See section 408(d)(2)(C):
(d) Tax treatment of distributions
(1) In general
Except as otherwise provided in this subsection, any amount paid or distributed out of an individual retirement plan shall be included in gross income by the payee or distributee, as the case may be, in the manner provided under section 72.
(2) Special rules for applying section 72 For purposes of applying section 72 to any amount described in paragraph (1)—
(A) all individual retirement plans shall be treated as 1 contract,
(B) all distributions during any taxable year shall be treated as 1 distribution, and
(C) the value of the contract, income on the contract, and investment in the contract shall be computed as of the close of the calendar year in which the taxable year begins.
For purposes of subparagraph (C), the value of the contract shall be increased by the amount of any distributions during the calendar year.
Note that the investment in the contract shall be computed as of the close of the calendar year in which the taxable year begins. With respect to IRAs, the investment in the contract is the individual's basis in nondeductible contributions.
Worksheet 1-1 deviates from this as a workaround to a complication not anticipated by the writers of section 408(d)(2)(C).
