Taxpayer Who Rolled After-Tax Contributions to Traditional IRA Has Basis in the IRA

He who hesitates is lost the saying goes, and in taxes that is often very true when facing statute of limitations to fix a problem.  But in Information Letter INFO 2017-0028 the IRS “solved” the taxpayer’s problem from 2006, largely by pointing it there really wasn’t the problem the taxpayer thought existed.

While we don’t know for sure why the taxpayer decided to look back at his actions in 2006 at this late date, he did so and contacted his Congressman who contacted the IRS.  The taxpayer in 2006 had rolled 401(k) funds from his employer’s plan to a traditional IRA.  However, the 401(k) included after-tax contributions and the taxpayer indicated he had “inadvertently” rolled those funds into a traditional IRA rather than a Roth IRA.  The taxpayer was asking how he could get credit for the taxes he had paid on those funds.

The IRS pointed out first that, in 2006, taxpayers could not roll amounts from employer-sponsored retirement plans to a Roth IRA.  The Pension Protection Act of 2006 did add a provision to the law that authorized such rollovers, but it was effective only for rollovers made after 2007.

However, the IRS pointed out all is not lost.  The taxpayer merely needs to complete Form 8606, Nondeductible IRAs, when he takes a distribution from the plan.  That form will give him credit for the basis he has in the account due to rolling over pre-tax contributions from the IRA, pointing out that “any after-tax monies would be excluded as they came out of the receiving plan or IRA.”

As the letter goes on to explain:

If an individual's traditional IRAs, when combined, contain both pre-tax and after-tax monies, the rules treat any distribution as consisting of a proportionate share of each. An individual must report such a distribution on Form 8606, Nondeductible IRAs. The instructions for line 2 of the form explain that any nontaxable portion of a rollover from a qualified retirement plan is reported on line 2. By reporting them on line 2 of the form, an individual gets credit for after-tax monies rolled into the IRA (even if the rollover was made in an earlier tax year).