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February 5, 1999
IRS Form 8606 - What's New for Tax Year 1998
By Roy Lewis (TMF Taxes)
Many of you don't have any idea that Form 8606 exists. That may soon change.
Under the old rules, Form 8606 was mainly used to report your "basis" in an IRA account. To put it another way, if you made nondeductible traditional IRA contributions in prior years or in a current year, Form 8606 was required to report (and keep track of) those nondeductible contributions. That only makes sense, right? Since they were nondeductible when you made the contributions, you received no tax benefit for the contributions and should not have to pay taxes on the contributions when you take a distribution from the IRA account or convert the IRA account to a Roth IRA. Form 8606 did that for you.
But Form 8606 has been expanded for the 1998 tax year. Now this form is used not only to report your nondeductible contributions to a traditional IRA, it is also used if you have converted your traditional IRA to a Roth IRA, or if you have "re-characterized" your IRA during the year.
Conversions? Roth IRA? Re-characterizations? What's this guy talking about? Well, if you have to ask, you really need to brush up on these tax issues. And you can. You can read all about the Roth IRA, conversions from a traditional IRA to a Roth IRA, Roth IRA re-characterizations, and many other IRA issues in the Taxes FAQ area. So, if you are not quite sure what we are talking about here, stop now and visit the Taxes FAQ area and catch up on your reading.
Form 8606 -- Who Must File?
There have been a number of questions about who is required to file Form 8606. The law says that you must file Form 8606 if any of the following apply to you:
1. You made nondeductible contributions to a traditional IRA for 1998. If this applies to you, you'll focus on Part I of Form 8606.
2. You received distributions from a traditional IRA in 1998 and you have made nondeductible IRA contributions in any prior years. Here is where you'll want to make sure that you don't get taxed twice for those prior-year nondeductible contributions. You'll also be dealing with Part I of the form.
3. You converted part or all of the assets in a traditional IRA to a Roth IRA during 1998. If this is you, use Part II of the form.
4. You re-characterized amounts that were converted to a Roth IRA. This basically refers to those of you who originally converted a traditional IRA to a Roth IRA, and then later determined that your Adjusted Gross Income was greater than the law allowed. Or it could be that you simply performed a re-characterization from a Roth IRA back to your traditional IRA, and then a reconverted back to a Roth IRA to dodge some taxes. Regardless of the reason, Part II of Form 8606 was designed just for you.
5. You received distributions from a Roth IRA in 1998. It's not likely, but it certainly could happen. If it happened to you, you'll want to complete Part III.
6. You have a re-characterization involving a Roth IRA contribution. This basically means that you made a Roth IRA contribution in 1998 and then found that your AGI was greater than the law allowed and are not entitled to made a Roth IRA contribution. If this was your situation, you'll be dealing with Part III.
7. You are the beneficiary of an Education IRA and you received distributions from the Education IRA in 1998. Again, it's not likely, but if this applies to you, you'll want to complete Part IV of Form 8606.
If any of the above apply to you, IRS Form 8606 must be completed and attached to your 1998 tax return.
A Closer Look at Part II
We certainly can't review each section of Form 8606. But the portion of the form that seems to be causing the most problems is Part II. So let's take a brief look at the specifics of Part II.
Line 14a asks for the total amount of distributions from your traditional IRA for 1998. Generally, you'll receive a Form 1099R from your IRA custodian to report those distributions. Those of you who made only one distribution will have only one 1099R form. But those of you who had multiple distributions from multiple IRA accounts, or went crazy with re-characterizations, may receive a plethora of Forms 1099R. Regardless, make sure to report your total amount of distributions from your traditional IRA on this line.
Line 14b asks for information on re-characterizations. You'll really have to go to the Form 8606 instructions to get a handle on what should be reported on this line. But basically, this line will remove all of the "back and forth" distributions from your traditional IRA account that may have been made and get you down to a "true" distribution to be reported on line 14c.
Example: In January 1998 you made a conversion from your traditional IRA to a Roth IRA in the amount of $30,000. In December 1998 you got word from your boss that you were going to receive a big bonus. That's good news. The bad news is that the bonus will take your AGI over the $100,000 limitation, and you will not be able to make a conversion to a Roth IRA in 1998. This being the case, in December 1998 you decide to re-characterize your Roth IRA back to a traditional IRA. At the time of the re-characterization, the value of the Roth IRA was $40,000. You might think that you would report $40,000 on line 14b. But a careful reading of the instructions tells you to simply report on line 14b the amount that was originally converted: $30,000 in our example. That would make line 14c equal to zero, which is what it should be. You have no taxes to pay since the re-characterization of the Roth IRA back to the traditional IRA simply "undid" the original transaction. You are back to where you started in the eyes of Uncle Sammy, even though your account grew $10,000 during the time it was in the Roth IRA.
So, as you see, line 14b is nothing more than a line to "adjust" your total distributions, which may be vastly overstated due to multiple re-characterizations, down to a final taxable distribution. Got it?
Line 14c is nothing more than a subtraction function, and represents your gross taxable distribution from your traditional IRA.
Line 15 wants you to record your "basis" in your traditional IRA. Remember, that basis comes from nondeductible contributions. If you had 'em, you most likely reported them in prior years on Form 8606. So dig out your Forms 8606 for the prior years and review them. Remember: if you made a nondeductible contribution in 1998 (which would be reported in Part I), you'll want to include that nondeductible contribution on line 15.
Line 16 is another subtraction function, and reports your net taxable distribution from your traditional IRA. See how it all comes together?
Line 17 allows you to elect not to spread the taxable distribution from line 16 over a four-tax-year period. Make this election at your own peril. Once it is made, it is difficult (if not impossible) to change your mind. If you decide to spread the taxable portion of the distribution over the four-year period, you enter 25% of the distribution on line 17 of Form 8606, and also on the appropriate line of your tax return (Form 1040, line 15b for most people).
So there you have it. A very, very brief overview of IRS Form 8606. If you are required to complete Form 8606, make sure that you carefully read the instructions and follow both the computations and the logic of the form. And if you use a tax professional or tax software to prepare your tax return, make sure that they have completed Form 8606 correctly. The only way you can do that is to understand the form and double-check their work. It may be a bit of a pain, but the taxes you save may be your own.
You can download IRS Form 8606 and the associated instructions from the IRS website. And, if you have any additional questions about Form 8606, feel free to visit the Tax Strategies messag