) in your traditional IRA. This basis is crucial in determining how much of your future distributions are taxable. Without an accurate record, you could end up paying more taxes than necessary.

Common Questions

Is the individual notifying their tax professional each year?

Yes, it is vital that individuals notify their tax professional each year of any non-deductible contributions to their IRA. This allows the tax professional to accurately complete Form 8606 and ensure that the basis in the IRA is correctly reported. Failing to report non-deductible contributions can lead to errors on your tax return and potential issues with the IRS down the line.

If you are a participant in an employee retirement plan and make “too much” money, then the contribution is not deductible.

For example:

Single Filers

In 2024, if your MAGI is $83,000 or more and you’re covered by an employer’s retirement plan, you can’t deduct your IRA contributions.

Married Filing Jointly

If you and your spouse have a combined MAGI of $136,000 or more, and either of you is covered by a workplace retirement plan, your IRA contributions are non-deductible.

Why bother reporting non-deductible activity if you are to report all contributions every single year?

Reporting non-deductible contributions annually using Form 8606 is essential for the following reasons:

Avoiding Penalties: The IRS imposes a $50 penalty for failing to file Form 8606 when required. This penalty can be easily avoided by ensuring the form is filed correctly each year.
Accurate Record-Keeping: Even though you must report all contributions, Form 8606 distinguishes between deductible and non-deductible contributions. This is crucial for determining the taxable and non-taxable portions of your IRA withdrawals in retirement.
Simplifying Future Tax Reporting: When you begin withdrawing from your IRA in retirement, having an accurate record of non-deductible contributions makes it easier to calculate how much of your withdrawal is taxable. This can prevent overpayment of taxes.

Example: How Form 8606 Impacts Taxation on IRA Withdrawals

Consider Jane, a high-income earner who has made $50,000 in non-deductible contributions to her traditional IRA over the years. Thanks to Form 8606, Jane has accurately tracked her basis. When she begins taking distributions in retirement, $50,000 of her withdrawals will be tax-free, as this represents her non-deductible contributions. Without Form 8606, Jane might mistakenly pay taxes on this $50,000 again, leading to double taxation.

Safeguard your retirement savings from unnecessary taxation.

Filing Form 8606 is an essential step for high-income individuals contributing to a traditional IRA. It helps you track your non-deductible contributions, avoid double taxation, and ensure compliance with IRS regulations. If you’re in this situation, make sure to communicate with us annually and so we can report all non-deductible activity accurately.

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About the Author

Eric Sheldon

Eric Sheldon is a certified public accountant with more than 25 years of experience in a wide variety of industries. He's the owner/operator of Eric Sheldon CPA, PC, an accounting firm that specializes in providing tax strategy and preparation, accounting, and bookkeeping services to individuals and small business owners.

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