IRS Form 8606: The Important Tax Form Many Taxpayers Don’t Know About

When most people think about tax forms, familiar names such as Form W-2, Form 1099, and Form 1040 probably come to mind.

But some lesser-known forms can be just as important.

One example is IRS Form 8606, Nondeductible IRAs.

If you’ve made nondeductible contributions to a traditional IRA, taken certain distributions from traditional, SEP, or SIMPLE IRAs, or completed certain Roth IRA conversions, Form 8606 can play an important role in determining how those transactions are taxed.

More importantly, failing to properly track nondeductible IRA contributions could potentially result in paying tax twice on the same money.

Here’s what taxpayers should know.

What Is Form 8606?

Form 8606 is used to report and track certain transactions involving individual retirement arrangements, or IRAs.

One of its most important purposes is tracking your basis in traditional IRAs.

In simple terms, IRA basis generally represents money in your traditional IRAs that has already been taxed because you didn’t receive an income tax deduction for the contribution.

Keeping track of that basis matters because eligible basis generally shouldn’t be taxed again when money is later distributed.

When Might You Need Form 8606?

Form 8606 may be required in several situations.

Common examples include when you:

• Make a nondeductible contribution to a traditional IRA
• Receive certain distributions from a traditional, SEP, or SIMPLE IRA while having basis in traditional IRAs
• Convert amounts from a traditional, SEP, or SIMPLE IRA to a Roth IRA
• Receive certain distributions from a Roth IRA

Additional situations can also require the form, so taxpayers shouldn’t assume it only applies to one specific type of IRA transaction.

What Is a Nondeductible IRA Contribution?

Traditional IRA contributions may be deductible in some circumstances, but the ability to claim a deduction can depend on factors such as income, filing status, and participation in a retirement plan at work.

A taxpayer may still be able to make a traditional IRA contribution even when the contribution isn’t deductible, subject to applicable contribution and eligibility rules.

That’s called a nondeductible contribution.

Because you don’t receive a tax deduction for that contribution, the money has already been taxed.

Form 8606 helps establish a record of that after-tax amount.

Why Is Tracking Your IRA Basis So Important?

Imagine you contribute $6,000 to a traditional IRA and don’t deduct the contribution on your tax return.

You’ve already paid income tax on that $6,000.

Years later, you begin taking distributions from your IRA.

If your nondeductible contribution wasn’t properly documented and your IRA basis isn’t accounted for, determining the taxable portion of your distributions can become more difficult.

In some circumstances, poor records could lead a taxpayer to treat more of an IRA distribution as taxable than necessary.

That’s why Form 8606 shouldn’t be viewed as just another piece of paperwork. It can create an important tax record that may remain relevant for many years.

Form 8606 and Roth Conversions

Form 8606 can also be important when money is converted from a traditional IRA to a Roth IRA.

A Roth conversion can create taxable income, but determining the taxable portion isn’t always as simple as looking at the amount converted.

If you have after-tax basis in traditional IRAs, that basis can affect the calculation.

Taxpayers sometimes assume they can choose to convert only the after-tax dollars in one particular traditional IRA. However, federal tax rules generally require consideration of the taxpayer’s applicable traditional, SEP, and SIMPLE IRA balances when determining the taxable and nontaxable portions.

This concept is often referred to as the pro-rata rule.

As a result, Roth conversion planning can become more complicated when a taxpayer has both pre-tax and after-tax IRA money.

What About the “Backdoor Roth IRA” Strategy?

Form 8606 is also frequently associated with what’s commonly called a backdoor Roth IRA strategy.

Generally, this involves making a nondeductible contribution to a traditional IRA and subsequently converting money to a Roth IRA.

Although the concept may sound straightforward, the tax consequences can become more complicated if you already have pre-tax money in traditional, SEP, or SIMPLE IRAs.

The pro-rata calculation can affect how much of the conversion is taxable.

This is one reason taxpayers considering this strategy should understand their existing IRA balances and tax situation rather than assuming the conversion will automatically be tax-free.

Don’t Assume Your Financial Institution Tracks Everything for You

Your IRA custodian may provide tax documents reporting contributions, distributions, or conversions.

However, maintaining accurate records of your IRA basis is ultimately important for your tax reporting.

Financial institutions may not have all of the information needed to determine your cumulative basis, particularly if you’ve:

• Used multiple financial institutions
• Transferred or rolled over accounts
• Made nondeductible contributions over several years
• Changed tax preparers
• Maintained IRAs for a long period of time

Keep copies of previously filed Forms 8606 with your permanent tax records.

What If You Forgot to File Form 8606?

If you made nondeductible IRA contributions in previous years but didn’t file Form 8606, don’t simply guess at your basis.

Review your prior tax returns, contribution records, Forms 5498, account statements, and other available documentation.

Depending on the circumstances, it may be possible or necessary to address a previously omitted Form 8606.

A tax professional can help determine the appropriate steps based on the specific years and transactions involved.

Form 8606 Is a Good Example of Why Tax Records Matter

Some tax documents are important for only one filing season.

Others can matter years—or even decades—later.

Form 8606 falls into the second category because the basis it tracks can carry forward until it is used in determining the tax treatment of future IRA transactions.

If you make nondeductible IRA contributions, don’t assume that you’ll remember the details years from now.

Maintain copies of your Forms 8606 and supporting IRA records.

The Bottom Line

Form 8606 may not be one of the best-known IRS forms, but it can be extremely important for taxpayers with certain IRA transactions.

If you make nondeductible traditional IRA contributions, convert IRA funds to a Roth IRA, or take certain IRA distributions, proper reporting can help ensure that after-tax money is accounted for correctly.

Have you made nondeductible IRA contributions or completed a Roth conversion? Contact our team to make sure your IRA transactions and basis are being properly reported and tracked.