Recouping nondeductible contributions to traditional IRAs.

• Author: Ellentuck, Albert B.
• Position: Individual Retirement Accounts

An individual who makes nondeductible contributions to a traditional (versus Roth) IRA acquires basis therein. Thus, a portion of each distribution will be a nontaxable return of basis; see Secs. 72(e) and 408(d). Unfortunately, except for certain rollover situations, a taxpayer cannot withdraw the nondeductible portion (basis) before withdrawing amounts includible in taxable income. Accordingly, each distribution has both a nontaxable and taxable component.

Note: Contributions to a Roth IRA are nondeductible, but earnings build up tax flee; taxpayers can eventually take out qualified distributions and related earnings without paying taxes. In addition, Roth IRA contributions can be withdrawn tax free at any time; nonqualified distributions are treated as made from contributions first.

Nontaxable Portion

In a year in which no IRA distributions have been rolled over to a plan other than another IRA, the nontaxable portion of current-year traditional IRA distributions (that are not rolled over) is calculated as follows:

Total nondeducatible contributions/ IRA account balances in all IRAs at IRA year-end + Amount distributed during year + Outstanding rollover x IRA distributions = Nontaxable portion of IRA distributions

"Outstanding rollover" means any amounts distributed before year-end, but rolled into another IRA in the following year under the 60-day rollover rule.

When calculating the nontaxable portion of distributions, the total fair market value (FMV) of all traditional IRAs the individual owns (including simple employer plan (SEP)-IRAs, savings incentive match plan for employees (SIMPLE)-IRAs and other traditional IRKs containing funds rolled over from a qualified plan), must be included in the computation. (The individual cannot use only the IRA from which the distributions were received.) The FMV of all IRAs at year-end includes both realized and unrealized appreciation of IRA assets; Roth IRAs are not considered.

Example 1

Dan, age 60, has four traditional IRA accounts; their FMVs on June 30, 2006 were as follows:

Account FMV 1 $20,000 2 22,000 3 43,000 4 10,000 Total $95,000 Dan has made nondeductible contributions totaling $10,000 to account #4. He has made no other nondeductible

contributions, and would like to withdraw his $10,000 nondeductible contribution from account #4. Can he do so tax free?

No. Dan cannot withdraw the nondeductible portion (basis) before withdrawing the amounts treated as taxable income. He must include...